According to the World Bank, which records global GDP data annually, the United States led the world in 2012 with a GDP totaling just shy of $15.7 trillion. Growth in U.S. GDP hinges on a couple of factors, including an increase in exports, strength in U.S. small businesses domestically, and, most importantly, strong consumer spending, since it accounts for around 70% of GDP.
Source: White House on Flickr.
But, despite being the largest country in the world, our Congressional representatives have pushed us into a government shutdown over a disagreement of what amounts to fractions of a penny. In spite of Congress' begrudging passing of a federal budget that contained roughly $3.8 trillion in spending last year, we're currently mired in a government shutdown over what appears to be $29 billion in revenue collection over the course of the next 10 years!
We at The Motley Fool would just rather keep our nose out of politics altogether if we could, as it rarely has a meaningful impact on our investments. However, sometimes delving into the possible outcomes of political gridlock is unavoidable, as is the case here. So rather than pointing the finger at either political party, let's have a closer look at what I think is the primary reason for this governmental gridlock, what the potential outcomes could be, and what you need to know as an investor.
What's the cause for the gridlock?
My contention is that the greatest sticking point between the Republicans and Democrats has to do with the provision in the Patient Protection and Affordable Care Act, which you'll likely know better by its shorthand, Obamacare, which requires medical-device companies to pay 2.3% of their top-line revenue as a tax to the U.S. government. This tax, known as the medical-device excise tax, has been projected by the Congressional Budget Office to bring in $29 billion in total revenue between 2013 and 2022. It taxes everything from sophisticated robotic surgery machinery such as that made by Intuitive Surgical all the way down to everyday hospital supplies like IVs.
Why is the medical-device excise tax even in the PPACA?
Obamacare is a complex law, but its primary purpose is to expand medical coverage to as many non-insured individuals as possible. Clearly, even with subsidies in place, many non-insured families still couldn't afford health insurance on their own. Therefore, to expand health-care options to these lower-income individuals and families, the PPACA added taxes on certain individuals and businesses to help pay for these subsidies and the upcoming Medicaid expansion, as outlined under the law.
One way of doing that is through a surtax on investment income of 3.8% for individuals making more than $200,000 annually, or couples earning more than $250,000 per year. Similarly, the PPACA also instituted a 0.9% Medicare tax boost on individuals and couples earning $200,000 or $250,000 annually. Keep in mind that these taxes kick in once you cross these thresholds and not up to it, but they are expected to bring in $318 billion, according to estimates by the CBO, over the next decade.
Another revenue-generating method of Obamacare is the medical-device excise tax, or MDET. By having medical-device companies pay a 2.3% tax off their top lines, $29 billion would be raised over a 10-year period, which can be used to offset subsidies and expand Medicaid.
Why do Democrats support the medical-device excise tax?
Contrary to belief, this law wasn't introduced to tax medical-device makers to death, but to expand Medicaid so that individuals who previously had no access to reasonably priced health care now have that choice. The only way to reasonably do that is to levy additional taxes, including the 2.3% tax on device makers, requiring them to pay their fair share into the system so that 10 million or more new enrollees can be covered under Medicaid.
Why do Republicans oppose the medical-device excise tax?
Obviously there are partisan lines in the sand being drawn that would give cause for the Republicans to oppose practically every budget offer drawn up by Democrats, but the primary reason Republicans dislike the medical-device excise tax is that it could cost the U.S. jobs and innovative capabilities.
How can the medical-device excise tax cost the U.S. jobs?
Because the MDET removes 2.3% of gross (not even net!) enterprise revenue, medical-device makers of all forms are feeling the pain in their bottom line -- especially those that are currently unprofitable. Specifically, many are choosing to look overseas for tax relief and cheaper labor. By moving operations overseas, it would remove any tax liability on those medical products and give device makers an opportunity to ramp up growth once again.
We've already seen this happening throughout the sector, with three industry bigwigs shuffling their operations because of Obamacare. Medical-device maker Stryker (SYK +0.63%), which you may be familiar with since it recently purchased robotic orthopedic specialist MAKO Surgical, laid off 5% of its workforce in 2011 in an effort to save more than $100 million annually. The move, in other words, was made to counter the higher taxes it was going to pay under the MDET.
Source: Steve Winton, Flickr.
Stryker isn't alone, though. Both Medtronic (MDT +0.64%), the largest spinal device maker in the world, and Boston Scientific (BSX +1.32%) which is a large cardiovascular device manufacturer, have announced a keen focus on overseas hiring. Last year, Medtronic announced that it would bring on 1,500 new employees, but the focus would be in areas outside the U.S., while Boston Scientific announced global layoffs totaling 1,200-1,400 people (with the expectation that the majority would come from the U.S.) despite announcing a $150 million investment in China where 1,000 new jobs would be created.
Put simply, if medical-device makers are circumventing the MDET in overseas markets, they aren't going to create jobs here. In addition, if they do choose to keep their operations in the United States and pay the MDET, they're losing valuable research and development, dollars which can harm innovation, job hiring, and their long-term bottom-line profit.
So, which party is right?
Here's the unsurprising kicker: They both are! Even though health-care costs before the implementation of Obamacare were rising at a slower pace than at any time in the previous five decades, there was no feasible way to ensure that low-income individuals would ever have access to affordable health care. So the Democrats are correct that something needed to be done to incorporate lower-income individuals and families into the fold. Obviously, there are going to be increased costs for expanding Medicaid, so why shouldn't medical-device makers share in the costs of that expansion right alongside most taxpayers?
Conversely, the Republican Party is also correct that the MDET is costing the sector jobs. All we have to do is look at the three aforementioned examples, and we can clearly see that medical-device makers are shifting their focus overseas to reduce their tax implications.
How will this affect my investments?
Here's another surprise: The outcome of whether or not the MDET will stick or be repealed is unlikely to have a material impact on your medical-device holdings for anything longer than a few days or weeks.
The reasoning is that medical-device makers have had years to prepare for the implementation of the 2.3% tax, so if it's upheld it's pretty much going to be business as usual. We've had a good taste for earnings thus far from medical-device makers, and in many cases they weren't nearly as bad as Wall Street had predicted.
On the flipside, even if the MDET is repealed, it isn't as if Medtronic, Boston Scientific and the like aren't going to look to emerging markets for growth opportunities. The trend for the past decade in the technology sector has been expansion into China, India, Brazil, and other rapidly growing emerging markets. There's no reason to believe that device makers, even with a repealed MDET, would suddenly give up their overseas growth opportunities given the success of other sectors.
Ultimately, "steady as she goes" could possibly be your best course of action through this government shutdown if you own medical-device stocks. I would strongly suggest not getting caught up in the emotional finger-pointing of the political parties and instead focus on what your holdings have done to reduce their exposure to the tax (if anything), boost their research-and-development pipelines, and seek out overseas growth opportunities. That's what will set you up for long-term success in the end.
