While the bulk of the proposed 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. increases and spending programs remain under debate, Democratic lawmakers have reportedly agreed on prescription drug pricing provisions as a starting point for a revived Build Back Better package. Advocates of the drug pricing policy argue it would allow Medicare to negotiate prescription drug prices, but it amounts to government price setting for prescription drugs enforced by an inordinately large excise tax penalty for noncompliance.
The legislation would require the government to “negotiate” the prices of certain prescription drugs under Medicare Part D, the program to help seniors afford prescription drugs. Government-set prices would lead to lower drug costs for certain drugs, and over time, spending by the federal government and some private payers would fall.
The government would use the leverage of excise tax penalties of up to 1,900 percent to make drug manufacturers lower their prices. The Joint Committee on Taxation (JCT) expects all manufacturers would participate in the price negotiation process (or pull a particular drug out of the U.S. market entirely) rather than pay the 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. on drug sales—so the excise tax itself does not raise revenue.
| Tax-Inclusive Rate | Tax-Exclusive Rate | Tax and Underlying Price for a $100 Drug without separately stated tax | Tax and Underlying Price for a $100 Drug with separately stated tax |
|---|---|---|---|
| 65% | 186% | $35 deemed price + $65 deemed tax = $100 total |
$100 stated price +$186 stated tax =$286 total |
| 75% | 300% | $25 deemed price +$75 deemed tax =$100 total |
$100 stated price + $300 stated tax =$400 total |
| 85% | 567% | $15 deemed price +$85 deemed tax =$100 total |
$100 stated price + $567 stated tax =$667 total |
| 95% | 1,900% | $5 deemed price +$95 deemed tax =$100 total |
$100 stated price + $1,900 stated tax =$2,000 total |
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Source: Author calculations based on H.R. 3. |
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The threat of excise tax penalties would provide enough leverage to force companies to lower their prices, thus generating cost savings for the federal government, not new tax revenue. The Congressional Budget Office (CBO) estimates over the 10-year budget window from 2022 through 2031, the drug pricing provision would reduce federal spending by $101.8 billion.
The cost savings would not be free. Instead, it would come at the expense of drug company revenues, thus reducing research & development spending. A reduction in R&D spending would reduce innovation and reduce the number of new drugs available.
The reduction in R&D, innovation, and new drugs is why the nonpartisan CBO, when analyzing past versions of drug pricing legislation, found, “The overall effect on the health of families in the United States that would stem from increased use of prescription drugs but decreased availability of new drugs is unclear.” In other words, it is not a clear win for Americans’ health to force lower prices for certain existing drugs today at the expense of the development of new drugs tomorrow.
A reduction in drug development, and lessened access to new drugs, is not just a hypothetical concern. The same story has played out before in Europe, as many countries pursued drug pricing policies in the 1990s that led to an exodus of R&D activity and other negative effects.
For example, economists Joseph Golec and John Vernon estimated by 2004, the real costs of the European Union drug pricing policies were “about $5 billion in forgone R&D spending, 1680 fewer research jobs and 46 forgone new medicines. Prospective long-horizon costs for the EU are estimated at between ten and 20 times these costs. … These policies essentially trade off the health and employment opportunities of future generations for cost savings for current pharmaceutical consumers.”
As a number of competitors, including China, Singapore, Japan, and Sweden, have implemented strategies to attract life-sciences innovation, U.S. policymakers should learn from the European experience of government price setting before pursuing similar policies in the reconciliation package that could chill U.S. R&D spending and medical innovation.
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