Four years ago, on August 16, President Biden signed the Inflation Reduction Act into law. Lawmakers promised that letting Medicare set drug prices would save taxpayers more than $100 billion over a decade.
New research suggests the IRA may accomplish the opposite in the long run.
A study by University of Chicago economist Tomas Philipson and his colleagues estimates that the law’s price controls could raise average lifetime prices for the first 25 medicines selected for price-setting by 19%.
How is that possible? Competition—or a lack thereof. Cutting the revenue a brand-name drug generates today can make its market less attractive to generic and biosimilar manufacturers tomorrow. Fewer competitors after the brand loses exclusivity can mean higher prices for years to come.
Generics are the pharmaceutical market’s biggest success story. They account for nine of every 10 prescriptions filled in America.
A new medicine generally enjoys a period of market exclusivity that gives its developer an opportunity to earn a return on the enormous investment required to bring it to market.
Eventually, the branded medicine loses its market exclusivity. Generic manufacturers can then seek approval to sell competing versions of conventional drugs, while biosimilar manufacturers can challenge biologic medicines.
That’s when competition takes over—and prices can fall dramatically.
Philipson and his colleagues found that when one generic manufacturer enters a market, the average generic price is about 79% of the brand-name drug’s price. When 10 or more manufacturers compete, the generic price drops to just 16% of the original price.
Generic and biosimilar manufacturers must invest in product development, manufacturing, FDA approval and sometimes patent litigation before selling a single dose.
A standard generic can cost up to $10 million to develop, while a biosimilar can cost $100 million to $300 million. Manufacturers therefore have to decide whether the potential market justifies the investment.
Larger, more valuable drug markets understandably tend to attract more competitors. Research cited by Philipson and his colleagues estimates that every additional $140 million in annual branded revenue before generic entry is associated with roughly one additional generic manufacturer.
More revenue attracts more competitors. More competition drives prices down.
That’s precisely the dynamic the IRA disrupts.
The law targets some of Medicare’s highest-spending medicines—the very markets that might otherwise attract vigorous competition once exclusivity ends. Under the IRA, Medicare can select small-molecule drugs for price controls seven years after FDA approval and biologics after 11 years. The government-set prices take effect two years later.
So the IRA lowers branded revenue before these medicines would ordinarily face generic or biosimilar competition. That can make the market less attractive to prospective competitors. And every manufacturer that decides not to enter means less downward pressure on prices after exclusivity ends.
Philipson and his colleagues modeled that chain, from Medicare price setting to branded revenue to generic entry to post-exclusivity prices.
They estimate that government-set prices reduce net prices for the 25 branded medicines they studied by 37%, on average. Their model predicts that the resulting decline in revenue would lead to 37% fewer generic and biosimilar entrants.
With fewer competitors, post-exclusivity prices would be about 45% higher on average than they otherwise would have been.
Over a 35-year period, those higher prices would more than erase the initial savings from Medicare’s price controls. The researchers estimate that average lifetime prices for the 25 drugs would ultimately be 19% higher than without the IRA’s price-setting regime.
The results depend on the model’s assumptions. But the economic mechanism is straightforward: Companies invest when the potential return justifies the cost and risk.
For decades, U.S. drug policy has balanced temporary market exclusivity for innovators with vigorous generic competition afterward.
The IRA risks upsetting that balance. By suppressing branded revenues before exclusivity ends, Medicare’s price controls may discourage the very competitors taxpayers eventually depend on to drive prices down.
Washington can mandate a lower price today. It cannot mandate robust competition tomorrow.
The true cost of the IRA’s price controls therefore can’t be measured by the government’s immediate savings alone. Policymakers also need to ask what those controls do to the competitive market that is supposed to keep drug prices low for decades to come.