Managing Director & Senior Partner
After years of building up their drug production in countries with lower operating costs and lower taxes, pharma companies supplying the US market could soon face an urgent need to rethink where they manufacture what they sell.
The Trump administration and Congress are considering an array of measures that have far-reaching implications for pharma leaders. Potential changes to US tax policies include the following:
The impact of just the import portion of a border adjustment tax (BAT) would be quite significant. Pharma companies supplying the US, particularly those focused on small molecules, obtain 80% of their active pharmaceutical ingredients and 40% of their finished drug products from overseas manufacturing facilities. An import tax could substantially decrease pharma profits.
Enactment of any of these proposals could bring fundamental changes to the global complexities of pharma supply chains and product networks. Companies across the industry would feel the impact of the changes differently, creating both challenges and opportunities for all players. Companies that understand the implications of tax policy shifts will be better prepared to act if economic considerations ultimately favor relocating production.
The current US corporate tax (35%) is well above the average tax rate among developed nations (the OECD average is 25%). Current US tax policies, in combination with attractive policies elsewhere, have encouraged global pharma companies to maximize their profits by placing manufacturing operations to other regions.
Developed nations such as Ireland, Singapore, and Belgium offer attractive combinations of lower taxes, a highly skilled workforce, opportunities for academic collaboration, IP protection, and streamlined regulation. Developing countries such as China and India offer labor rates that may be as low as one-tenth those in the US, along with significantly lower construction, energy, and other costs. As a result, many pharma companies have located not just their manufacturing, but also their IP and—in some cases—their corporate headquarters overseas.
As of this writing, the Trump administration has offered few specifics with regard to its planned overhaul of the federal tax system. One of its stated goals, however, is to close trade deficits and shift manufacturing jobs in all industries back to the US. Pharma companies must understand the implications for their industry of whatever program emerges in the next year and must anticipate how the new policies could affect their decisions about where to manufacture and sell their products.
In light of the Trump administration’s intention to reform the tax code, pharma leaders should begin evaluating their supply networks’ exposure, in the event that these policies become law. The potential tax policy changes have at least five significant implications:
With so many major policy proposals in play, predicting winning and losing sectors within the pharma industry is difficult. (See the exhibit.) In a BAT-imposition-pluscorporate- tax- reduction scenario, we might see the following effects on hypothetical examples of four types of companies.
US-based biologics companies serving a global market would be big winners. Companies of this type have the most to gain from new tax policies, particularly if their businesses do not import inputs from overseas. These companies would face a lower corporate tax rate, and their export tax-free profits from overseas sales would reduce their overall tax exposure. They would also enjoy a pricing advantage in international markets over competitors that cannot discount on the basis of tax-free export status. Companies for which US production is already attractive in the current environment would likely find that the revised tax policies further increased the benefit of their current supply chain.
Small US-based OTC producers serving the US domestic market would be modest winners. In comparison with foreign competitors, these companies stand to benefit somewhat from a reduced corporate tax and from new tax advantages of manufacturing in the US. The benefit that these companies would realize depends on whether and at what stage they brought in inputs from abroad. For example, small US-based producers would benefit more than overseas competitors if they imported raw chemicals rather than APIs. Companies should identify the stages or inputs (if any) to their supply chain that rely on foreign inputs. They could then assess the net value of using those inputs, in light of the increased tax burden, as opposed to using alternative domestic US sourcing options.
Foreign-based generics companies selling to the US market would be worse off. If an import tax were enacted, offshore companies would face an immediate cost hike for product they imported into the US. Tax-free exportation would not benefit them, and neither would lower US corporate taxes or tax benefits for US manufacturing. If their margins were already low due to competitive market dynamics, they might find it difficult to compete profitably with domestic US rivals. In organizing their supply chains, these companies might need to focus on reducing overall costs to stay competitive, given the new import penalties. Or they might need to consider shifting value-add portions of their supply chain to the US.
Foreign-based innovative companies with mixed assets and a global market might ultimately be worse off. A foreign-based company with assets in the US and other markets would encounter a blend of the issues highlighted above. Although most large pharma companies locate some of their production in US facilities, many of them import parts of their supply chain into the US. These imports often take place during the earlier stages of production. A rise in internal pricing of higher-value API materials might significantly increase such a company’s tax exposure. The right balance between domestic and offshore production stages would depend on how much of the US production was subsequently exported.
Implementation of any of the tax policies currently under consideration is far from certain. The Trump administration’s difficulty (thus far) in shepherding changes to the US health care system through Congress serves as a warning. It may not be easy for the administration to convince Congress to adopt policies that retool the entire corporate tax structure. Nevertheless, biopharma companies should be prepared to adapt—and in some cases they may need to be ready to move quickly.
To prepare for potential changes to US tax policy, biopharma companies should take the following steps:
Effecting any of these supply chain changes is a nontrivial exercise in time (likely a multiyear effort, given technical and regulatory timelines), cost (one multinational pharma has estimated a capital investment of over $1 billion to reshore production for US sales), and complexity. That said, if the tax and trade policies discussed here are enacted, the benefits of adopting these supply chain changes—or the cost of not doing so—may justify the investment for many pharma companies.
The lack of consensus on tax policy direction within the government and across industries clouds the prospects for comprehensive corporate tax reform. As a result, companies are not likely to make any decisions about shifting supply chains to the US yet, and they may choose to delay other potential network changes. Nevertheless, pharma companies should monitor and participate in conversations regarding policy reform, and should be ready to respond quickly as legislation moves forward.