Biotech Values

[DewDiligence]

Stalled Healthcare Bill Leaves Big Pharma in Limbo

[The proposed FY2011 federal budget contains a tax change with serious adverse consequences for the pharma industry.]

http://www.nytimes.com/2010/02/05/business/05pharma.html

›February 5, 2010
By DUFF WILSON

With the possible demise of health care legislation, getting back to business as usual may not be the best thing for the nation’s drug makers.

After all, in return for the prospect of tens of millions of newly insured customers and a large degree of regulatory certainty, the pharmaceutical industry had agreed to pay a relatively small price: $8 billion a year in discounts and fees. It was a modest compromise for an industry with $246 billion in prescription drug sales last year.

But now, with the health care overhaul on a back burner in Washington and possibly dead for this year, drug makers are getting a sinking sense of how a piecemeal public policy future might look for them.

President Obama’s proposed budget this week, for example, includes a plan he alluded to in last week’s State of the Union address: a new tax on profits from some patents and other intangible assets parked in overseas tax havens by American companies.

For drug makers, which are among those most likely to be affected by such a tax, the president’s proposal “pretty much came out of the blue,” said Martin A. Sullivan, an economist formerly with the Treasury Department and Joint Committee on Taxation.

Another expert agreed. “Pharma’s one that would really get hit,” said Erik Gordon, a professor at the Ross School of Business at the University of Michigan. “That’s a biggie.”

The industry giant Pfizer, for example, which has said that 88 percent of its $56 billion in income from 2004 through 2008 originated overseas, could be subject to the corporate 35 percent tax rate on at least some of its foreign profit in the future if the president’s proposal goes through. [PFE already has the highest tax rate in the industry due to the repatriation of ex-US profits in order to pay for the cash portion of the Wyeth acquisition.]

Although the tax idea faced a cool reception from Democratic and Republican leaders of the Senate Finance Committee, it highlighted the risks to the drug industry of unpredictable election-year politics. It is a time when bolt-from-the-blue challenges may await drug makers, compared with the carefully mapped future they had worked out with the White House and the Senate under the health care legislation.

…Just last month, before the Republican candidate Scott Brown’s victory in a special election in Massachusetts upended the Democrats’ supermajority in the Senate, Pfizer’s chief executive, Jeffrey B. Kindler, told analysts that the Senate health care bill was “largely consistent with the principles” that were important to his industry.

The drug industry had forecast lower revenue in the early years of its cost-savings deal, in which it agreed to pay $80 billion in rebates and fees over a decade. But its revenue and profit were expected to more than make up the difference later in that period as more than 30 million uninsured people began receiving health and drug coverage.

And just as important, the industry had received assurances from the Obama administration and some critical Congressional Democrats that long-feared proposals that might have popular appeal — including government negotiation of Medicare drug prices and allowing the import of cheaper drugs from Canada — would be tabled in return for drug makers’ support of the rest of the health care overhaul. And some industry experts say any notions of an offshore tax had also been taken off the table.

As part of the deal, the drug industry had also pledged and spent more than $100 million on TV advertising in support of the overhaul effort.

It is unlikely that the drug industry will run ads promoting President Obama’s offshore tax proposal. Drug makers are fighting it through a Washington-based business coalition called Promote America’s Competitive Edge, which includes many other multinationals.

The group argues that lower foreign tax rates create a level playing field for American companies and international competitors and, ultimately, save jobs in the United States.

Mr. Sullivan, the former Treasury economist who now writes about tax issues, said that all the big drug makers engage in offshore tax sheltering of one sort or another. And the portion of overseas profit and revenue has been growing in recent years.

“Typically when a pharmaceutical company develops a new drug, it transfers it to a holding company in a tax haven like Bermuda or the Cayman Islands, usually on very favorable terms,” he said. “There’s a tremendous amount of income taken out of the U.S. and put into the tax haven. This proposal seems targeted to just that type of situation.” [No kidding.]

Pfizer has reported that 58 percent of its revenue came from overseas in 2008, compared with 39 percent a decade earlier. For other drug markets, overseas revenue in 2008 amounted to 46 percent for Lilly, 44 percent for Merck and 42 percent for Bristol-Myers.

Professor Gordon of the University of Michigan, who studies pharmaceutical companies, said the president’s new plan to tax “excessive” offshore profits had surprised the industry and revealed the risks of a piecemeal health policy.

“The industry thought that it got some uncertainty off the table,” Professor Gordon said. “They’re not thrilled about what happened in Massachusetts. It’s not working to their advantage.”

Some analysts, meanwhile, say parts of the $80 billion, 10-year deal could come back to bite the drug industry — if it is held to some of the cost pledges without receiving the offsetting political protection. The pact, for instance, committed the industry to support an increase in the rebate the government receives on Medicaid drugs — to 23 percent, up from 15 percent currently.

In the current deficit-cutting environment, that discount may still look attractive to lawmakers. And it could conceivably be enacted by Congress at any time without being part of an industry quid pro quo. “No question that’s alive,” said Seamus Fernandez, pharmaceutical industry analyst for the health care investment bank Leerink Swann.

But the overall health care reform package, he added, is “either dead or severely hobbled.”‹