Patents and the Arithmetic of the Medical Device Tax

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Wednesday, 20 March 2013 04:23

The medical device industry is pushing hard to repeal a tax imposed as part of the Affordable Care Act (ACA). The NYT had an article on its massive bipartisan lobbying effort. While the piece notes in passing that, "the White House argues that demand for new devices will offset the economic impact of the tax," the piece doesn't explain what this means.

The marginal cost of producing most medical devices is very low relative to their price. The companies are in effect collecting a big premium because of their patent monopolies. The ACA meant that they would sell many more devices and therefore collect a much higher dividend from their patents, even though the amount spent on research had not changed.

To see the logic here, imagine that it costs a medical company nothing to produce a scanner that it will sell for $1 million apiece. (Again, the high price is allowing it to recover development costs.) Before the ACA it would have expected to sell 1000 scanners, netting it $1 billion. After the ACA the company can expect to sell 1100 scanners, netting it $1.1 billion.

The tax is intended to recoup this additional $100 million. While the tax hit will not be exactly offsetting to the increased profit to the industry in every case, on average this will be the case. In other words, the White House is not making a bizarre argument, they are presenting the facts. The industry is trying to pocket extra profits as a dividend from the ACA and does not want the government to tax back part, or all, of this dividend.