The Zadroga Act v. the Medical Device Excise Tax

This story highlights why Speaker Ryan has to be seen as repugnant. Let me start with a shout out to someone I admire:

There had been widespread support for a stand-alone measure to help the 9/11 responders, but congressional leaders were never quite able to push it across the finish line. While lawmakers from the New York area were strong advocates for the bill, it also had the forceful backing of Jon Stewart, the former host of “The Daily Show,” who made repeated trips to the Capitol to push for it.

John Stewart was right to push hard for passage of this Zadroga Act. But Speaker Ryan held support for our heroes until he could engineer tax breaks for his rich buddies:

But the House Democratic leader, Representative Nancy Pelosi of California, has voiced angry opposition to the huge package of tax breaks, saying it would unfairly benefit big business.

Pelosi of course would vote for the Zadroga Act as a standalone bill. Let’s focus on one of those tax breaks:

It also appeared that manufacturers of medical devices were on the threshold of a victory in their campaign to roll back an excise tax on many of their products. Under the tentative agreement, the device tax, which took effect in 2013, would be suspended through 2017, congressional aides said. Republicans said the device tax discouraged the development and sales of innovative, lifesaving medical technology. Some Democrats from states with thriving medical technology companies agreed.

The notion that this modest estate tax would discourage innovation set Dean Baker off:

The economics of the medical device industry are similar to the economics of the prescription drug industry. Companies have large research costs, but then are able to sell devices for a markup of several hundred or several thousand percent above their marginal cost. By giving more people access to health care, the ACA was increasing the demand for medical devices and therefore increasing the number of devices that could be sold at high markups, creating a windfall for the industry. The purpose of the tax was to take back some of this windfall.

That should read a very small portion of the windfall. Permit me to expand on what Dean said by a simple illustration of how this excise tax works. Let’s assume that a medical device giant like Medtronic or J&J has $10 billion in U.S. sales per year. The 2.3% tax does not apply to the $10 billion but to a constructive price defined as the arm’s length price between the production division and the wholesale distribution division. Let’s also assume that production costs are $2500 billion and distribution costs are $3000 billion, which would mean profits are a staggering $4500 billion. Now where this constructive price lands depends on what portion of these profits should accrue to the distributor versus the manufacturer. The Big Four is basically lying for their clients by arguing that the constructive price should be only 30 percent of the price paid by customers as if all of the intangible assets are attributable to marketing rather than patents, product intangibles, and process intangibles. If they get away with this, the effective tax rate would be only 0.7 percent of sales. A company that receives a 45 percent profit margin is going to be discouraged an effective tax rate of only 0.7 percent? And the notion that the owner of valuable patents, product designs, and process intangibles are entitled to a contract manufacturing return? Who are these people kidding?