Government's War on Vital Innovation

[There is a definite political slant to this essay, but it raises some vital points relevant to readers of this forum.]

Casey Daily Dispatch
http://www.caseyresearch.com/cdd/governments-war-vital-innovation

Government's War on Vital Innovation
By Doug Hornig, Senior Editor

We are unabashed technophiles here. Technology has improved the lives of people everywhere to an astonishing extent over the past hundred years, and the future is brighter than even we can imagine. We are also, as you know, friends of the inventor, the innovator, the entrepreneur - and the free market in which they get to test their ideas.

There is little that ingenious men and women cannot accomplish when government stays out of the way.

As we have written here and in Casey Extraordinary Technology, the field of medical devices has been particularly fertile ground, yielding a mind-boggling array of things that existed only in the realm of science fiction just a few years back. These are transformative technologies that have done so much good for so many.

While the press loves devices of the super-high-tech variety like the da Vinci surgical robot or Mako's joint-replacement robotic arm (a CET portfolio pick, mind you, which did very well for our subscribers, more than doubling their investments from open to close), not all have been so headline-grabbing. Other, more modest advances also have notably enhanced our quality of life.

For one, think of the squirming child who had to hold still for five minutes for a mercury thermometer to register an accurate temperature. Not to mention the hazard caused if that thermometer broke and spilled the mercury on the floor -or worse, into the child's mouth. Under-the-tongue digital thermometers that work in less than a minute were a big improvement. And today, how much more convenient and safe it is to have a gadget that can accurately read body temperature from the eardrum in one second.

Or consider the leaps forward (pun intended) that have been taken by modern artificial limbs. They're now so far from their wooden forebears that recipients can do almost anything the able-bodied can do, including running competitive races on legs of metal.

With the perfection of lens transplants, cataracts - once a leading cause of blindness - can easily be eliminated.

Insulin pumps have gone from being cumbersome backpacks just a few decades ago to tiny, 4-oz. boxes that can be clipped to a belt, freeing many diabetics from the necessity of carrying around syringes and vials of insulin.

Our subscribers have made a solid return on the innovation of home hemodialysis machines, which enable renal-care patients to more frequently perform these critical treatments from the comfort of their own homes - an innovation which research has shown is more effective in improving quality of care and extending life than any drug has ever proven to be.

The list, of course, is endless.

But there's more as well. Beyond the physical benefits, many medical devices have also been the basis of outsized profits for investors. Just a few examples: Intuitive Surgical - inventor of the da Vinci robot - has been a market darling for the past decade, up 70% in just the last six months and up 4,500% since the beginning of 2003. Implant maker Stryker returned 1,570% between 1995 and 2007. And pacemaker manufacturer Medtronic rose a staggering 16,000% over a 15-year period.

So, considering all of the amazing things medical-device inventors and companies have given us over the years, along with the spectacular amount of wealth they have created for investors and society, we couldn't help feeling dismay when we learned that the government is planning to pour cold water all over further innovation.

Not overtly, of course. But effectively, to be sure.

How do you stifle invention and kill job growth? One of the surest ways is to enact punitive new taxes that single out a particular sector for its success and put it at a disadvantage to the rest of the market. And that's exactly what Congress has in store for the medical-device industry.

It all has to do with the Affordable Care Act, the law popularly dubbed "Obamacare." When our misrepresentatives were crafting that massive, convoluted chunk of legislation, they realized that it was going to be costly and that they had to dream up some fresh sources of revenue to help fund it. Well, when in doubt, tax somebody; and why not go after someone who's doing relatively well? The medical-device industry lost only 1.1% of its employees during 2007-2008, while the manufacturing sector as a whole was being reduced by 4.8%.

So into the bill they inserted a new 2.3% tax on medical device companies' sales. Not profits, mind you - gross revenues. It is basically a royalty on innovation.

What this translates to, as a general rule of thumb, is a 15% tax on profits, to be stacked atop the 35% federal corporate tax (already the world's highest) and whatever state and local taxes companies might pay. That's a very heavy burden, and although the tax doesn't kick in until next year, the mere anticipation of it is already having an effect.

Stryker, for example, cited the new tax as one of the reasons it is laying off about a thousand of its workers. Surgical instrument maker Covidien did the same in announcing that it will shed 200 workers in the US and move production to Costa Rica and Mexico. Orthopedics giant Zimmer is laying off 450 and taking a $50 million charge against earnings. Medtronic has said it expects an annual charge against earnings of $175 million. And so on.

As bad as these numbers are, an even worse result could be the dampening effect the law will have on future industry growth. Revenues from the tax are projected to come in at $20 billion next year. That's nearly double the industry's budget for R&D. And who can say how many small inventors with big ideas will have their enthusiasm snuffed out?

"What on earth could Congress have been thinking?" you might ask. Good question. Personally, I've long since given up trying to deduce politicians' rationales from their actions. So here, from a Bloomberg article by Ramesh Ponnuru, is an explanation of why medical devices became a target: "The justification for this selectivity was that the legislation would be a boon for this sector. By expanding health coverage, the new law would increase demand for medical devices and thus, in effect, subsidize the industry. The tax was, therefore, a partial clawback of this subsidy."

This explanation is nonsense, Ponnuru asserts. Stephen L. Ferguson, the chairman of the board of Cook Group, a privately held medical-device maker based in Bloomington, Indiana, argued in support: "First, after enacting a similar law, Massachusetts saw no greater growth in sales than any other state. Second, a disproportionate number of the newly insured will be young people with low health risks, thus limiting the potential increase in sales. Third, in many cases pre-Obamacare law already requires hospitals to provide medical devices to uninsured people who need them."

This potential disaster has not gone unnoticed. So far, nine Democrats have joined 216 Republicans in the House to sponsor Minnesota Representative Erik Paulsen's legislation to repeal this section of the Affordable Care Act. A companion bill in the Senate has been introduced by Utah's Orrin Hatch, but as yet no Democrats have crossed over in that chamber.

That could change. Not only does current Republican Senator Scott Brown of Massachusetts want a repeal, so does liberal Elizabeth Warren, who's opposing him in the fall election. Now, it's not likely that Warren has suddenly been hit by a lightning strike of free-market sense. As a candidate grubbing for votes, she's acutely aware, as is Brown, that her state's medical-device industry employs 24,000 people and accounts for 13% of Massachusetts' exports.

Nevertheless, since the message is often more important than the messenger, Warren did have this to say: "When Congress taxes the sale of a specific product through an excise tax ... it too often disproportionately impacts the small companies with the narrowest financial margins and the broadest innovative potential."

Well put.

How this all plays out depends, of course, on whether the Supreme Court strikes down the entirety of the Affordable Care Act or just the parts it considers unconstitutional. Before that ruling is handed down, it is likely nothing will happen. But if the bulk of the law stands, it'll be up to Congress to rid it of this burdensome new tax. While you never want to bet on politicians doing the right thing, in this instance they just might. For the sake of technological advancement, we hope so, anyway.