Econ 465 Policy Paper
Should the Federal Government be Allowed to Negotiate Brand-Name Drug Prices for Medicare?
Spending on prescription drugs in the US is very high when compared to other developed countries. A recent study found that branded drug prices were 5-198% times higher in the US than in other countries, as shown in an analysis by Panos Kanavos on IMS data. This paper will further explore the cost of branded drugs in the US and whether or not the government should negotiate brand-name drug prices for Medicare specifically Part D the “Non Interference clause.”
When referring to drug prices, there are two widely used terms: generic and branded. A generic drug has the same active ingredients as a branded drug but does not contain the brand name. Brand drugs hold the name of the company that originally developed the drug and a patent giving the company the exclusive right to sell the drug and earn back money they spent on R&D until the patent expires. This exclusivity allows these patent holding companies to drive up prices, which many argue are too high. The focus of this paper will be on the latter, since the cost of these drugs are much higher. Another keyword to understand regarding this argument is outpatient prescribed drugs, which is a medicine used at home.
The premise of this paper is that the government should not negotiate brand-name drug prices for Medicare. Historically speaking the effects of Medicare have been surprisingly positive. However, as of recent, brand-name drug prices have increased dramatically and many believe that the government can lower prices through negotiation. This paper explores the counterargument and proposes other solutions to the problem including value-based pricing and antitrust enforcement.
History of Medicare
It is difficult to fully understand and appreciate the complexity of this problem without a good understanding of the history of government provided healthcare in the United States. The first US president to introduce proposals for a national healthcare system was Harry Truman in 1945, but he received fierce pushback from the American Medical Association. It wasn’t until 1965 that President Lyndon Johnson signed into law Medicare under Social Security (Glen, 4).
“Under the new law the US government would provide health insurance to people age 65 and older, regardless of medical or income history.” Throughout the years the law has expanded to meet the needs of more people. However, it wasn’t until four decades after the creation of Medicare that the US government started to provide outpatient prescribed drugs to qualified participants. The legislation enacting such benefits was the Modernization Act of 2003 which created a federal-government program known as Part D, lowering the cost of prescription drugs and prescription drug insurance premiums through government subsidies. The caveat was a new limitation on the government called the “noninterference clause,” which prevents the federal government from negotiating prices with pharmaceutical companies.
Individuals on Medicare can obtain the benefits provided by Part D through plans administered by private insurance companies. The idea was to make sure plans competed in quality and cost to provide the beneficiaries with options. To do so the plan would implement different tools to control costs without the government’s direct intervention in negotiating prices of brand-name drugs for outpatients. The plan is much more involved than was explained; however, this basic knowledge should suffice for this paper, but it is worth knowing that the costs of the program are covered through plan formularies, low-income and middle income subsidies, excluded drugs, beneficiary premiums and cost sharing. These last terms may be mentioned briefly throughout the paper but a deeper knowledge won’t be necessary.
In recent, prescription drug expenditures have sharply risen, causing policymakers to rethink the “noninterference clause.” Before making the argument, it is important to consider the factors causing increased drug expenditures and the effects the Medicare program has had on expenditures for beneficiaries.
There are many reasons and hypotheses explaining why prices have risen over the past decade. Many economists have concluded that the rapid growth can be attributed to the major advances in medical technology and science. The Congressional Budget Office (CBO) has ascribed nearly half of the expenditures to technological advances in healthcare. Other factors that have led to increases include government regulation giving new drug patents, and research and development. Not only attributed to natural growth causes but other inherent problems in the healthcare market contribute to the increase in prices such as asymmetric information, lack of competition, and the “donut hole” effect (Cutler, 3).
The United States is not alone in this category, other countries around the world have also seen a high increase in brand-name drugs. Many argue that price in US has risen much higher in comparison to other countries. Critics generally attribute this large increase to a free-rider problem and that US pharma companies are taking advantage of consumers in the US (Kesselheim, 1). This paper analyzes this issue and addresses the argument that the US should negotiate prices because almost all other countries do which is why many believe they have lower prices.
Another contributor to the rise in prices is the increased spending mainly due to new specialty drugs (Mills, 1). An example of this is the new drug for hepatitis C, which is extremely expensive and causes many Americans to pay out-of-pocket cost for such drugs and increase the amount of government spending. The treatment for hepatitis C is still a brand drug protected by its patent so generic versions are unable to enter the market to compete and contribute to lower costs.
Surprisingly, Medicare Part D cost less in its first five years than the CBO had projected. The lower cost can be contributed to the lower number of enrollees than expected, national decrease in drug spending, and increased competition. In a study published in the journal of American Geriatrics Society it’s shown that over time beneficiaries have received more access to needed medicines. An attributable implication was that those enrolled in Medicare had wider access to treatments for Congestive Heart Failure because of the better access (Einav, 847).
Due to the rise in prescription drug price and effects Part D had on the US many have begun to question whether or not the government should be allowed to negotiate Medicare drug prices. Interestingly, this was one of the potential plans being proposed when Part D was first created and seems to always be a topic of conversation when changes are being made to Medicare. If the US would have gone with the initial debate than government would directly provide benefits which would most likely result in a type of price regulation.
Current Political debate
During the 2016 Presidential Election there were very few topics that all candidates agreed upon; however, all agreed that the government should negotiate brand-name drug prices for Medicare. This is a rare situation to have such a strong consensus, not only do all agree but it is backed by very little research and much of their argument is based off intuition that negotiation would result in savings. Figure 1 is a study done by the Kaiser Family which depicts the consensus of those who favor government interaction in behalf of Medicare beneficiaries.
President Trump said, “We’re the largest buyer of drugs in the world and yet we don’t bid properly,” he said at a news conference in early January. The common perception is that Medicare does not have a bid system to get the best prices for beneficiaries. This created a belief system that if government could negotiate brand-name drug prices more people would have access to affordable healthcare. President Trump even criticized the big pharma companies saying that they are “getting away with murder.”
Much of the criticism is unprecedented. News media portray a system in which big pharma companies set prices and consumers have no power to negotiate. This is a myth, the current system has about 100 private insurers who negotiate prices with pharma companies for Medicare.
Another reason America is convinced that the government should have negotiating power is because countries abroad have lower brand-name drug prices than in the US. Figure 2 a graphical representation of brand drug prices by country sourced by the World Bank shows the price discrepancy by country and the general increase in prices from 2000 to 2010. However, this is not a fair comparison. The US health system is not like the Universal Healthcare systems that are seen in other developed countries. Not only are the systems different but the word negotiate does not properly define how prices are set abroad. Typically, foreign governments set up regulations to set caps on drug prices. In most of these situations the government sets the prices for the manufactures.
Another prominent argument to give negotiating power to the government is that other healthcare programs in the US like Medicaid and the Veterans Administration has the ability to negotiate prices. However, this is a distorted argument because Medicaid is based on state rebates meaning that pharmaceuticals have to lower costs. VA also does not negotiate prices, it fixes them. The lower prices create a limit on the number of drugs that are offered to beneficiaries.
Each party has different policy proposals to combat the rise in prices by terminating the “Non Intervention Clause” and allowing the government to some degree negotiate prices with big pharma companies directly for the beneficiaries of Medicare Part D. If the new bill became law the Secretary would be given negotiating power on behalf of the government to then work with pharmaceutical companies to lower price.
It is unclear if the political debate has analytical evidence showing that a change to the current Medicare Part D will have a positive overall effect. In essence the study would need to show that out-of-pocket spending decreases for beneficiaries, brand-name prescription prices fall, and a clear path on how this would work. It would also be essential to show any other external effects such a change would have on the economy which can be extremely complicated. So, although the initial movement to grant the federal government negotiating power for Medicare seems logical, there is actually a lot that must be studied and planned before any policy is changed.
Policy Analysis and Recommendations
On the contrary to what much of the public and politicians have been saying about giving government power to negotiate prices this paper curtails the argument, government should not be granted such power and other policy measures should be enforced to combat the rising prices. This section will focus on refuting the ideas mentioned in the previous section, exploring effects of the current Medicare Part D and offering potential recommendations that can help lower brand-name drug prices for those on Medicare.
As mentioned in the previous section the proposed legislation would essentially create price controls as done in other countries. Previous studies show the effects such changes have on innovation in the healthcare market. Blume-Kohout analyzed the the market when Medicare was first released to show that the market size increased with the implementation of Part D. Not only did the market size increase but they also saw a significant increase in pharmaceutical research and development. The conclude with an estimation that a 10% increase in market size will have a 30% increase in R. Dubio et al studied the effect that price controls in other countries have on innovation. He found that because the lower expected spending per consumer the R decisions in foreign countries were not as responsive to unit changes in projected revenue as compared to the same changes in the US.
Contrary to reducing spending, proponents of negotiating prices for Medicare think that to help overcome the potential downfall of innovation, the government could offer rewards for innovation. The idea being that the return from the public system on R will be higher than the return from the private sector. There are few situations in which the public-sector spending is good for the market, For example, research would be needed in which a private market does not exist. However, this is not the case for healthcare. Therefore, price rewards in the healthcare market would not be appropriate due to the existence of goods and products already being brought to market.
A typical argument contradicting such studies is that the innovations produced by an increase market share are not breakthrough drugs rather “me-too” drugs that add little value to society. Assuming that treatment effects are heterogenous, and across the whole population two drugs produce similar benefits but different in subpopulation the reduced amount of innovation of “me-too” drugs could have a negative impact on health. Some argue that the federal government is a better judge of the value offered by brand-name drugs; however, there is little evidence supporting such an argument (Joyce, 4). In contrast, Medicare promotes competition and value as consumers are given choices to the plan and medicine they want based on cost.
The analysis to determine the effects Medicare Part D has had on the economy show surprising results. Over the first five years (2006-2010) of the plan, it cost much less than projections. As mentioned above one of the contributions to this measurement could be that less people enrolled than planned, but the analysis also shows that per-person the cost of Medicare Part D was lower than original projections. This is shown in Figure 3 by a report from the CBPP.
The solution to the high drug prices is much more complicated than giving government negotiation power. The obvious problem is that drug prices are two high for many consumers; however, a decrease in prices could provide weaker incentives for innovation therefore less brand-name drugs will be produced. Instead of this short-term solution the government should focus on providing tools that place more risk on providers, essentially shifting the focus to value rather than price.
An overall macro analysis of the healthcare system shows that the focus on high drug prices is disproportionate compared to the other inefficiencies. One of the key reasons for this focus is that brand-name drug prices are extremely high; however, this is in part to the market regulation and patent control. “Today’s high-priced branded drug is tomorrow’s generic.” Essentially, the high prices are the cost we pay to use the drug affordably in the long run. World stats show that 97% of the medicine in use has already been around for 10 years. Prescription drugs play a valuable part in our economy. Giving the government power to negotiate prices would have a negative impact on the prescription drugs produced due to the decrease in innovation.
However, it is clear the facts cannot be ignored of the high initial prices of brand-name drugs. A possible government solution that is being worked on by different organizations is a tool to measure value and cost-effectiveness that can help guide decisions on drug treatments (Joyce, 7). This would help providers give beneficiaries the best value of care rather than the highest cost. Pay-for-performance contracts, great price scrutiny, and promoting competition are all potential solutions to move the paradigm shift to policies and movements that could provide more benefits than government negotiation.
The common consensus supports that the government should negotiate prices of brand-name prescription drugs for Medicare Part D. To do so the government would need to amend the Modernization Act of 2003, appealing the “nonintervention clause.” This paper argues that this policy would not be effective in creating a long-term solution for the high prices of drugs for outpatients. Instead of focusing the argument on a program that gives consumers choices, promotes competition through the multiple providers that already has a method to negotiate prices; the shift should place greater focus on providing value to beneficiaries through pay-for-performance contracts, price scrutiny, and promoting competition.
On a personal note. I believe that we should minimize government involvement because the company I work at was contracted by the government to do market research. We scoped out the project, gave them a quote and received their invoice. Once the invoice was received our client (the government) stopped communication with us. We reached out multiple times to finish the project to no avail. Essentially, the government just handed us money, this never happens in business! Point being, the government should not try to negotiate brand-name drug prices because it most likely won’t follow through. The private sector is much more effective when correctly regulated.
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