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DRUG FIRMS "PENALIZED" IN OTA REPORT BECAUSE R&D TAX CREDITS ROSE WHILE TAXES DROPPED, PMA SAYS; LILLY EXEC SAYS INDUSTRY PROFITS EQUAL CAPITAL EXPENSES

Executive Summary

The pharmaceutical industry is "penalized" for tax code changes that appear to increase the profits earned on products studied in an Office of Technology Assessment report, Pharmaceutical Manufacturers Association Exec VP Robert Allnutt contended at a Feb. 25 press conference. The corporate tax rate "decreased from 48% in the 1970s to 32% through most of the 1980s," the period when the drugs studied were developed, Allnutt said. Over the same period, higher tax credits for R&D in the 1970s were followed by sales taxed at a lower rate in the 1980s and made pharmaceutical firms' returns on investment appear greater than they actually were, he said. "We get penalized because the drugs [OTA] selected happened to be invented in a high tax time and sold at a low tax time." PMA called the press conference to respond to the OTA report - - titled "Pharmaceutical R&D: Costs, Risks and Rewards" -- which was released earlier in the day by Rep. Waxman (D-Calif.) (see preceding story). Allnutt was responding to the report's conclusion that for each new chemical entity introduced to the U.S. market between 1981 and 1983 the industry will earn "at least $36 mil. more for its investors over its product life than is needed to pay off the R&D investment." That amount, OTA says, represents 4.3% more "than was required to reward investors for the time and risks incurred." To calculate return on R&D investment, Allnutt argued, OTA "should select one tax rate and apply it to expenses and sales." PMA maintained in a Feb. 25 press release that if a constant tax rate had been used in the calculation, "it would have significantly reduced or eliminated the 'surplus return' found by OTA's model." Eli Lilly Chief Scientific Officer Leigh Thompson, MD/PhD, who served on the advisory panel that OTA consulted for the study, agreed on Feb. 26 that tax rate changes affect return on investment. Because calculating the industry's return on R&D over the 12 years required to develop new molecular entities is "very complex," Thompson added, it is possible to estimate "a wide range of figures" for that return. "The best estimates I've seen are that the rate of return of the drug industry is exactly the expense of capital" and equivalent to the amount risked by investors in drug companies, when the uncertain nature of drug development is considered, Thompson said. PMA contested OTA's estimates of the effects of generic drugs on the profitability of the branded pharmaceutical industry. "They assume a lower rate of generic competition than we are seeing," Allnutt said. In addition, he continued, "they assume lower expenditures for capital plant and equipment" than the industry pays, and "PMA would challenge" assumptions made by OTA about the importance of sales abroad. Thompson contended that the ratio for domestic to international sales used in the report "is way out of whack," noting that Lilly's international sales are about half of U.S. sales. The OTA report assumed that world revenues were twice U.S. revenues on average. The Lilly official also questioned OTA's conclusion that the drug industry reaps a 2%-3% greater profit than other industries, after accounting for risk. He said the comparison of the drug industry to other industries is "a very tenuous economic model" that does not account for "heterogeneity" among companies in the industry at different times. In calculating the cost of bringing NMEs to market, Thompson said the OTA report accounts for only costs associated with the first indication approved by FDA, but it measures sales for all indications. He added that although OTA's estimate that the average drug included in the report cost $359 mil. (pretax) to bring to market "is quite good" for the period studied, "the cost of research is going up now while the number of drugs [developed] is the same."
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