Over the past few days, several news sources have called attention to the rising cost of prescription drugs in the United States. Yesterday, USA Today reported that the nominal cost of prescription drugs rose 13% in 2014, the largest percentage increase for over a decade. This morning, CNBC noted that 73% of Americans believe that medication costs too much. And, last week, a Huffington Post contributor called attention to the case of brand-name prescription drugs, whose prices rose by an average of over 40% between October 2012 and April 2015.
The articles in question gave several possible explanations for rising drug prices, including the introduction of new specialty medications, higher research and development costs, and pharmaceutical companies’ falling revenues. None of the news sources, however, raise the possibility that recent federal policy changes may have influenced rising drug prices. In particular, it seems likely that a new federal fee on branded prescription drug sales has contributed to the rising cost of drugs.
The Branded Prescription Drug Fee is one of several new excise taxes included in the Affordable Care Act to help cover fund the federal government’s expanded role in the health care system. In fact, it is one of the most significant revenue provisions in the bill, designed to bring in $27 billion of new revenue over ten years.
As its name implies, the Branded Prescription Drug Fee is targeted at pharmaceutical companies that sell branded prescription drugs. Unlike most taxes, the Branded Prescription Drug Fee is calculated, not as a percentage of pharmaceutical company’s total sales, but in proportion to its share of the branded prescription drugs market. For every year, beginning in 2011, the Affordable Care Act specifies a certain lump sum that the IRS must collect from the branded prescription drug industry. Then, each pharmaceutical company pays a portion of this sum that roughly corresponds to their market share of branded prescription drugs.
The annual revenue targets for the Branded Prescription Drug Fee are displayed in the graph above. As an example of how the fee works, if a pharmaceutical company accounted for 15% of all branded prescription drug sales in 2015, it would owe the federal government 15% of the 2015 revenue target for the Branded Prescription Drug Fee – or $450 million (15% of $3 billion).
There is significant reason, in theory, to believe that an excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. such as the Branded Prescription Drug Fee would lead to rising pharmaceutical prices. According to a study from RAND, demand for prescription pharmaceuticals is highly inelastic: sales typically fall by only 0.05-0.08% for each 1% increase in cost. This means that a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on branded prescription drugs would probably not lead to a large fall in drug sales, but would mostly translate into an increase in drug prices. Because the branded prescription drug industry is about $268 billion in size, a tax of $3 billion on the industry is equivalent to roughly 1% of sales – which would lead to a significant portion of the observed rise in prices.
One important source of evidence that the Branded Prescription Drug Fee has, in fact, contributed to recent rising drug prices is that, over the past two years, prices of branded drugs have risen much more dramatically than those of generics have. According to data from the IMS Institute for Healthcare Informatics, the average price of branded prescription drugs grew by 17.0% in 2013 and 24.9% in 2014, while the average price of generic prescriptions grew by 2.9% and 9.8% in those two years. Of course, it is always difficult to pinpoint specific causes of price movements – especially because of the extensive effects of the Affordable Care Act on other aspects of the pharmaceutical market – but the relatively high price growth of branded drugs is evidence that the Branded Prescription Drug Fee has contributed to higher drug prices overall.
News coverage of the rollout of the Branded Prescription Drug Fee has been sparse, but some evidence has emerged over the past few years that the fee has significantly affected pharmaceutical industry profits. In October, Gilead Sciences reported that their $337 million Branded Prescription Drug Fee had lowered their company’s earnings from $2.05 a share to $1.84 a share. While news sources do not yet appear to have made this connection, it is likely that pharmaceutical companies including Gilead anticipated these reduced earnings and raised drug prices in response.
The Branded Prescription Drug Fee is set to increase over the next few years, spiking in 2017. If the usual rules of economics apply, we can expect these fee increases to be passed along to consumers over the next few years in the form of even higher branded prescription drug prices.Share