In The News

The latest Medicare guidance will stifle pharmaceutical innovation—and it’s worse than we thought.

The Biden administration has issued guidance on how it will implement the Medicare drug price controls in the Inflation Reduction Act. The controls will be far-reaching and much worse for the health of the country than critics had anticipated.

The rationale for the price controls is to save taxpayers and seniors money. But the savings on existing drugs are minuscule in comparison to the loss in health resulting from a decrease in drug innovation, which is already taking place. The Congressional Budget Office finds the Inflation Reduction Act will cut drug spending by $238 billion by 2031. Meanwhile, a University of Chicago analysis (of which I am a co-author) predicts the cuts in innovation in new drugs will lead to health losses valued at $18 trillion during the same period.

CBO predicted only a dozen drugs would be lost by 2039, but four months into the Inflation Reduction Act the consulting firm Horizon Government Affairs found that at least 24 companies had announced that they’re curtailing drug development owing to the bill. At the current pace, the University of Chicago analysis finds that the estimated number of drugs that will be lost from the Inflation Reduction Act, which some members of Congress argued were overblown, will be far too low.

Not only was the law itself rushed, but the 90-page guidance from the Centers for Medicare and Medicaid Services reveals it will be implemented with minimal public input. The rules of the so-called price negotiations won’t be subject to the typical notice-and-comment requirement, and there is no appeals process for the mandated prices. Instead, the new pricing team at CMS has been given a massive budget—$21 million per drug negotiated—while private organizations that review drug pricing operate at less than 3% of that cost.

The guidance, and the text of the law, specifies that Medicare can’t pay more than 40% to 75% of the prices that private insurance companies pay. The Medicaid program already dictates a 23% discount. Mandatory government discounts heighten drug companies’ incentive to raise prices for private insurers.

The administration last week sent out a 45-page information request for manufacturers to fill out that will be used to justify setting prices even below these ceilings. Most of the request focuses on research-and-development and manufacturing costs, presumably to justify a pricing model in which the government sets prices for the negotiated drugs at a level that allows drugmakers to recoup their expenses and earn a modest return for those drugs.

Because negotiated drugs are mandated to be the top-selling drugs, this model would be a disaster. About 90% of the experimental drugs that enter clinical trials don’t make it through the Food and Drug Administration’s approval process. For companies to earn a normal return on their development portfolio, they need abnormal returns on the few drugs that succeed. R&D investments will dry up if the government adopts a de facto cost-plus pricing model on negotiated blockbusters.

Bureaucrats may demand additional discounts if National Institutes of Health funding to universities helped develop drugs being overseen. But the value of that research is tiny relative to total development costs. In 2020 American universities earned in aggregate about $3 billion from selling patents to the private sector, with many being outside the biotech sector. Compare that with drug-industry development spending of $99 billion in the same year.

Price controls will be more far-reaching than anticipated. Although the number of negotiated blockbusters is small, they account for 32% of total Medicare drug spending. Seventy-two percent of total Medicare drug spending will be affected when you add in the drugs that have to cut their prices to compete with negotiated blockbusters. In addition, when returns to innovation are reduced due to Medicare cuts, patient populations outside Medicare suffer.

The administration learned nothing from the European experience with similar price controls. Of all drugs launched world-wide between 2011 and 2018, 89% were available in the U.S. while only 48% were available in France. Bureaucrats may be well-intentioned, but markets are always better at setting prices.

Mr. Philipson, an economist at the University of Chicago, was a member of the White House Council of Economic Advisers, 2017-20, and its acting chairman, 2019-20.

READ MORE