The Wall Street Journal’s James Taranto highlights a press release from Novation, an intermediary supplying medical devices to hospitals, complaining that some manufacturers are unethically shifting the tax to Novation’s customers. This complaint is ignorant of the law, economics, and ethics.
According to Novation, some medical device manufacturers are billing hospitals for the new 2.3% tax enacted through the Affordable Care Act. Novation “is taking a firm stance with suppliers who are trying to pass their medical device excise tax obligations on to hospitals.” Exactly what that “stance” is Novation does not say. Nonetheless, Novation implies that it is unethical for medical device manufacturers to shift this tax to hospitals, which are Novation’s customers:
While the administration of the Medical Device Excise Tax is complex and still evolving, it is clear that Congress did not intend to impose this tax on hospitals…
Despite their slim operating margins, health care providers committed to $155 billion over 10 years. Likewise, the pharmaceutical industry committed to $80 billion. Medical device manufacturers, however, refused to voluntarily contribute. As a result, the government imposed the Medical Device Tax to cover their portion. This Tax was specifically intended to be a tax on the manufacturer. Even then, by comparison, the Tax is anticipated to amount to roughly $20 billion over 10 years.
What Congress intended is not nearly as clear as Novation asserts. In fact, the Affordable Care Act does not include any text prohibiting medical device manufacturers from passing on the tax to customers. The tax is found at 26 USC 32, Subchapter E:
(a) In general
There is hereby imposed on the sale of any taxable medical device by the manufacturer, producer, or importer a tax equal to 2.3 percent of the price for which so sold.
( b) Taxable medical device
For purposes of this section –
(1) In general. The term “taxable medical device” means any device (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act) intended for humans.
(2) Exemptions. Such term shall not include –
(B) contact lenses,
(C) hearing aids, and
(D) any other medical device determined by the Secretary [of the Treasury] to be of a type which is generally purchased by the general public at retail for individual use.
Thus, if the text of the law is used as the basis for discerning congressional intent, then Novation’s statement is false. Moreover, what is clear from the text is that Congress did not want to appear to be levying a tax on the general public.
A plausible ethical argument might be made that health care providers and pharmaceutical manufacturers have an obligation not to pass on their costs to customers — after all, it is said that they agreed to bear these costs. But why should such an agreement bind medical device manufacturers, a third party, that “refused to voluntarily contribute” to funding the Act?
Novation does not give any ethical basis for its assertion that claim that those who are not party to a voluntary agreement nevertheless ought to be subject to its terms.
The economics of taxation are well understood and captured in most elementary economics textbooks and all textbooks on public finance. Wikipedia’s explanation is both accurate and accessible to non-economists (boldface added):
In economics, tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare. Tax incidence is said to “fall” upon the group that ultimately bears the burden of, or ultimately has to pay, the tax. The key concept is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply.
The relative magnitudes of supply and demand elasticity determine who actually bears a tax. Medical device manufacturers will bear the burden of the new tax if and only if the demand for medical devices is highly elastic. If this were true, the tax also would result in a disproportionate decline in the quantity of medical devices purchased.
But there is no evidence that Congress intended to substantially reduce the quantity of medical devices purchased. If that were to happen, reduced sales would mean that revenue from the tax would be much less than Congress expected. It is much more likely that Congress recognized, at least intuitively, that market demand for medical devices was inelastic and the tax would have little effect on the quantity of medical devices demanded. (It is a staple in public finance economics that, for the purpose of generating revenue, it is best to tax things for which demand or supply are highly inelastic. It is for this reason that the head tax remains the most efficient tax of all, there being a perfectly inelastic demand for heads.)
Wikipedia also explains why Novation is hypocritical:
The theory of tax incidence has a number of practical results. For example, United States Social Security payroll taxes are paid half by the employee and half by the employer. However, some economists think that the worker is bearing almost the entire burden of the tax because the employer passes the tax on in the form of lower wages. The tax incidence is thus said to fall on the employee.
Employees bear the burden of the payroll tax except in cases where they are so unique that the demand for their services is highly inelastic. Few, if any, Novation employees would be so defined. Therefore, like almost every other employer, Novation shifts the employer’s share of payroll taxes to its employees.
What Novation objects to is not tax shifting; it objects to taxes being shifted to Novation. This is a debate about self-interest, not ethics.
One final irony: Novation’s press release says the firm is a “Winner of the Ethics Inside® Certification”:
Novation earned the coveted Ethics Inside Certification from Ethisphere Institute, a leading international think tank dedicated to the research and promotion of best practices in corporate ethics and compliance. Novation was also named on Ethisphere’s World’s Most Ethical Companies list, and is the only company in the health care industry to earn both distinctions.
It would be interesting to determine supply and demand elasticities in the market for ethics certifications, and to estimate how much of the cost of acquiring this certification Novation has shifted to its customers.