2.3 Excise Tax: Taxation on Revenue, Not Profit

Monday, we broke down the Medical Device Tax.  In order to understand the full effects of the 2.3% Excise Tax placed on medical devices, it is important that the distinction between a tax on profit and a tax on revenue be made.  The following is a brief illustration of the taxation process and how the same percent would apply to the two different areas.  However, it should be noted that most real-life situations will be more complicated and have many more variables; this simplified example is for illustrative purposes only.

Taxing at Various Levels

Let us assume that a particular medical device costs $9,000 to manufacture and ship to the customer including all direct and indirect costs, and is being sold for $10,000 to a medical practice.  For this particular item, the company has chosen to limit its price to a 10% profit margin as a way to remain competitive and sell more units. In this scenario, the company’s profit will equal $1000.

If a 2.3% were to be placed on the profit of each item, this would equal a tax equivalent of $23 per unit sold and a remaining profit of $977 per unit.  In most circumstances, 2.3% can be considered to be a very minor tax, especially as many sales taxes are significantly greater.  The company also has the choice of billing the customer for the tax in addition to the cost of the item and letting the consumer pay, which would increase the cost per unit to $10,023 and leave the company’s profit at exactly $1000, for a profit margin of 9.98% (still within a 10% profit margin when rounded).

An excise tax placed on the initial sale of each item creates a very different scenario.  At the price of $10,000 per unit, a tax at this level would result in a tax amounting to $230 that the company would either have to absorb or pass on to its customers.  With no change in the previous manufacturing requirements, this would give the company a profit of $770 for each unit sold, or a 7.7% profit margin.  In other words, this would be a loss of 23% of the profit margin for this particular product.  This is only for a scenario in which the company has a substantial profit margin.  Companies selling devices with a smaller profit margin will suffer a proportionately greater drop in profits, possibly pushing them into the realm of suffering a loss instead of making a profit on each unit unless the cost of the tax is passed on to the consumer.  In order for this company to regain a 10% profit margin they would have to increase the price of the device from $10,000, not to $10,230, but rather to $10,256.

As you can see from this illustration, the difference between an excise tax on sales and a direct tax on profit is profound, and the implications that it may have are difficult to overstate

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