It's been four years, nearly to the day [August 12, 2022], since Congress passed the Inflation Reduction Act (IRA) on a party-line vote. The bill accomplished Democrats' longstanding goal of allowing Medicare officials to "negotiate" the price of prescription drugs.
At the time, liberal lawmakers claimed these price negotiations would save the federal government more than $100 billion over the next 10 years, with the savings compounding in subsequent decades.
Their math was -- and still is -- wildly off. As my University of Chicago colleagues and I show in a new paper, the IRA's price controls will likely increase long-term prices of medicines.
That counterintuitive finding stems from the complex relationship between the prices of brand-name drugs still protected by patents and regulatory exclusivity periods, and the much lower prices of generic and biosimilar therapies that arrive after market exclusivity expires. The IRA concerns price controls on brand name drugs that make up less than 10% of prescriptions, with 90% of prescriptions being written for generics and biosimilars. The question therefore is how the larger overall market is impacted by brand name price controls. The trade group for generics and biosimilars, The Association for Accessible Medicines, immediately raises concerns with IRA impacting their membership negatively. It's no secret that drug prices plummet after generic and biosimilar competitors hit the market.
But the magnitude of those price drops isn't random. As is true in most industries, more entries cut prices, so it depends on how many manufacturers decide to launch copycat products.
Our review of the evidence base finds that when there is just one generic competitor to a brand-name drug, the generic costs about 79% of the former brand-name drug's price, on average. When there are five generic competitors, the average price falls to roughly 49% of the pre-competition price. With 10 or more competitors, it drops to about 16%.
The same principle applies to biosimilars, which are near copies of brand-name "biologic" drugs derived from living cells. Since 2015, manufacturers have launched at least 67 biosimilars in the United States, and those drugs have saved Americans a collective $56.2 billion. In the case of some top-selling biosimilars today, biosimilar prices are now about 20% that of the branded product's list price.
Developing a generic or biosimilar is much easier than creating a novel drug from scratch. But it still takes years and can require tens or even hundreds of millions of dollars in development, manufacturing, regulatory, and legal costs.
Generic and biosimilar manufacturers therefore target markets where the expected payoff is largest. A blockbuster brand-name drug earning billions annually is a far more attractive target than a niche drug with limited revenue.
The data bear this out. Research has found that, on average, every additional $140 million in sales that a brand-name drug generates in the year prior to losing exclusivity is associated with roughly one additional generic entrant.
In other words, the higher a brand-name drug's revenue, the more generic or biosimilar competitors it is likely to attract. And more competitors push prices lower.
That is where the IRA creates a problem.
Medicare's price controls take effect before generic or biosimilar competition emerges. By pushing down a brand-name drug's revenue, the government essentially shrinks the prize available to future generic and biosimilar developers. Some of those manufacturers rationally decide that launching a competing product is no longer worth the risk and expense.
As a result, Medicare "saves" money thanks to lower government prices on brand-name drugs for a few years -- but misses out on even greater savings it would have realized from more intense generic and biosimilar competition.
Our analysis assessed this tradeoff, looking at the first 25 medicines for which Medicare officials have already set government prices. We estimate that the price controls have, or will, reduce those drugs' net prices by about 37%, on average, relative to a world without government price setting.
In our model, that drop in brand-name drugs' revenue leads to a 38% decline in the number of generic or biosimilar competitors coming to market. As a result of this decreased competition, the price of those post-exclusivity generics and biosimilars would be 45% higher, on average.
All told, we estimate that average prices for those 25 drugs in the three and a half decades after price setting takes effect will be 21% higher than they would be in the absence of price setting. Put simply, IRA makes drugs more expensive.
Congress made a fundamental error by assuming brand-name drug prices exist in isolation. The high revenues earned during a drug's market exclusivity period are precisely what entice generic and biosimilar manufacturers to eventually launch competing products. The IRA replaces this cutthroat market competition with bureaucratic price setting that could deter the launch of cheaper drugs.
The bottom line is that IRA may not just make future health more expensive by cutting innovation into new drugs but in addition raise the price of existing drugs. To call that a victory for patients is misleading on both fronts.
Tomas J. Philipson is an economist at the University of Chicago and served as a member and acting chairman of the White House's Council of Economic Advisers from 2017 to 2020.
At the time, liberal lawmakers claimed these price negotiations would save the federal government more than $100 billion over the next 10 years, with the savings compounding in subsequent decades.
Their math was -- and still is -- wildly off. As my University of Chicago colleagues and I show in a new paper, the IRA's price controls will likely increase long-term prices of medicines.
That counterintuitive finding stems from the complex relationship between the prices of brand-name drugs still protected by patents and regulatory exclusivity periods, and the much lower prices of generic and biosimilar therapies that arrive after market exclusivity expires. The IRA concerns price controls on brand name drugs that make up less than 10% of prescriptions, with 90% of prescriptions being written for generics and biosimilars. The question therefore is how the larger overall market is impacted by brand name price controls. The trade group for generics and biosimilars, The Association for Accessible Medicines, immediately raises concerns with IRA impacting their membership negatively. It's no secret that drug prices plummet after generic and biosimilar competitors hit the market.
But the magnitude of those price drops isn't random. As is true in most industries, more entries cut prices, so it depends on how many manufacturers decide to launch copycat products.
Our review of the evidence base finds that when there is just one generic competitor to a brand-name drug, the generic costs about 79% of the former brand-name drug's price, on average. When there are five generic competitors, the average price falls to roughly 49% of the pre-competition price. With 10 or more competitors, it drops to about 16%.
The same principle applies to biosimilars, which are near copies of brand-name "biologic" drugs derived from living cells. Since 2015, manufacturers have launched at least 67 biosimilars in the United States, and those drugs have saved Americans a collective $56.2 billion. In the case of some top-selling biosimilars today, biosimilar prices are now about 20% that of the branded product's list price.
Developing a generic or biosimilar is much easier than creating a novel drug from scratch. But it still takes years and can require tens or even hundreds of millions of dollars in development, manufacturing, regulatory, and legal costs.
Generic and biosimilar manufacturers therefore target markets where the expected payoff is largest. A blockbuster brand-name drug earning billions annually is a far more attractive target than a niche drug with limited revenue.
The data bear this out. Research has found that, on average, every additional $140 million in sales that a brand-name drug generates in the year prior to losing exclusivity is associated with roughly one additional generic entrant.
In other words, the higher a brand-name drug's revenue, the more generic or biosimilar competitors it is likely to attract. And more competitors push prices lower.
That is where the IRA creates a problem.
Medicare's price controls take effect before generic or biosimilar competition emerges. By pushing down a brand-name drug's revenue, the government essentially shrinks the prize available to future generic and biosimilar developers. Some of those manufacturers rationally decide that launching a competing product is no longer worth the risk and expense.
As a result, Medicare "saves" money thanks to lower government prices on brand-name drugs for a few years -- but misses out on even greater savings it would have realized from more intense generic and biosimilar competition.
Our analysis assessed this tradeoff, looking at the first 25 medicines for which Medicare officials have already set government prices. We estimate that the price controls have, or will, reduce those drugs' net prices by about 37%, on average, relative to a world without government price setting.
In our model, that drop in brand-name drugs' revenue leads to a 38% decline in the number of generic or biosimilar competitors coming to market. As a result of this decreased competition, the price of those post-exclusivity generics and biosimilars would be 45% higher, on average.
All told, we estimate that average prices for those 25 drugs in the three and a half decades after price setting takes effect will be 21% higher than they would be in the absence of price setting. Put simply, IRA makes drugs more expensive.
Congress made a fundamental error by assuming brand-name drug prices exist in isolation. The high revenues earned during a drug's market exclusivity period are precisely what entice generic and biosimilar manufacturers to eventually launch competing products. The IRA replaces this cutthroat market competition with bureaucratic price setting that could deter the launch of cheaper drugs.
The bottom line is that IRA may not just make future health more expensive by cutting innovation into new drugs but in addition raise the price of existing drugs. To call that a victory for patients is misleading on both fronts.
Tomas J. Philipson is an economist at the University of Chicago and served as a member and acting chairman of the White House's Council of Economic Advisers from 2017 to 2020.
