Critical Condition

More Price Controls, Fewer Jobs, and Less Innovation

One common deficit-reduction idea — proposed by President Obama and floated in Congress’ bipartisan “supercommittee” — is to impose additional rebates on Part D drugs for “dual eligibles.” In other words, the government would force drug companies to partially reimburse it for the drugs purchased by seniors who participate in the Medicare Part D program (which gives seniors a subsidy so they can buy a private drug plan) but are also eligible for Medicaid (which simply requires drug companies to give large rebates if they want their drugs to be covered). Put more simply, the president wants to impose price controls on a large portion of the pharmaceutical market. According to the president’s proposal, mandatory rebates for these populations would reduce the deficit by approximately $135 billion over ten years.

Before Medicare Part D went into effect in 2006, drug companies had to pay Medicaid’s required rebates for seniors who were eligible for the program; now, when a Medicaid-eligible senior enrolls in Part D instead, drug companies have to pay only the rebate they negotiate with the private insurance company, which is typically lower. Therefore, the argument goes, Part D is a “giveaway” to drug makers.

First of all, Part D isn’t a “giveaway,” since the program requires drug companies to compete with each other to offer significant discounts to all Part D enrollees —  in 2009, these discounts totaled about 11 percent of prescription-drug costs, although they can reach as high as 20 or 30 percent for some brand-name drugs, according to the most recent report by the Medicare trustees. (The required Medicaid rebates are 23.1 percent for brand-name drugs and 13 percent for generics.) Part D’s strategy of using market competition to keep prices low has worked much better than almost anyone expected, with Part D costs to tax payers about 40 percent less than originally estimated.

So what? critics might reply. Let’s just take $135 billion more from those greedy pharmaceutical companies. The problem, as former Massachusetts governor Mitt Romney observed not too long ago, is that corporations are people too. Or rather, they are legal fictions that represent their employees, their shareholders, their vendors, and the patients who rely on them for a steady stream of innovative new products — in this case, medicines.

As a result, Medicare Part D price controls will affect people in a number of different ways. Maybe companies would just take a hit to their bottom-line profits and eat the rebates. But even if that happened, investors would respond to the lower profitability by shifting their money elsewhere, depriving the industry of the money it needs to develop drugs and dealing damage to the companies’ share prices. If you happen to have a 401(k) with any drug-company stocks in it, you’d feel the pain.

Instead, companies would probably pursue two other basic options: cut costs or raise prices.

Cost cutting would come in the form of laying off workers (or reducing pay and benefits), sending more jobs and manufacturing facilities to low-cost countries abroad, or reducing investment in discovering new medicines. None of these responses should count as a winner for the U.S. economy. One recent study found that the president’s proposal could reduce direct and indirect employment in the pharmaceutical industry by up to 238,000 jobs by 2021.

Reducing research-and-development spending might seem like a clear “winner” for the supercommittee, since fewer expensive new drugs would come on the market. The government’s drug tab would decline rapidly (aided by the expiration of existing drug patents), but as the U.S. population aged and more people became afflicted by cancer, Alzheimer’s, and other expensive chronic illnesses, we’d just spend more money on hospital care and physician care — actually increasing overall health-care spending. (Economist Frank Lichtenberg estimates that for every $1 that Medicare spends on newer medicines, it saves about $6 in other health-care costs, mainly from reduced hospital costs.)

Finally, companies could respond to larger rebates by increasing prices (or decreasing discounts) in the rest of the Part D program, or for non-Medicare insurers. Given the size of the cuts the president has proposed, companies would likely do all of this to some degree — raising premiums for non-dual-eligible seniors, and thus requiring the government to give higher subsidies for non-dual-eligible Part D recipients (reducing the expected deficit savings).

Given the complexity of the underlying markets, it’s hard to say exactly what mix of job losses, research-and-development cuts, and price increases would follow from the president’s proposal. What is certain is that these are all bad outcomes for patients and the country.

They are particularly bad because they are hitting an industry in the midst of enormous revenue losses from patent expirations, rapid increases in the costs of developing FDA-approved drugs, and new hurdles from health-care reform, such as Medicare’s Independent Payment Advisory Board, that will make bringing new drugs to market even more of a financial risk than it is today.

A better alternative for Medicare reform is to enact something like House Budget Chairman Paul Ryan’s premium-support plan. Similar plans have been proposed by bipartisan experts for years, and such a model would introduce market forces to correct the inefficiencies that have plagued the program for so long.

Ryan’s plan, rather than penalizing innovators, would reward them for finding better ways to hold costs down. The president’s plan to impose price controls on Medicare Part D would kill jobs, strangle medical innovation, and shift health-care costs to other seniors and private insurers. It’s a bad idea, and the supercommittee can do much, much better.

— Paul Howard is director of and a senior fellow at the Manhattan Institute’s Center for Medical Progress, and the managing editor of

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