Naked Capitalism: The Prescription Drug Rip-Off


Tax Breaks for Big Pharma on Top of Unreasonable Price Hikes

By Ed Walker, who wrote as masaccio at Firedoglake and now writes regularly at emptywheel. You can follow him at Twitter at @MasaccioEW, and here’s his author page at Shadowproof.

Big Pharma is under increasingly bitter attacks by people from all sides, outraged by enormous increases in drug prices. Notorious price-hikers include Martin Shkreli ond his company, Turing Pharmaceuticals, and Valeant Pharmaceuticals. Shkreli and the two companies were called before a House Oversight Committee hearing by the Republican Jason Chaffetz of Utah and Ranking Member Elijah Cummings of Maryland. The hearing can be viewed here, and there is a partial transcript. Shkreli pled the Fifth, and left after acting like a jerk. The price hikes are outlandish even by the standards of this money-sucking industry. According to Truveris, a health-care data company, drug prices increased more than 10% in 2015, “… with branded drugs up 14.77 percent, specialty drugs up 9.21 percent and even generic drugs rising 2.93 percent.“ That’s massively higher than the inflation rate of 0.7% for the same period.

Big Pharma has standard responses to this hostility. It claims that Turing and Valeant are bad actors, leaving the implication that all other companies are fabulous corporate citizens. Recently it began telling heart-warming stories about how the drugs help people, which in some cases is true, but has nothing to do with the price of drugs. It tells us about patient assistance programs that pick up the co-pay on drugs, but ignores the fact that the balance is picked up by insurance companies and passed along to insurance policy holders. It tells us that hospitals and some drug plans can bargain for lower prices, which is true only if there is competition, and for many generics and specialty drugs there is no competition. All of the companies say the same things, as Lee Fang demonstrated in a recent article. We need to communicate better. We are victims here. We need to work across party lines to influence public policy (meaning we need to spend more on legislators). There’s something like a new marketing plan, described by Stat, which specializes in pharmaceutical issues.

But, at the top of the list is that old stand-by: We need the money so we can do expensive Research and Development. Ian Read, the CEO of Pfizer, was on CNBC with Brent Saunders, CEO of Allergan. You can watch part of the interview here. Asked about the increase in prices of 105 drugs, Read gets outside the standard talking points and tries to pass price hikes off as some kind of market-driven thing, which is facially stupid, since many of the drugs with price hikes are protected by patents and others are generics which have no competition. He also said drug prices are a drop in the bucket, that they account for only about 10% of total health care spending, which comes to about $310 billion, a bit less than $1000 per person in the US. So, a 10% hike costs each of us an average of about $100. All this talk is just politics, says Read, who in 2014 received total compensation of $23.3 million. Surely for that kind of money he could do a better job of defending his company’s thuggishness.

The Allergan merger enables Pfizer to move to Ireland and cut its taxes. As expected, Read claims that the money will go to increased R&D. He implies Pfizer doesn’t have enough money for R&D right now. Let’s see what Pfizer’s 2014 financial statements say about that. In 2014, Pfizer reported net income of $9.1 billion. P. 58. It paid dividends of $6.6 billion, and repurchased stock for $5.0 billion, a total return to shareholders of $11.1 billion. No wonder there is no money for an increase in R&D.

Remember that R&D expenses are deductible in full in the year incurred, a temporary tax law recently made permanent by Congress. Pfizer takes advantage of that whenever possible. Note J of Notes to Consolidated Financial Statements. Let’s see what we get for that tax break. Pfizer reports that in 2012, it had an R&D expense of $250 million paid to AstraZeneca to “obtain the exclusive, global, OTC rights to Nexium”. P. 28. So, Uncle Sam gets stiffed for about $80 million to help pay for that purchase. In 2014, Pfizer counted as part of its increase in R&D this gem: “$309 million, reflecting the estimated fair value of certain co-promotion rights for Xalkori given to Merck KGaA”. That’s a non-cash transaction that cut Pfizer’s taxes.

And here’s a description of the R&D program at Pfizer:

We take a holistic approach to our R&D operations and manage the operations on a total-company basis through our matrix organizations described above. Specifically, a single committee, co-chaired by members of our R&D and commercial organizations, is accountable for aligning resources among all of our R&D projects and for seeking to ensure that our company is focusing its R&D resources in the areas where we believe that we can be most successful and maximize our return on investment. We believe that this approach also serves to maximize accountability and flexibility.

There is, of course, nothing there about producing new drugs to help people. It’s about being accountable to make money for shareholders and the CEO.

Turning to the Allergan deal, CEO Read assures us that Pfizer will use the tax savings for R&D. Frank D’Amelio, CFO of Pfizer, disputes that assertion. He says Pfizer will continue to pay dividends of about 50% of earnings per share, meaning that at least half the savings will be used to pay dividends. Let’s ignore that disagreement, and try to guess the amount of tax savings. According to Americans for Tax Freedom, in 2014 Pfizer paid an effective world-wide tax rate of 7.5%. That compares with the 25.5% reported on its 10-K. P. 28. ATF offers a detailed explanation of the way this was engineered, and explains that most US multinationals don’t use the same accounting treatment. ATF adds that Pfizer had as much as $148 billion parked overseas and untaxed in the US. At least that explains where they get the money to pay off their shareholders and keep Wall Street happy.

What are their actual R&D plans, as opposed to the happy talk? In recent years, Pfizer has shut down R&D facilities after each of its mergers.

Writing in Nature, former Pfizer R&D executive John LaMattina noted that the company’s three largest buyouts–Warner-Lambert, Pharmacia and Wyeth–resulted in sweeping research cuts and site closures, leaving more than 20,000 scientists out of work. And those who stick around were saddled with major R&D delays, LaMattina wrote, as integrating two large companies involves a painstaking review of assets that can slow development down to a crawl. Even more difficult to quantify is the effect on productivity, he wrote, as word of potential layoffs spreads fast throughout a large company and distracts workers from their projects.

After the merger the number two man, Brent Saunders of Allergan, will oversee operations. Here’s Saunders in August, 2015, discussing his vision of R&D with Randall Pierson of Reuters.

Saunders said discovery research, where researchers test ideas and compounds in test tubes and animals, typically eats up about 30 percent of pharmaceutical company research budgets, although only about one of every 20 such products that enters human trials succeeds and is approved.

“Discovery is where the industry has its lowest return on investment,” he said, “and not a good (use) of Allergan’s research dollars.”

Instead, he said Allergan will acquire products from companies that have already done the research spadework, and then itself develop the medicines and submit them for regulatory approvals.

In other words, Pfizer’s business model will be buying other people’s research and then doing some tests and filling out the paperwork for drug approvals. This gets them a patent and a fat tax deduction for all the paperwork. Then they can sell the drugs for monopoly prices. Or, they could sell the drug rights for a profit that is taxed (if at all) at capital gain rates, and if a US company buys it, the US company gets to treat the price it paid as a fully deductible R&D expense. Sweet.

Remember that Read is magnificently compensated for running this business, but what does he bring to the table? He is indifferent to drug creation and manufacture. His contribution is measured by how little Pfizer pays in taxes, and how well he engineers earnings, and not by any contribution to the well-being of humans. That’s your free market at work.

The Congressional Hearing on this issue droned on for quite a while, with the usual grandstanding and inability to ask decent questions. Then a Democrat, obviously fed up with the garbage from the industry witnesses, started trying to verbalize an inchoate idea of how to fix this once and for all. It involved conditioning patents on reasonable pricing, and some kind of license to the US government which if the pricing was deemed unreasonable would spring to life and enable DARPA (the Defense Advanced Research Projects Agency) to arrange for the manufacture of the drug and sale at a small profit. That, or something like it, might be a good idea.

But remember, Pfizer will soon be an Irish company. It could transfer the rights to a Vietnamese company, and institute proceedings under the Investor-State Dispute Resolution provisions of TPP and then what? Or, maybe the TISA will be adopted, and they won’t even have to pretend to have a Vietnamese company. That would be a two-fer: Free Market and Free Trade.


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