A "Sophie's Choice" for Pharma in Tax Policy: R&D or Marketing?

The tax write off available for pharmaceutical marketing costs has been a popular political target for industry critics for more than 20 years—and all the moreso in the era of broadcast direct to consumer advertising. Many in Congress want to ban DTC ads outright; that almost certainly won’t pass First Amendment scrutiny, so making advertising more expensive by changing the tax code is an appealing alternative.

Still, while it makes a good talking point, advertising critics have never succeeded in pushing the idea through to enactment.

Now the Democratic leadership in Congress is considering a new twist, a proposal to give pharma companies a choice: write off R&D costs or write off marketing costs. Not both.

That, according to Polsinelli Shugart public policy group Chair Jim Davidson during his update to the DTC National Congress April 15, was an idea offered by former Rep. Rahm Emanuel during a closed door meeting with some advertising types last year.

The idea sure sent a ripple through the 400 or so pharma, ad agency and media attendees at the DTC Congress.

Emanuel has since left Congress to serve as chief of staff to President Obama, which does nothing to blunt concerns among advertisers about the potential for the tax policy proposal to slip into legislation this year, especially in the context of finding new revenues to cover costs of expanded health care coverage. (Read more about Emanuel’s recent statements here.)

Coalition for Healthcare Communications Director John Kamp noted the threat of Emanuel’s proposal, describing it as presenting a “Sophie’s choice” to industry by asking, in effect, whether companies love their marketing departments or their R&D organization more. It is a classic divide-and-conquer maneuver, Kamp says, since it is sure to exploit the tensions that already exist within pharma companies over that very question.

“Think about your own companies,” Kamp told the brand managers in the audience.

Well, it certainly got us to thinking…and quickly got us thinking that maybe this “Sophie’s choice” wouldn’t be all bad.

Now, let’s be clear: biopharma companies will fight this proposal, as will advertising and media companies. And, if history is any guide, they will win. Pharma, in particular, has a good track record in working the intricacies of tax policy. No reason to expect a different outcome here. Nor do we seriously think pharma should support a tax hike on itself in any event.

It is just that this could be a case where a policy threat would force a healthy business adjustment.

The new tax policy would, in effect, force pharma companies to choose between a reduced return-on-investment from their R&D or a reduced RoI on marketing, since the elimination of the tax deduction in effect amounts to a reduced return on the dollars devoted to the affected activities.

So the first step would be to force senior management to take a stand on which actually delivers a better RoI in the first place.

In some cases, it is easy. Most biotech companies, for instance, only wish they had marketing costs to write off, and even those that do wouldn’t have too much trouble choosing to keep writing off R&D. On the other hand, “specialty” companies like Forest or Ovation would surely want to write off marketing costs, since they tend to in-license late-stage projects rather than shoulder the full R&D burden themselves.

But what would Pfizer do? The company spends billions on R&D and billions on marketing, and so could ill afford to accept higher taxes on either front.

Surely one option would be to divide into smaller companies that more clearly fit the biotech (R&D-first) or specialty (commercial-first) models. That happens to be exactly what some of us have been suggesting for a long time now.

Indeed, one way to view the Pfizer/GlaxoSmithKline HIV partnership is as a baby step (or maybe a toddler step) in that direction. Glaxo/Pfizer HIV Inc. would surely choose to keep its R&D deduction. (As would, presumably, a stand-alone Pfizer oncology unit.)

Pfizer itself, on the other hand—if it indeed continues to consolidate towards a GE style health care marketing colossus—would probably end up protecting the deductibility of its marketing costs. In fact, its hard to see how R&D fits long term in that GE model anyway. (You can read coverage of Roger Longman’s latest take on this topic in “The Pink Sheet” here.)

See how fun it is to play what ifs?

And that’s the point. Pharma companies are right to oppose the policy, but there is surely value in playing out this “Sophie’s choice” anyway. It may turn out to be good business for pharma to focus on one side or the other of the great pharma divide between R&D and marketing, even if Congress doesn’t force that choice upon them.