By Bill DeRosa
Connecticut’s biosciences sector is one of the crown jewels of the state’s high-tech, knowledge economy.
Over the last two decades, state policymakers have shown strong support for growing the sector through strategic tax policy and direct funding programs—with an impressive return on investment.
As was reported in last month’s CBIA News, however, the governor’s proposed 2016–2017 state budget now before the state legislature contains tax proposals that would effectively pull the rug out from under one of the state’s key economic drivers and greatest success stories.
In addition to making the 20% corporate surcharge essentially permanent, the proposed budget would change various formulas for calculating R&D tax credits and the amount of net operating losses that can be carried forward, dramatically devaluing their worth as economic development tools. Those tools are critical to bioscience companies, which typically have to make huge investments in R&D over long periods before ever realizing a profit on a medicine, medical device, or other product.
Approaching Critical Mass
Home to two major bioscience research institutions—Yale and UConn—and industry leaders Achillion, Alexion, Boehringer Ingelheim, Bristol-Myers Squibb, Cara Therapeutics, Covidien, Kolltan, MannKind, Pfizer, and Purdue Pharma—to name just a few—Connecticut has become an important center for biosciences innovation.
According to a 2014 report by Battelle and the Biotechnology Industry Organization (BIO), Connecticut ranks 4th in the nation for bioscience patents per 1,000 people. The state also ranks 9th for technology capacity (Milken Institute) and 5th for the percentage of scientists and engineers in the workforce (National Science Foundation).
Encompassing subsectors such as biopharmaceuticals; biotechnology; medical devices and equipment; research, testing, and medical laboratories; and bioscience-related distribution, this high-growth sector included 864 Connecticut companies in 2012.
Those firms directly supported more than 24,000 jobs in the state and had a total employment impact of more than 113,000 jobs (Battelle/BIO).
The Connecticut bioscience job base covers a broad range of careers, from laboratory management to clinical trial design and implementation to Ph.D.-scientist cutting-edge research.
Each bioscience job is characteristically high paying: In 2012, the average bioscience position paid $103,385, creating significant economic activity and income tax revenue for the state.
In 2011, the biopharma and biotech subsectors alone generated nearly $17 billion in total economic output in Connecticut (Battelle, 2013).
“Connecticut offers bioscience companies access to a highly educated workforce, good quality of life we can offer to employees, and proximity to bioscience investment communities in New York and Boston,” says Mary Kay Fenton, executive vice president and CFO at Achillion Pharmaceuticals Inc. in New Haven.
“In addition, Connecticut is beginning to garner critical mass in its community of bioscience companies, and jeopardizing that growth to date could unravel years of investment by private companies, universities, and the state.”
‘We Produce the Innovation’
Connecticut’s robust biosciences sector and university-based research environment gives the state an important competitive advantage, says Paul Pescatello, chair of the CBIA Connecticut Bioscience Growth Council, a newly formed entity charged with representing the interests of bioscience companies at the State Capitol.
“Intellectual property creation will drive the economy going forward,” says Pescatello.
“Yale, UConn, hundreds of private companies, and our highly educated workforce are a powerful force for innovation and novel patents.
“When it comes to drug development, it’s the intellectual property creation that’s most economically valuable. It’s the lengthy research and development phase where all the high salaries are paid and all the expensive equipment is bought and used.”
In Connecticut, says Pescatello, “we produce the innovation and the high-value-added work. That’s our strength, and for a high-cost state like ours, that’s our competitive advantage.”
A Supportive State—So Far
Recognizing the bioscience industry as one of Connecticut’s key economic assets, the state has done what it takes to attract and retain bioscience companies.
Policymakers have employed a range of direct funding mechanisms and tax incentives that enable these firms to engage in the expensive long-term research and development that is essential to their existence.
For example, the state has:
- Committed more than $1 billion for the expansion of the UConn Health Center and the development of The Jackson Laboratory Genome Research Facility.
- Set up the Connecticut Bioscience Innovation Fund (CBIF) and Regenerative Medicine Research Fund (RMRF). Administered by the quasi-public Connecticut Innovations, the CBIF provides grants, equity investments, and loans from a $200 million fund to speed commercializable bioscience breakthroughs to market. The RMRF, also administered by Connecticut Innovations, provides millions of dollars in grants each year to scientists who are conducting biomedical or embryonic or human adult stem cell research that shows clinical promise.
- Formed a bipartisan Life Science Caucus consisting of state representatives and senators tasked with supporting scientific innovation and the growth of bioscience through public policy.
- Created CTNext, Connecticut’s innovation ecosystem, a public-private partnership with hubs in Hartford, New Haven, Stamford, and Storrs to support high-value technology based startups and stage-2 companies.
Perhaps even more important, says Pescatello, has been the state’s strategic tax policy, which has provided incentives for bioscience companies to make the major R&D and capital investments necessary to take a product from concept to commercial viability.
These incentives include a competitive general research and development tax credit, a credit for R&D activity greater than that conducted in the prior year, a tax credit exchange for tech companies, the ability to carry forward net operating losses for 20 years, and a sales and use tax exemption for laboratory equipment.
“Connecticut has created a number of innovative policies that provide incentives for companies to grow and continually reinvest in the state, including the R&D tax credit (though it has been capped at 70% of its value since 2002) and the Job Expansion Tax Credit1 (JET),” says Jim Baxter, senior vice president of development at Boehringer Ingelheim Pharmaceuticals Inc. in Ridgefield.
The R&D tax credit, says Baxter, has provided support for the construction and maintenance of Boehringer’s state-of-the art research facilities in Ridgefield.
“These policies create a competitive environment that helps Connecticut maintain its status as a center of excellence for research and development, allowing businesses to grow and invest within the state.”
The budget proposal now being considered by the legislature, however, is a curious turnabout in the state’s support for the biosciences sector—particularly considering the economic success of current tax incentives and the need to put Connecticut on a solid long-term fiscal footing through economic growth and private-sector job creation.
The tax measures in the budget proposal:
- Reduce the value of earned investment incentives for research and development, capital purchases, and other key economic drivers by reducing the caps on business tax credits from 70% of a company’s tax liability to 35% in 2015, 45% in 2016, and 60% in 2017
- Cap at 50% the use of the net operating loss carryforward—an important tax mechanism that encourages investment in Connecticut by allowing companies to use operating losses incurred during the research and development period to offset future tax obligations
- Make permanent the 20% corporate surcharge that was scheduled to be eliminated, increasing Connecticut’s corporate tax rate from 7.5% to 9%; only five states have a rate higher than 9%
“The investment incentives that are part of the state’s tax structure matter greatly to Connecticut because they afford us the opportunity to be competitive despite being a high-cost state,” says Bonnie Stewart, CBIA’s vice president of government affairs and general counsel.
“Tax credits are part of companies’ locational decisions. Nearly all state and foreign jurisdictions offer credits, and only three states have permanent limitations on their use.”
As an exemplar, Pescatello cites Massachusetts—Connecticut’s most formidable competitor in building a bioscience cluster and attracting bioscience companies.
“Massachusetts’ R&D tax credit is marketed and is a permanent feature of the state tax code,” he points out.
“It’s my understanding that the stated rate of the Massachusetts R&D tax credit is not diminished by separate formulas elsewhere in the tax code or budget legislation. It can be used to reduce a corporation’s tax to the Massachusetts minimum tax of $456.”
Stewart believes the best way to grow tax revenues is to grow our economy.
“Although we recognize the difficult challenges facing the governor and the legislature in closing budget deficits, we shouldn’t close those gaps by inhibiting investments by the very companies that drive our economy.”
“If anything, you’d want to increase the economic development incentives to help Connecticut’s foundational industries, because those industries are actually going to increase employment and tax revenue over time.”
Indeed, one bill now under consideration by the legislature, HB 5978, calls for expanding the R&D tax credit for bioscience companies.
Testifying in favor of the proposal, Pescatello told members of the Commerce Committee that the bill, which would authorize the redemption of unused or “stranded” R&D tax credits from previous years, is “very good policy” but would become moot if the tax measures in the proposed state budget are approved.
Understanding the R&D Business Model
Bioscience and advanced manufacturing (think aerospace and submarines, for example), two of Connecticut’s economic powerhouses, have lengthy R&D and product manufacturing cycles representing many years and enormous financial expenditures before a company begins to earn a return on its investment.
“Biotech and biopharma companies make huge investments of time and money in researching, testing, and obtaining regulatory approvals for new medicines and devices,” says Pescatello.
“It takes approximately $1.5 billion and at least a dozen years to bring a new medicine or medical device from concept to working concept, through early clinical development and large clinical trials, to final FDA approval for use by patients.”
Which is why tax credits are so critical.
“They enable bioscience companies to balance their investments without returns—for example, medicines in development—against returns from approved products—medicines on pharmacy shelves,” he says.
“If we want the bioscience headquarters and their laboratories and the jobs that go with them, we must show these companies that we understand their business model and value the risk they take in making huge research and development investments.”
For Mary Kay Fenton, tax incentives offered by the state are critical to her firm’s ability to get through the clinical phases of medicine development.
“The R&D tax credit allows Achillion to generate future value for investments we make in Connecticut’s economy today,” says Fenton.
“Not only do we value our net operating losses and R&D credits, we particularly value the ability to exchange currently unusable credits (unusable because we do not yet have income) for cash, which allows us to advance our clinical programs in hepatitis C and immune disorders.
“Clinical trials we are running this year cost in excess of $100,000 per patient, and the credit offsets that substantial investment in treating patients in clinical trials.”
It’s also important to keep in mind that tax credits are incentives identified and approved by Connecticut governors and the legislature to encourage companies to make certain investments in the state.
Only investments made in Connecticut can earn tax credits. There is no cost to the state until after a Connecticut investment is made, and the tax revenues generated from the investment far exceed the credit earned.
“Tax credits have been revenue generators for Connecticut for years,” says Stewart.
“Since the adoption of the R&D tax credit in 2000, $109.2 million in credits have resulted in $3.14 billion of investments in Connecticut. In addition, since 2001, $724 million of fixed capital tax credits have resulted in $14.5 billion in in-state investments.
“And those billions of dollars don’t include the additional economic activity that results from the investments. What a multiplier effect!”
Undermining the Foundation of an Industry
“Reducing the value of tax credits to 35% of their value and capping the NOL carryforward at 50% sends precisely the wrong message to our existing base of bioscience companies and, of course, to companies we hope to recruit to Connecticut,” says Pescatello.
“It sends a message that our incentives cannot be counted on, our policies are inconsistent, and our stated rates are really just labels only loosely related to reality—35% is the new 100%.”
Such action, argues Pescatello, “undermines the foundation of an industry we have invested in heavily as a means to build a new, healthy jobs base for Connecticut.”
Baxter sees inconsistent tax policy as a major problem for businesses, particularly when it comes to planning for future investments.
“Most companies work off long-term strategic business plans that look five to 10 years in advance,” he says. “Changes in tax policy impact the ability of businesses to plan and make informed long-term business decisions, including investments in infrastructure and workforce.”
Once those investments have been made, removing or limiting the economic development tools that incentivized them is a huge problem for companies—and, says Fenton, can cause them to look elsewhere for a base of operations.
“Connecticut’s bioscience companies have committed to the state through their hiring of well-paid employees, investing in expensive laboratory equipment, and by running operations here, creating additional jobs in surrounding communities.
“When proposed tax changes modify the playing field after we make these investment decisions, it makes it challenging to stay committed to operating here.
“Most of us have directors who also sit on boards of other companies in bioscience hubs like Cambridge, San Diego, and San Francisco. Noncompetitive tax provisions make it easy for those directors to advocate for leaving the state to find more competitive locales.”
A Strong Voice for Bioscience and Jobs
Through its newly formed Connecticut Bioscience Growth Council, CBIA is working to ensure that doesn’t happen and that state tax policy continues to promote economic growth and jobs.
Headed by Pescatello, the council represents the interests of bioscience companies—large and small—at the State Capitol and regulatory agencies, providing greater advocacy support and resources and developing an overall plan for better positioning these companies at the state, regional, and national levels.
As part of the council’s government advocacy role, Pescatello works to enhance and secure important policies, such as the R&D tax credit, for both established and early-stage companies.
Bill DeRosa is editor of CBIA News. Contact him at firstname.lastname@example.org.