Despite big promises embedded in the name, the Tax Cut and Jobs Act turned out just partially accurate for the pharmaceutical industry.
Top U.S. companies in the sector enjoyed a nearly 6 percentage point reduction in effective tax rates on average, but generated only a negligible change in U.S. employment.
Income tax payments by the 11 biggest drugmakers shrank by nearly $4 billion between 2016 and 2018, to $12.8 billion in 2018, according to a BioPharma Dive review of regulatory filings. Yet the employment increase sold by the law's backers has not materialized, as the number of U.S.-based jobs at the companies that disclose those statistics rose just 2%, to 61,000.
"We did not anticipate increases in employment in the pharmaceutical sector as a result of the tax cuts," Michael Sinha, a researcher at the Harvard-MIT Center for Regulatory Science at Harvard Medical School, wrote to BioPharma Dive.
"These predictions have generally panned out as predicted: stock buybacks and dividends have increased, drug prices continue to rise, and manufacturers have announced cutbacks in certain areas of important research, such as Parkinson's and Alzheimer's disease."
Sinha forecasted these outcomes last year in an article.
The headline of the law that passed in late 2017 was a cut in the statutory corporate tax rate from 35% to 21%. Even before the law, biopharma companies generally had a lower effective rate than 35%, due to their heavy investment in R&D as well as a global presence that allows them to take advantage of parking profits from assets like intellectual property in low-tax countries.
Drugmaker tax bills have now dropped even lower. The cohort of big U.S. biopharma companies, for example, had an average effective tax rate of just over 20% in 2016, the year before the law was passed, and that average fell below 15% after the law took effect.
Then and now: The tax burden of U.S.-based drugmakers
|Taxes paid, millions||Taxes paid, millions||Change, millions||Tax rate||Tax rate||Change|
|Johnson & Johnson||$3,263||$2,702||-$561||16.5%||15%||-1.5|
|Merck & Co.||$718||$2,508||$1,790||15.4%||28.8%||13.4|
SOURCE: Company 10-Ks on file with the SEC
U.S. employment did not see a surge following the law, however. Slightly less than 1,300 jobs were added among the companies from this group that disclosed numbers for both 2016 and 2018.
Some of the biggest companies, such as Amgen, Johnson & Johnson and Pfizer, did not include U.S. employment totals in their SEC filings. When asked, those companies either did not respond or declined to disclose that information.
Then and now: Employment at U.S.-based biopharma companies
|Johnson & Johnson||n/a||n/a||126,400||135,100|
|Merck & Co||26,500||25,400||68,000||69,000|
SOURCE: Company 10-Ks on file with the SEC, fact sheets, press office inquiries. NOTE: * does not include AbbVie numbers for 2018, as 2016 U.S. total not available.
Like most large corporations, biopharma companies are complex machines, and the change in rate was only one among many moving parts affecting their tax payments. Most importantly, the law lowered taxes on profits from overseas operations beginning in 2018 and allowed any cash profits retained overseas from earlier years to be repatriated after taking a single charge of 15.5%.
This one-time levy skewed tax rates for 2017, giving at least one company an effective rate above 100%, so comparing 2018 to 2016 is a clearer way to measure the effects of the tax law.
The change from a "worldwide" taxation system to "territorial" taxation may reduce the incentive for U.S. companies to seek to acquire overseas rivals to achieve lower corporate tax rates. In the past, both AbbVie and Pfizer attempted such financial engineering with scuppered plays to acquire Shire and Allergan, respectively, both domiciled in low-tax Ireland.
In place of a global corporate rate, the tax law imposes some minimum taxes on overseas business activities relevant to the biopharma sector and any other industry that derives significant revenue from intellectual property. The two new regimes are called the Global Intangible Low-Taxed Income (GILTI) and the Base Erosion and Anti-Abuse Tax (BEAT).
GILTI imposes an effective 5% tax on income in excess of normal expected return of 10% on tangible assets of any overseas subsidiary. This assumes intangible assets such as brand names or intellectual property contributed to the excess return. Thus a high-margin product like a branded pharmaceutical could be expected to result in an overseas tax obligation.
BEAT places a 10% tax on outbound payments to overseas subsidiaries. This would affect pharma companies that have domiciled drug patents with foreign subsidiaries and shielded U.S. profits from taxation by paying royalties to the subsidiary.
Though the industry reaped big benefits with lower taxes, they actually are not the biggest winners of the tax cuts.
"When you look at the entire corporate sector, the ones who have benefited the most are the ones that are heavily domestic," said Eric Toder, fellow and co-director of the Urban Institute and Brookings Institution Tax Policy Center, in an interview. "High tech [companies' rates] are not so much lower, because they're hit by this tax on what used to be tax exempt foreign income."
Indeed, the law could be a negative for some companies, noted Edward Kleinbard, a University of Southern California law professor and former chief of staff at Congress' Joint Committee on Taxation. "International operations in the new world order could actually end up costing some firms money, depending on how aggressive they were in what I call stateless income tax planning," he said in an interview.
On the other hand, Harvard's Sinha points out that the overseas taxation regime is "still less than the effective tax rates of many of large pharmaceutical manufacturers prior to the law taking effect."
"We are now taxing corporations at a level on par with the lowest individual tax rate in America, and because of this, individuals are now paying an increasing share of federal tax revenues," he wrote.
The long-term sustainability of the tax rates under the tax law is another question.
The U.S. government's deficit jumped 17% to $779 billion in 2018, and the Congressional Budget Office forecasts another 15% jump to $896 billion in 2019. Corporate income tax revenue stood at $300 billion in 2016, the final full year before TCJA was enacted, and sunk to $205 billion in 2018, the CBO says. Corporate income taxes will rise modestly in 2019, to $245 billion, according to CBO estimates.
Worries over the deficit have faded in recent years, which could mean that its growth will not be an impetus to change the law.
"Politicians have decided that as long as the deficits aren't causing pain to anybody in the public, they can just ignore it," Sinha said. "Interest rates are low. The economy's doing well. Nobody's complaining."
Kleinbard, on the other hand, thinks the deficit will be a trigger for increasing rates. "The business tax system of the United States needed comprehensive renovation. The 2017 act attempted to do that," he said. "But it did it in ways that are not politically sustainable. We gave away too much."
An even bigger risk to the sector could be global efforts to rethink what Toder calls the "architecture of global taxation" because of the ability of innovation-based industries like biopharma and high technology to domicile high-margin businesses in the lowest-tax jurisdiction.
TCJA moved the U.S. from being a country with one of the highest corporate tax rates in the Organization for Economic Co-operation and Development to somewhere in the middle of the pack. At a 21% statutory corporate rate, the U.S. is tied with the Slovak Republic — but lower rates in places like Ireland or Bermuda often beckon.
"Everybody's rethinking what the rules are for where international income gets taxed," Toder said. "That's probably more unsettled than at any time in the last 70 years."