By David Wainer

No matter how high President Trump cranks up tariffs, many industries are never coming back to the U.S. For industries that require cheap labor such as apparel and toys, bringing that production to Pennsylvania or Ohio just doesn't make sense.

For pharma, an industry in which gross margins are among the highest in the S&P 500, labor was never really the reason for moving offshore to places like Ireland -- it was always about playing the global tax game.

Tariffs are certainly getting pharma CEOs to listen, and many are already stockpiling imports while expanding production within existing U.S. sites. That is in order to avoid steep penalties on their profit-shifting strategies as the Trump administration conducts a probe into pharmaceuticals in a bid to impose levies on the sector.

But changes to the tax code could prove even more crucial to long-term investment. Before the 2017 tax cuts, the U.S. corporate rate was 35%, compared with just 12.5% in Ireland, making the U.S. a tax outlier. Companies responded by setting up complex offshore structures to house intellectual property and book profits in low-tax jurisdictions.

Things changed in 2017, when Trump's tax reform cut the U.S. corporate rate to 21% and introduced a minimum tax on certain foreign earnings. Meanwhile, Ireland responded to global pressure on tax havens and raised its headline rate to 15%. While many firms still shift profits abroad, making drugs in the U.S. -- and reporting the profit here -- became less of a deal breaker.

"The real answer is to reduce the gap that led to that problem to begin with," Eli Lilly CEO David Ricks said during an earnings call last week, "which is really an income tax situation." In recent weeks, Ricks was joined by pharma chiefs from companies including Pfizer, Johnson & Johnson, AbbVie and Merck in publicly pushing for further changes to the tax code.

Unlike in other advanced industries such as semiconductors, where manufacturing has almost entirely moved offshore, the U.S. still retains a significant base of drug production, particularly for high-value medicines. Much of the raw production of drugs occurs abroad, but high-cost regions such as Europe and the U.S. specialize in high-value branded manufacturing, especially for injectables and final-stage processing of complex or branded drugs.

Ideas to spur more production in the U.S. could include a 15% tax rate for U.S. manufacturing while restoring full expensing for capital investments, says Christine Kachinsky, leader of KPMG's life sciences tax sectors. Both of these are under discussion in Congress now. Congress could also restore R&D deductions, which have become less favorable under recent law, and bring back more-generous interest deductions tied to domestic facility spending, she said.

Congress also has plenty of sticks it could deploy. For instance, it might make changes to rules that let drug companies continue to report U.S.-generated profits in low-tax jurisdictions, says George Callas, who leads the public finance team at Arnold Ventures and is a former tax counsel to House Speaker Paul Ryan. Callas says this is being considered by Congress and getting strong interest from Trump administration officials.

Currently, companies receive generous deductions on income earned abroad under the Global Intangible Low-Taxed Income (GILTI) regime. Policymakers could fix this by allowing the low GILTI rate to be applied only to genuinely foreign profits, not to those artificially routed through foreign entities. Another option would be to raise the GILTI rate, says Brad Setser, a senior fellow focused on global trade at the Council on Foreign Relations.

There is a distinction to be made between branded pharmaceutical products and generics, which are cheap copies of medicines that have lost patent protection.

The generic drug industry, which produces about 90% of the prescriptions Americans use, is a low-margin business. In recent years, it has increasingly shifted production, primarily to India and to a lesser degree to China. Tariffs on that industry could exacerbate quality problems and drug shortages in the U.S. To bring portions of it to the U.S., the Trump administration would need to directly support it financially, says Marta Wosińska, a senior fellow at the Brookings Institution.

Since Trump's reelection, drugmakers have made sweeping U.S. manufacturing commitments. Eli Lilly announced plans to invest $27 billion, Roche pledged $50 billion, and J&J committed $55 billion to boost its U.S. footprint. These announcements should be taken with a grain of salt: Much of that investment might have gone ahead even without Trump's threats, but it underscores that the pharma industry is definitely ready to invest in its U.S. capacity.

Income taxes, more so than tariffs, will play a decisive role in how sustainable those investments are over the long term.

Write to David Wainer at david.wainer@wsj.com

(END) Dow Jones Newswires

May 07, 2025 05:30 ET (09:30 GMT)

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