The InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act (IRA) imposed a new policy to allow the government to set the price of certain prescription drugs for Medicare. If firms do not comply with the government-mandated price, they can face exorbitant excise taxes on their drug sales (up to 1,900 percent). Forcibly lowering prices will reduce prescription drug spending, but it will also reduce investments that produce new drugs and new applications of existing drugs—side effects that are already being felt.
Medical innovation has brought trillions of dollars’ worth of benefits to Americans in recent decades in terms of longevity and better health outcomes. For instance, from 1990 to 2015, life expectancy in the U.S. increased by 3.3 years, 35 percent of which is attributable to pharmaceuticals. As the Congressional Budget Office (CBO) notes, drugs in clinical trials indicate that current innovation is focused on specialty drugs for new cancer therapies, Alzheimer’s disease, and Parkinson’s disease. Many recently approved drugs are “specialty drugs” that are expensive to develop and treat chronic, complex, and rare conditions. Rather than double down on the innovation-chilling Inflation Reduction Act policy as President Biden’s new budget and recently introduced legislation from Senators Amy Klobuchar (D-MN) and Peter Welch (D-VT) would do, lawmakers should work to improve investment incentives in the United States.
It takes an average of 10 years and up to $2 billion or more to develop a new drug, and ultimately, only about 12 percent of drugs that enter the clinical trial phase are approved for introduction by the Food and Drug Administration. In other words, developing a new drug is very costly and very risky; when a drug is successful, companies recoup their research and development (R&D) costs for failed and successful drugs alike through their sales.
In 2021, the industry spent more than $100 billion on R&D, and overall, the industry’s share of revenue devoted to R&D is higher than other knowledge-based industries. Expected future returns help determine companies’ R&D levels. The Inflation Reduction Act disrupts that process by placing a ceiling on prescription drug prices within Medicare, reducing the expected return to R&D, and thus reducing the incentives to develop new life-saving drugs and innovations.
Under the Inflation Reduction Act, the government will select its first 10 drugs this year to enter forced negotiations, which will begin in October 2023 with price controls taking effect in 2026. In 2025 and 2026, the government can select another 15 drugs, after which it can select 20 drugs per year, including single-source small molecule drugs that have been on the market for seven years and biologics that have been on the market for 11 years. While price controls only apply to Medicare Part D in 2026 and 2027, afterward they will apply to Part B as well. President Biden’s budget proposes bringing more drugs into forced negotiation and doing so sooner after they launch. And the recently introduced bill from Senators Klobuchar and Welch would increase the number of drugs to 20 and 40 while accelerating the applicability to Part B, among other changes.
The CBO estimates the Inflation Reduction Act will cause pharmaceutical revenues to drop by $237 billion by 2031, while other estimates find a larger drop: $450 billion from 2026 through 2032. Academic literature indicates a 1 percent drop in pharmaceutical revenues translates to a 1.5 percent drop in R&D activity.
As a result of the Inflation Reduction Act, we may see up to 135 fewer drugs brought to the market, amounting to $18 trillion of health losses through 2039. Specifically, by reducing revenues and the return to drug development, the Inflation Reduction Act may reduce the discovery of new treatments, new uses for existing drugs, and generic competition.
Pharmaceutical companies’ expectations align with academic projections. For instance, in one survey, 78 percent of respondents expected to cancel early-state pipeline projects, and 95 percent expected to develop fewer new uses for medicines because of the limited time available before being subject to government price setting.
While anecdotes do not equal data, they do suggest the predicted decline in drug development is coming to bear. One analysis found that in the first four months of 2023, at least 24 companies made announcements to curtail drug development because of the new law. For example,
- Eli Lilly announced it is canceling work on a drug that had been undergoing studies for certain blood cancers.
- Alnylam announced it is suspending development of a treatment for Stargardt disease, a rare eye disorder.
In addition to the direct reduction in revenues, the Biden administration recently released rules revealing the steep compliance burden companies will face as a result of the new policy.
For example, companies will have to submit information on “research and development costs for the drug and the extent to which the manufacturer has recouped those costs, unit costs of production and distribution, prior federal financial support for novel therapeutic discovery and development with respect to the drug, data on patents and on existing and pending exclusivity for the drug [and] market data and national sales volume data for the drug.” As others have pointed out, the sheer volume of data required for the government to determine a price for a single drug is massive and creates a significant burden on government administrators as well as companies.
We don’t have to look far to see how similar drug pricing policies have played out around the globe. Drug pricing policies in the European Union have discouraged R&D and slowed patient access to new drugs. For example, patients in the United States have access to 93 percent of new cancer treatments that have been approved since 2012, while patients in other countries have much lower access—Germany (71 percent), United Kingdom (69 percent), France (64 percent), and Canada (59 percent). Capping prices and profits in the United States, as the Inflation Reduction Act does, invites similar delays and lack of access for U.S. patients.
As predicted, the Inflation Reduction Act’s misguided price-setting policy is already discouraging drug development. Rather than double down on it, as President Biden proposes doing in his budget, lawmakers ought to restore incentives to invest in the United States, such as canceling R&D amortization and canceling the phase-out of 100 percent bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. .
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