Should Congress Use The Income Tax To Discourage Consumer Drug Ads?

Senator Jeanne Shaheen (D-NH) and a score of Democratic cosponsors want to use the tax code to discourage direct-to-consumer advertising by drug companies. Their bill, the End Taxpayer Subsidies for Drug Ads Act, would prohibit firms from taking tax deductions for any consumer advertising of prescription drugs.

Limiting tax deductions is a blunt and arbitrary way of approaching a legitimate concern. Consumer drug ads play an important role in debates about the costs of prescription drugs, the risks of misuse and overuse of some medications, the balance of authority between doctors and patients, the limits of commercial speech, and a host of other issues. For overviews, see here, here, and here.

But the bill is not well crafted to address those issues. The problem starts with the legislation’s name: Allowing drug companies to deduct advertising costs is not a subsidy. Many other deductions are: The charitable deduction in the personal income tax, for example, subsidizes charitable giving. And the mortgage interest deduction subsidizes borrowing to buy a home.

But the business deduction for advertising costs is not a subsidy. The corporate income tax is a tax on corporate income. To calculate income properly, businesses tote up their revenues and deduct their expenses. Those expenses may include wages for workers, rent for office space, and yes, the costs of advertising.

Under an income tax, companies deduct those expenses because they incur them in pursuit of the profits we have chosen to tax. One can debate how rapidly companies in any industry should write-off their advertising costs. But in an income tax, there is no question that they should write them off.

Rhetoric aside, the broader question is whether limiting deductibility is a good way to discourage consumer drug advertising. Using the corporate income tax to impose penalties this way has the same strengths and weaknesses as much more common efforts to offer rewards.

On the plus side, the tax code provides ready infrastructure for creating a financial penalty. With little legislative effort (the bill is less than three pages), lawmakers can design a meaningful deterrent to consumer ads.

But limiting deductibility is a blunt and arbitrary instrument. In principle, lawmakers should discourage ads based on the harms they want to reduce. Congress should impose large deterrents against the most damaging forms of consumer ads, smaller disincentives to less damaging ads, and rewards for beneficial ads (there is evidence some consumer drug ads create benefits).

Ending the tax deduction does not allow such careful calibration. Instead, it creates a single financial penalty based on the corporate tax rate. Recent tax changes illustrate how arbitrary this can be.

When proposals to eliminate tax deductibility for drug ads were floated in 2009, 2015, and 2016, the corporate tax rate was 35 percent. Eliminating the tax deduction would have increased the effective cost of drug ads by more than half. Without deductibility, a $100,000 ad would have cost as much as a $154,000 ad with the deduction.

But the 2017 Tax Cuts and Jobs Act (TCJA) lowered the corporate rate to 21 percent. Now, eliminating tax deductibility would increase ad costs only by about a quarter. A non-deductible $100,000 ad would cost as much as a deductible $127,000 one.

To those not steeped in tax policy, the Shaheen bill has the same rhetorical power as earlier proposals to eliminate tax deductibility for consumer ads. Indeed, it may have even more rhetorical power – a similar billgarnered only four sponsors last year. In practical terms, however, the bill has lost half its economic effect since passage of the TCJA.

For better or worse, advocates for limiting the tax deductibility of drug ads have lowered their ambition. Such are the perils of basing policy on arbitrary parameters of the tax code, rather than focusing on the real costs and benefits of drug advertising.

So what’s a better approach? Well, as much as I enjoy talking tax, regulation should be the first line of attack here. The Food and Drug Administration should weigh the pros and cons of consumer ads and how they vary across different conditions, therapies, and advertising media.

If taxes are the only game in town, lawmakers should do the hard of work of deciding how bad consumer ads are. They do that when they impose taxes on alcohol and tobacco. They do that when they propose taxes on carbon dioxide. And they do that (for goods not bads) when they decide how big tax credits should be for electric cars and research and development. Arbitrary tweaks to the tax code are not the way to go.