Thursday, November 19, 2009

The Healthcare Reform Bill will Kill R+D, and one solution to that.

Note the quote from the McKinsey report on health reform:
"Big Pharma faces the largest potential revenue risk," the document predicts. Partly that's because of existing trends in the drug industry. But it's also because studies of comparative effectiveness are sure to reduce the sale of drugs that don't work as well. McKinsey suggests that the drug industry can survive and even thrive in this environment "by focusing on 'productive' innovation (supported by strong evidence), collaborating with payors and providers in new ways, and revamping commercial and R&D models to significantly improve effectiveness and efficiency."
Good, you say?
Here's the problem.
Researchers rarely know what R+D is going to be good, ex=ante. The best research is often accidental - things useful for small issues become useful for much bigger problems (if I recall correctly, penicillin, digitalis and botox are great examples of this). If drug companies "focus" on what looks most promising, they will be focusing on what looks most derivative, because derivative things are easy to make calls on. Truly groundbreaking research requires the ability to risk failure, and tanking companies' potential revenues from a drug crushes any incentive to take on very risky projects to begin with.
A requirement of X% to basic research would be good, but unenforceable.
Another solution presents itself, though: capitalizing R+D and making the amortization 75% tax deductible could be awesome... you'd basically increase medical research by drug companies by an entire order of magnitude (also depriving the government of billions in taxes, but that's probably a worthy expenditure).
Tax writeoffs would have to be able to be carried forward to ensure that little companies can still compete when they don't earn revenue. Would this create situations where big companies buy little companies with no real drugs but lots of tax writeoffs? Yes, but that's not a bad thing... it still encouraged past research, and just cuz it failed doesn't really matter. It can't be 100% deductible, or biotech startups would basically be riskless for VCs, encouraging stupid startups that indirectly waste government money. 75% still leaves the company and its investors on the hook for 25% of the costs, which means that selling your tax writeoffs is an exit strategy for good startups while still not palatable to bad startups. It'd encourage possible-blockbuster-but-likely-to-fail startups, which is a plus, not a minus.
In any case, which drug company wouldn't prefer to dedicate a high % of revenues to research that can increase revenues in the future, instead of slightly less (20% less, if you use 75% writeoffs) revenues to the government in a manner that can't increase future revenues?
In any case, unless you decrease risk by a massive amount (which that measure does by making R+D up to a certain point a costless tax-replacement), the healthcare bill will tank meaningful R+D.

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