H.R. 3 Would Reduce R&D Spending and Medical Innovation

September 8, 2021

The technological advancements that allowed many employees to work from home and patients to seek medical care remotely throughout the COVID-19 pandemic would have been impossible without earlier investments in research & development (R&D). Likewise, thanks to decades of R&D in the pharmaceutical industry and the resulting technological breakthroughs, nearly every adult in the United States has access to safe and effective COVID-19 vaccines.

Lawmakers are considering policy changes within the reconciliation bill that would reduce private R&D within the pharmaceutical industry and reduce the number of new drugs coming to market. Instead of hampering medical progress, policymakers should work to ensure that the tax code remains conducive to R&D spending and the resulting innovation.

In 2018, the pharmaceutical industry invested about $129.5 billion in medical and health R&D, compared to $43 billion from federal agencies. The Congressional Budget Office (CBO) reports that the pharmaceutical industry spends a relatively large share of its revenue on R&D,  even compared to other knowledge-based industries, such as semiconductors, technology hardware, and software. Further, the CBO finds that public- and private-sector R&D spending are complements, not substitutes.

As explained here, lawmakers are considering H.R. 3, the Elijah Cummings Lower Drug Costs Now Act, to allow the government to set prices for prescription drugs under Medicare Part D using excise tax penalties of up to 1,900 percent for noncompliance. This would generate about $581 billion in cost savings over ten years (not new tax revenue) for the federal government.

The CBO previously estimated the policy would reduce global pharmaceutical revenues by about 19 percent, leading to 8 to 15 fewer new drugs coming to market over 10 years (about a 3 to 5 percent reduction) and 30 fewer in the next decade (about a 10 percent reduction). The impact could be even worse—in CBO’s view, this estimate is the middle of the distribution of possible outcomes.

A white paper by Kirsten Axelsen and Rajini Jayasuriya of Charles River Associates highlights some shortcomings of the CBO’s approach, including that CBO does not account for certain features of the U.S. market and likely understates the reduction in pharmaceutical company revenues and innovation.

Similarly, Doug Holtz-Eakin of the American Action Forum argues that CBO’s estimate should be thought of as a lower bound: “The real issue is that the drug industry would be much, much less attractive as a location for risk capital, so that the lost revenues [estimated by CBO] is the lower bound for the loss of innovation finance.”

Some in the industry argue that smaller firms would be disproportionately affected by H.R. 3, leading to a drop in new drugs from these firms. Smaller and emerging biotech companies account for a growing share of new drugs; they receive venture capital funding as well as support from larger pharmaceutical companies.

A 2019 study from IQVIA Institute for Human Data Science explains how the drug development ecosystem has evolved over the last decade, including the growing role of emerging biotech firms:

A record number of new active substances (NAS) [59] were approved and launched in the United States in 2018, bringing new treatment options to patients…. Emerging biopharma (EBP) companies patented almost two-thirds of these new drugs and registered 47% of them, while large pharma companies patented one-quarter of the total. The critical role of emerging biopharma companies in sourcing innovative medicines has expanded significantly since 2010, when they registered 33% of the drugs launched that year. Although the importance of large pharma in originating molecules is decreasing, they remain important partners for EBP companies even as EBP are increasingly able to commercialize alone. Large pharma companies registered nearly half of the new drugs in 2018, approximately half of which originated with emerging biopharma companies.

While advocates of the proposed legislation will challenge industry analyses, estimates from outside groups find the cost of H.R. 3 to be much higher than what CBO finds.

A 2019 study updated in 2021 by Avalere finds H.R. 3 would have a larger effect on federal spending and pharmaceutical revenues than CBO’s estimates: Avalere estimates it would reduce federal spending by $850 billion to $1.06 trillion and reduce pharmaceutical company revenues by $1.3 trillion to nearly $1.7 trillion, or a 34 percent to 44 percent reduction in U.S. brand drug revenue across the Medicare and commercial markets.

A 2021 study from Vital Transformation found that—depending on how quickly the government implements government-set prices—by 2024 earnings would fall by 46 percent under a slower implementation, or 62 percent under faster implementation. On average, one-fourth of affected companies would lose more than 100 percent of their annual earnings, because H.R. 3 would have an additive effect for companies with multiple drugs subject to government-set prices.

The Vital Transformation study anticipates that on average, H.R. 3 would cause a loss of $102 billion in revenue per year and a 90 percent or greater reduction in the number of medicines developed by smaller and emerging businesses, or 61 fewer medicines over ten years.

In August 2021,CBO published a new paper with estimates of a hypothetical policy change that would reduce pharmaceutical revenues by 15 to 25 percent, a range roughly similar to their estimated impact of H.R. 3. Such a drop in revenue would lead to 2 fewer drugs in the first decade (a 0.5 percent reduction), 23 fewer in the second decade (a 5 percent reduction), and 34 fewer in the third decade (an 8 percent reduction), according to their analysis. Factors such as how far along in development drugs are when the policy is implemented and how the policy could change the cost of capital could push the impact up or down.

Even in CBO’s estimates—which likely represent a lower-bound in the reduction in innovation—they conclude that the impact of H.R. 3 on American’s health is unclear because the harm caused by fewer new drugs available to consumers may outweigh the benefit of lower prices for existing drugs. Given that other analyses indicate H.R. 3 may have an even larger chilling effect on R&D spending, risk-taking, and the development of new drugs, it would be unwise for lawmakers to use government-set pricing under the threat of steep excise tax penalties as a way to pay for reconciliation or address prescription drug prices. It would come at the cost of R&D, innovation, and the resulting improvements in health outcomes.

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An 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 make up a relatively small and volatile portion of state and local tax collections.