Imagine you own a business.  There’s a knock on the door.  It’s the government, and they’re here to help.  “We’re going to give everyone enough money to buy your product.  We’re not going to make anyone buy it, but it won’t cost them anything if they do.  Your profit is going grow 20%, but we’re going to take half of the new profit so we can afford to pay people to buy it.  But you get to keep the rest.

That’s essentially what happened with the Affordable Care Act (ACA) with respect to Medical Device Manufacturers (MDM).  MDM’s started paying a 2.3% excise tax on the sale of their wares in January 2013.  The logic behind the compromise was as simple as the opening scenario.  Prior to ACA, 30 million to 50 million people were either uninsured or uninsurable.  As a practical matter, people without insurance go without hip and knee replacements and similar procedures.  They just limp.

While there may well be more knee replacements, there will be many more people with insurance, and virtually everyone will have access to insurance if they need it.

Now the winds are shifting.  Tea Party Republicans, ostensibly opposed to deficit spending, have shut down the government and are threatening to cause the first credit default in US history.  In a particularly ironic twist, a compromise is emerging, most recently championed by Sen. Susan Collins, a Republican from Maine, to repeal the tax on MDMs.

In other words, the government will be greatly expanding the market and increasing the profits of MDMs, but will not ask for anything in return for that expanded market.  The result will be an increase in the deficit of $30 billion over the next 10 years.

The Industry submitted a letter to Congressional leadership on September 9, 2013 http://advamed.org/res.downloa… claiming the tax would cripple their industry.  They creatively compared the $30 billion excise tax over a decade, with the $10 billion they spend on R&D annually.  Clearly, the argument goes, the industry will have to increase prices, decrease innovation, and reduce wages.

This letter demonstrates pure rent-seeking behavior.  The industry wants the fruits of ACA, but does not wish to put anything back on the table to make it happen.  You can call it shameful, or you can call it an industry exercising its fiduciary responsibility to maximize shareholder value.  Either way, it is a lie.

The top 9 MDMs each have annual revenue greater than $10 billion, with Johnson & Johnson leading the way with $26 billion. http://www.mddionline.com/arti…  To gauge the efficacy of the industry argument, let’s focus on Medtronic, Inc.  It’s the largest pure MDM on the list, coming in at #4 with $16 billion in revenue in 2012.  Check out their stock price since January 1, 2013 when the tax went into effect (all data on MDT from Yahoo Finance unless otherwise noted).

http://finance.yahoo.com/echar…

The stock is up 29.4%.  And it’s like that across the entire industry.  Medtronic is not an outlier.  Does that sound like an industry whose profitability is being raided by Obamacare?  So why is the stock price up when their taxes are so much higher?  Because their after-tax profits are up as well.   The most recent quarter showed revenue up 1.9% and earnings per share up 12.0% compared to the same quarter a year ago.  Their current year earnings, projected by S&P, are slated to reach $3.85 per share, an increase of 14.2% compared to prior year.  And those earnings, revenues, and projections all assume the excise tax on medical devices.

If you remember the industry letter, there was no mention of reducing dividends.  Just that the tax will cut employment, reduce R&D, and raise the cost of health care.  So, which is it?  That is, if you can raise the price to cover the cost, then why would you have to cut R&D or reduce employment?  The fact is, prices may go up marginally, but certainly no more than 2.3%, and that’s if the entire cost could be shifted to the consumer.  Unless the market is perfectly inelastic (that is, the same amount of medical devices would be bought no matter the price), the cost will be shared by consumers (in the form of higher prices, something less than 2.3%) and the shareholders of the corporation (in the form of lower sales/profits), all other things being equal.

But all other things are certainly not equal.  The industry will reap massive profits from the increased demand generated by an insured American market.  So let’s put this in perspective, again using Medtronic, Inc.

Medtronic’s latest full year showed $16.6 billion in annual revenue.  Even if 100% of those revenues would be subject to the tax (they are not), and even if 100% of those devices were sold in the United States (they will not be), the total tax bill would come to:  $16.6 billion X .023 = $382 million.  In fact, according to the company’s earnings report, exports account for 46% of their sales.  That reduces the maximum impact to $191 million, because exports are exempt.

That’s 19 cents per share on a stock that closed just under $55 on Friday.  Annual earnings per share are 20 times that amount!  The dividend alone is six times larger.  But they will not have to reduce the dividend either.  Since the tax went into effect, the company has actually INCREASED the dividend by 2 cents (7.7%).

The government shutdown, meanwhile, is costing the economy $160 million…..per day.   http://www.businessweek.com/ne…

The claim that critical research and development will be cut is a complete fabrication as well.  For the fiscal year ending April 2013, R&D at Medtronic, Inc. increased to $1.557 billion from $1.490 billion the prior year.  The company invests in R&D, because there is a positive Return on Investment (ROI).  While gross margins may be marginally lower, the ROI actually increased on R&D because the market has expanded for them so dramatically.

One last thought experiment, using Medtronic.  How many more devices will they have to sell to make up for the tax hit?  Medtronic has an operating margin of 28.8%.  That means they generate $28.80 for every $100 worth of devices they peddle.  The amount of new revenue they generate, if they don’t raise prices or cut dividends or R&D spending, and if they don’t lay anyone off is:  $191 million / .288 = $663 million.  That would be an increase of less than 4%.  It is frankly unimaginable that the increase in demand for their products, coupled with the fact that no one who buys their products will have to charge them off in bankruptcy, will fail to exceed 4% of their revenue.

So that’s the deal.  Congress is going to agree to open the government and honor our bills in exchange for a $30 billion higher deficit and a massive payoff to shareholders of MDMs.  Omar Ishrak is the 57 year old CEO of Medtronic.  His share of the tax cut on his 611,713 shares could be as high as $115,000.  That’s on top of his salary of nearly $4 million, and the $685,119 in dividends he’ll earn on his Medtronic stock this year.  I can understand why Mr. Ishrak would like the compromise (he probably has kids in college).  Or the Congress person who represents his district in Minnesota.  But for the rest of us?  I would prefer the industry just pay the tax and send a letter to the American people thanking them for the massive windfall they will enjoy from Obamacare.