(Bloomberg Opinion) -- House Speaker Nancy Pelosi introduced legislation last month to lower the price of prescription drugs. That’s a worthy and achievable goal. Unfortunately, she gave a misleading explanation of how the law would work, obscuring its probable counterproductive effects.
Instead of pushing down prices by forcing drug companies to compete more vigorously, it would put them in the hands of government bureaucrats in a way that’s likely to restrict innovation and reduce access to many important medications.
Pelosi claims that her bill would allow drug prices to be “negotiated by Medicare.” Most accounts accepted this explanation, as for example the New York Times did in its Sept. 19 headline, “Pelosi’s drug plan would let U.S. negotiate prices of 250 medications.”
A more accurate headline would have read, “Pelosi’s drug plan would give the U.S. government the power to set the prices of 250 medications.” Government price-setting, not negotiating, is called for by the bill.
Here’s how it would work. Each year, the Department of Health and Human Services would identify up to 250 brand-name drugs that do not have a generic or biosimilar competitor. Insulin, which has seen large price increases in recent years and has been the subject of much attention, would also be included on the list. HHS would be required to “negotiate” prices for at least 25 drugs per year. Drugs would be selected based on their costs — taking into account both price and sales volume — to Medicare and the broader U.S. health-care system.
The maximum price a drug manufacturer could receive would be no higher than 1.2 times the average of the prices charged in six countries: Australia, Canada, France, Germany, Japan and the U.K. The goal would be to push prices below the maximum, according to an outline of the proposal.
Drug companies would be required to offer this price to private insurers. Medicare’s prescription-drug program (Part D) and private plans that offer Medicare benefits (Medicare Advantage) would be given flexibility to negotiate even lower prices.
That sounds like negotiation, but it isn’t. That’s because if a drugmaker refuses to negotiate with HHS, or exits the negotiations before a price is agreed to, then it would face a tax starting at 65% of annual gross sales — a tax on revenue, not profit — for the drug in question. This tax rate would increase by 10 percentage points every quarter the manufacturer does not comply, until it maxes out at 95%.
In a negotiation, both parties are free to walk away from the table and both parties have at least some leverage to affect the final outcome. But under Pelosi’s plan, drug companies have no negotiating power. Their choice is simple: accept the price set by HHS or exit the market.
HHS is supposed to take into account the costs of developing and producing a drug in setting its price. But the law doesn’t say how this would work. And given the low marginal cost of producing brand-name drugs — that is, the cost of making the physical pills, after the research and development has been done — the price set by the government could become confiscatory.
In a landscape of true negotiation, prices would reflect the goals of both parties at the table. The government’s priorities — for example, the political consideration of trying to lower prices for drugs that receive a lot of attention, like insulin — would be balanced against a drugmaker’s goal of large profits. But with price setting, political considerations would be relatively unchecked. Since government priorities and the politics around drug prices change every few years, the long-term effects of the policy are hard to ascertain. Prices could be higher or lower depending on who is president.
This uncertainty would cripple scientific innovation. Drug companies require years of profit to recoup the costs of developing a drug, and uncertainty about the course of price regulation would make it hard for them to decide which long-term investments might be profitable.
There are also problems with importing the maximum price from the six foreign countries named in Pelosi’s bill. The health-care economist Benedic Ippolito, my colleague at the American Enterprise Institute, argues that drugmakers would respond by taking steps to keep U.S. prices artificially high. They could do this by adopting opaque and complex contracting arrangements with reference countries or by offering special dosing, package sizes or delivery mechanisms in the U.S. so that direct foreign comparisons would not exist.
Prices are lower in those six countries in part because U.S. profits fuel the pharmaceutical innovations that they enjoy. They can have lower prices without worrying about the effect low prices will have on the development of new and better drugs. As the global innovation powerhouse, the U.S. cannot be blasé about this trade-off.
That doesn’t mean that current U.S. prices aren’t too high. President Donald Trump and Democrats in Congress both seem to think the current system places an inappropriately large weight on innovation over affordability, and they’re probably right.
To make drugs more affordable, Congress should encourage competition from both generics and patented, brand-name drugs. Congress should also rein in the tactics drug companies use to delay competition from generics.
Supply competition and regulatory changes that make it easier for generic drugs to come to market can lower prices while preserving the ability of the U.S. pharmaceutical sector to deliver remarkable breakthroughs and discoveries. Price setting — even if described as negotiating — would squelch innovation and, over the long term, reduce access to drugs.
That’s a price Americans shouldn’t have to pay.
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Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”
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