Denying Deductions for Pharma Ads Is Bad Tax Policy

April 12, 2021

At the beginning of the year, Sen. Jeanne Shaheen (D-NH) introduced the “End Taxpayer Subsidies for Drug Ads Act,” which would prohibit companies from deducting the costs of prescription drug advertisements directed at the public. However, the bill’s title is a misnomer: the deduction is not a tax subsidy.

To start, the corporate income tax is a tax on profits, or revenues minus costs. Under current law, firms can deduct the cost of pharmaceutical advertising, just like any other firm can deduct their advertising spending. A tax subsidy would allow companies to reduce their tax burden by more than just subtracting the costs of advertising. One example of a tax subsidy is the research and development (R&D) tax credit: companies can claim a tax credit to further reduce their tax liability as well as deduct the cost of R&D spending. There’s no equivalent credit for advertising.

Additionally, there is a tacit assumption when discussing ending the deductibility of drug advertising that there is some specifically designated “deduction for drug advertising” in the tax code. This is not true, as the deduction exists for all marketing expenses. Under a neutral tax code, costs should be deducted the year they are incurred, and that includes advertising.

However, some might still argue that we should deviate from the terms of a neutral tax code in order to punish direct-to-consumer (DTC) advertising by pharmaceutical companies. The U.S. is one of the few countries that allows drug advertising, and there is an ongoing policy debate on the merits of DTC drug marketing. There are valid criticisms of direct-to-consumer drug advertising, but there are also similarly legitimate arguments for its benefits.

Even if the critics are right, though, creating different cost recovery rules for different industries is a recipe for complexity and a poor approach to dealing with that issue. In a way, this issue is similar to the policy conversation around energy production and the fossil fuel industry. There have been several proposals targeting supposed subsidies for fossil fuel companies that are actually consistent with neutral tax principles. Fossil fuels do produce negative externalities but toying with the definition of the corporate tax base is a bad way to try and price them.

Similarly, there are many avenues to deal with harmful advertising. As the Tax Policy Center pointed out, regulation would be a more appropriate tool to deal with the potential problems associated with DTC drug ad campaigns. To use an extreme example, in 1970, the government banned smoking advertising on TV and radio—they did not change how tobacco companies could deduct their marketing costs, although the Clinton administration did suggest that in 1993.

 The “End Taxpayer Subsidies for Drug Ads Act” is not the first bill of its kind. Versions of this proposal were introduced or floated in 2009, 2015, 2016, 2018, and 2019. But all of them rely on a faulty understanding of the purpose of the corporate income tax: a tax on profits, or revenues minus costs.

 

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The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

Cost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. 

A corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.