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Home Publications Blogs Beat the Press Medical Device Tax Is Recouping Some of the Excess Profits from the ACA

Medical Device Tax Is Recouping Some of the Excess Profits from the ACA

Thursday, 17 October 2013 04:48

The NYT ran a column by Topher Spiro which defended the medical device tax. The column neglected to give the main rationale for the tax, it will recoup some of the excess profits that the industry will accrue as a result of the Affordable Care Act (ACA).

The logic here is fairly straightforward, medical devices are like prescription drugs, they can cost a lot to develop, but are cheap to produce. Companies get back their research costs by charging prices that are far above their production costs, which they are able to do as a result of patent monopolies.

To take a simple example, suppose a medical device company has a new screening device that it sells for $1 million. It cost $100,000 to manufacture, so it will make $900,000 from each device it sells. Before the ACA it had expected to sell 1000 copies of this screening device. That would gross it $1 billion, or $900 million in excess of its production costs.

As a result of the ACA more people will have access to health care and therefore demand for the screening device will increase. Suppose it were to rise by 10 percent. In this case the industry's revenue would rise to $1.1 billion and the profit over production costs will increase to $990 million.

Since the industry had not anticipated the ACA when it developed the screener, and had not expected these extra sales, this additional $90 million is pure gravy in the form of unanticipated profits. The logic of the tax is to take away this gravy to limit the windfall that device manufacturers enjoy as a result of the ACA.

It is also worth noting that the corruption cited in Spiro's column is the predictable result of a situation in which a product sells at price far above its marginal cost as a result of government protection. This is the same problem that we see in the prescription drug industry.

The economist's solution would be to devise a mechanism for funding research that would allow drugs and medical equipment to be sold in a free market. However because of the power of the affected industries and the dominance of protectionists in national politics, the efficiency of patent protection in these sectors is rarely discussed.

Comments (6)Add Comment
In Health Care, Patent Protectionists are for Suffocation, not Innovation
written by Last Mover, October 17, 2013 6:51

It's the nature of hi-tech goods and services to have high fixed costs and low variable costs of production. The reverse has become an exception rather than the rule, especially in health care.

For example, the personal computer broke the barrier of high fixed costs for larger computers on which consumers had to depend indirectly by buying services from them.

Back then, prices charged for these services were not outrageously high - above marginal/variable cost of production, like they typically are now for using hi-tech products and services such as medical devices.

Since then, Corporate America has essentially cornered the market on anything of value to consumers, especially in areas like health care where demand is inelastic that allows astronomic prices when patent protectionists block market entry for competitive alternatives.

What should be happening in the medical device industry for example, is many entrepreneurs using 3-D printing technology to churn out a wide range of experimental medical devices for which some make it to the low variable cost production line and marketplace.

But because of the monopoly/oligopoly lock on the market held by a few manufacturers in tandem, such competition is snuffed out in the cradle in the name of patent protection claimed necessary to "innovate" exclusively by them rather than actually suffocate the competitive advance of medical technology as they do now.

Better that fewer Americans get hip replacements and MRI scans at outrageous prices than more Americans get them at lower prices that reflect true economic opportunity costs (free of economic rent). And to dare tax away economic rent without affecting research and production incentives at all, well ... (fill in big commie lie here).

Let the many suffocate so Corporate America can innovate for the few. After all, those high fixed costs have to be recovered through extortion pricing you know, or innovation will die on the vine won't it.
NYT Op-ed NOT a defense of tax
written by VicJane, October 17, 2013 7:31
But your points today and earlier are necessary for discussion of this issue, about which one hears nothing elsewhere except headlines.
written by skeptonomist, October 17, 2013 9:01
Spiro's piece does not "defend" the tax, it criticizes the device makers for lobbying against it. Of course it should also have criticized Republicans for obeying the lobbyists and interjecting this thing into the debate about the debt limit - apparently nothing at all gets done in Washington until lobbyists have their say.

The piece actually gives several alternative ways of reducing costs of devices.
written by Eric, October 17, 2013 2:04
The article is good, but Dean's right in that it totally missed the point on why the tax exists in the first place. When the ACA was being crafted, every single player in the health care industry except for the medical device makers (hospitals, pharma, insurance, etc.) made concessions to help pay for a bill that they would all benefit from. The device makers had a fairly compelling double-taxation argument for repealing the tax based on the fact that hospitals already agreed to cost cuts and that that would fall on device makers. However, this article goes to show that that argument was pretty disingenuous.
Excess Profits?
written by RWForce, October 18, 2013 12:38
Old New Yorker cartoon: Two businessmen chatting, "I've never seen an excess profit."
Funding US research
written by Paul, October 18, 2013 12:57
I have to agree strongly with Dean on the need to alternatively fund basic health research. The pharmaceutical and drug industries depend heavily on the talent of people trained through NIH funded activities as well as the freely provided fruits of these research efforts that they can cherry pick for drug development. I roughly calculate that if even 8% of the money spent on drugs in the USA were returned to the NIH in repayment for these contributions, the entire NIH budget would be covered. There is no reason why the services provided to this industry by NIH is not compensated by the industry without any expectations for control on their part

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.