The Drug Provisions of The Inflation Reduction Act are Far from Harmless

Supporters of the Inflation Reduction Act are applauding its drug pricing measures, claiming they will help average Americans get a handle on rising healthcare expenses. But at what cost in terms of health impact?

Together with my colleagues at the University of Chicago, I have found that the existing evidence implies that lowered R&D incentives resulting from the IRA will reduce lifespans by an amount 30 times higher than COVID mortality effects to date.
 
This calculation is substantially at odds with other assessments, including a recent and influential one by Avik Roy and Gregg Girvan published in the Washington Post. While I often agree with their work, they have misstated the effects in this case.
 
First, Roy and Girvan claim that the largest companies – 'big pharma' – are unproductive in conducting their R&D. They reach this judgment based on inputs per drug produced. But for drug makers, the measure of output is not the number of new drugs, but the improved health they produce. A new aspirin substitute is not the same as a drug that cures all cancers, and thus the output generated by Pfizer's and Moderna's COVID-19 R&D was not 'two drugs.' Rather, the vaccines saved millions of lives and restored trillions in economic output to the global economy.
 
Indeed, the evidence suggests the research-based biopharmaceutical industry has been very productive in transforming R&D investments into improved health – responsible for 35 to 73 percent of U.S. longevity gains of the past 30 years. Because life and health are valued far more than anything else, this represents an enormous creation of value. Using standard government metrics, we have found an annual value of $2.3 trillion to $4.7 trillion without including the value of reduced morbidity.

For benchmarking purposes, this was about 9.8% to 20.5% of GDP in 2021. But this value is not included in GDP, which measures spending. The research-based pharmaceutical industry has generated this value with sales making up about 1.4% of our GDP. Similar studies of the value generation for specific drugs treating HIV, cancer, hypertension, and other diseases complement this aggregate finding.

Second, it is argued that price controls on larger biopharmaceutical companies are justified because their research productivity is lower than that of smaller companies. This overlooks the different roles played by big pharma and smaller bio-techs in drug development. About two-thirds of R&D spending is on clinical trials. Larger companies fund the more costly FDA phase 3 trials relative to cheaper phase 1 and 2 trials often funded by smaller bio-techs. The latter simply fund the cheaper part of the development process.

More importantly, price controls on big pharma will hurt the whole development chain, whose value ultimately derives from big pharma's sales. Thus, the price controls on big pharma will lower R&D investments into smaller bio-techs, because all companies in the development chain are ultimately driven by the final sale of the product. Even though the legislation attempts to insulate smaller firms from the effects of price controls, their imposition on large companies inevitably hurts smaller bio-techs as well.

Third, it is argued that because the drugs subject to price controls represent a minuscule share of the thousands of drugs on the market, price controls will have a negligible effect on innovation. But the Act has the government take over pricing of the top-selling drugs – a status these drugs gained by helping the most patients. Because drug development, like many other innovative industries, is highly skewed in its returns, these blockbuster winners fund all the losers in the FDA process, where more than 90% of drugs fail.

Indeed, estimates suggest that revenues from the Medicare outpatient drug program (Part D) will be reduced by 45% from the Act by 2031. Given that the U.S. market provides around 75% of the global returns on drug innovation, that's a large hit to the US engine that finances R&D investments.

Add to this that drugs competing with the price-controlled drugs will have to lower their prices to survive. Funds available to their makers for R&D will be cut accordingly. In essence, arguing innovation won't be affected much by the government taking over a small set of top-selling drugs is like arguing that the performance of a 3,500-pound car wouldn't be affected much by removing its 5-pound steering wheel.

More importantly, government programs typically grow over time through marginal expansions. This Act will open the door to a larger set of price-controlled drugs in the future. Indeed, that slippery slope is already part of the Act, which expands the set from 10 drugs in 2026 to 25 in 2027 and 60 in 2029. Eligibility expansion is a true and tested strategy to expand government involvement after gaining an initial foothold. Exhibit 1 would be Medicaid.

These misunderstandings about the health effects of the IRA aside, high prescription drug prices are a real concern for many Americans. We need good policies to address them. But the high prices themselves are often government-induced, whether by well-intended policies that erect entry barriers or reimbursement incentives that reduce price competition. For example, Medicare pays doctors more if they use more expensive drugs in their clinics. Perversely, this means that customers – the doctors themselves – actually want higher prices, not exactly an ideal setup to generate price competition. Ironically, many lawmakers upset about high drug prices push for the policies that generate them.

For many lawmakers and price-control advocates, their underlying concern is industry profits – even though on a risk-adjusted basis those are lower than for the majority of industries. In a risk-taking capitalist economy, it seems pertinent to ask if there is any activity more deserving of financial reward than helping people rid themselves of dreadful diseases. If life and health are valued more than anything else, shouldn't those who enhance them receive large rewards?

Philipson is an economist at the University of Chicago who served on the White House Council of Economic Advisers as a member and acting chairman, 2017-20.