Supply & Demand

Pharma’s Rebate Rule: Inside Job or Political Genius?

(michaelquirk/Getty Images)
Trump's proposal to eliminate drug rebates might be good politics, but it would hurt consumers.

America’s candy bars kept getting smaller. The federal government, especially its Office of Price Administration (OPA), claimed that it would protect consumers by putting a ceiling on the prices of food items during World War II. OPA knew that candy makers would try to evade the controls by putting less candy in the package, so it promulgated price regulations based on the weight of the candy indicated on the package. Packages got lighter anyway because, as OPA discovered years later, the makers had always put extra candy in the package and were thereby able to increase the price per ounce merely by putting in fewer extra ounces.

Dissolved long ago, OPA is today a reminder that price regulations intended to “protect consumers” are usually gamed by industry to gouge them instead. Indeed, President Trump has a record of helping consumers of everything from Internet service to automobiles, prescription drugs, kidneys, and vaccines, by eliminating or relaxing regulations that distort prices.

But now President Trump’s Health and Human Services secretary Alex M. Azar II is promulgating a new “rebate rule” that will regulate pricing of business-to-business transactions in the pharmaceutical industry. Specifically, it prohibits rebates in Medicare Part D, a major part of the prescription-drug industry.

“Rebates” are checks reluctantly written by drug companies to health-insurance plans. Much in the same way that a food manufacturer asks a grocery store for prominent shelf space, or a beverage manufacturer asks to be exclusively offered on a restaurant’s menu, each drug manufacturer asks health-insurance plans to give their product special placement (in terms of, say, percentage reimbursed by the plan). The store, restaurant, or insurance plan may grant the manufacturer’s request, but only in exchange for steep rebates on the product, which are savings that ultimately benefit consumers. For insurance plans covering prescription drugs, the consumer savings come in the form of lower monthly premiums (the insurer’s payment of claims needs less in the way of premiums paid by consumers when there are more rebates from drug companies). Effectively, a drug company charges less when it strikes a deal with an insurer.

Naturally, drug companies would prefer not to write rebate checks, but they must write them to remain competitive. Unless, of course, they can persuade the federal government to end the practice. If it holds up in court, Secretary Azar’s rebate rule will do exactly that. When members of his staff first brought the idea to the White House in 2018, they proudly recounted how they “showed this to the President of Pfizer [a major drug company] and he thought it was an excellent idea!” (Secretary Azar himself used to be president of Eli Lilly, another major drug maker.) It did not occur to them that, in a room full of White House staffers enthusiastic to help “drain the swamp,” drug-company approval of a regulation helping to protect it from competition would be seen as convincing evidence that the regulation contradicts administration priorities.

The federal Office of the Chief Actuary projected that, if legal, the rebate rule would raise premiums on prescription-drug plans and transfer more than a hundred billion dollars (over ten years) from taxpayers to drug manufacturers. The non-partisan Congressional Budget Office reached a similar conclusion. Vice President Pence aptly called the rebate rule “corporate welfare” shortly before President Trump told Azar to withdraw the rule in 2019.

Eager to further reduce prescription drug prices, President Trump issued an executive order this summer directing Secretary Azar to consider passing the rebate rule if he could “confirm — and make public such confirmation — that the action is not projected to increase Federal spending [or] Medicare beneficiary premiums…”

Although he is making the rule final, Secretary Azar has not provided any coherent confirmation. Instead, the final rule redirects to his web page, which brags about the prominence of Big Pharma on his resume and then proceeds to assert that “middlemen” rather than beneficiaries will pay for the missing rebates. This assertion defies arithmetic, given that the profits of middlemen are only 2 percent of industry revenue, whereas the rebates to be eliminated are almost 30 percent (see Table IV.B8 of this document).

So why then is President Trump tolerating this giveaway to Big Pharma? I am no lawyer, but one possibility is that White House attorneys suspect that courts will reject or relax the rule, as they have other parts of the secretary’s “Drug Pricing Blueprint.” In other words, the rebate rule is an exercise in political advertising (drug prices must come down!) rather than actual policy.

Or maybe, like the candy makers of the 1940s, insurance plans will cleverly circumvent the new prohibition, thereby retaining premium savings for their customers.

Casey B. Mulligan is a professor of economics at the University of Chicago’s Kenneth C. Griffin Department of Economics, and served as the chief economist of the White House Council of Economic Advisers in 2018–19. He is also the author of the recently released You’re Hired! Untold Successes and Failures of a Populist President, which details conflicts between President Trump and special interests.