Drug Price Controls in the "Inflation Reduction Act" Will Be Bad for Your Health

Earlier this month, both the House and the Senate passed what is referred to as the Inflation Reduction Act (IRA). President Biden signed the IRA earlier this week, thereby making it law and worth a discussion. The IRA is a budget reconciliation bill that was reduced in size and scope in comparison to the Build Back Better Act that never passed. Even so, this bill [as proposed by the Senate] has multiple provisions, including raising $737 billion in taxes, spending $369 billion on climate change, and $300 billion in deficit. I hope to cover some of these other aspects at another time, but there is one aspect of the IRA that I would like to cover today: prescription drug price reform. 

The three main drug price reforms in the IRA are "allowing Medicare to negotiate select prescription drug prices, limiting drug price growth to inflation, and repealing the Trump-era drug rebate rule." I want to focus on the first two since they are forms of price controls, which refer to legal minimum or maximum prices [typically] mandated by the government for specified goods or services. Much like with other price controls, the Democrats are trying to implement price ceilings on prescription drugs in an attempt to manage their affordability, particularly for senior citizens on Medicare. 

At first glance, it might seem like the government could help out as a result of these de facto price ceilings. The Congressional Budget Office (CBO) projected that the IRA's drug policies will save $287 billion over the next decade.  

Normally, I would heed the CBO's estimation because CBO is generally considered the gold standard in legislative analysis. However, I have my doubts that these reforms would have net positive benefit. One of my main doubts is based on the economy theory of price controls (see analysis from the Federal Reserve Bank of St. Louis here). When the government limits the price of a good or service, it puts the new price below the equilibrium price that the market price (see below). Since the government mandated price is below the equilibrium market price, demand exceeds supply. In other words, the price control creates a shortage. In the pharmaceutical market, this makes even more sense since pharmaceutical companies devoted about 25 percent of its revenue to research and development in 2019 (CBO). Based on mainstream microeconomic theory, a price control will create a shortage of medicine. 

We have seen how price ceilings in other markets create unintended consequences. One example is that of rent control. Imposing the price ceiling of rent control creates a housing shortage, increasing housing costs in the uncontrolled areas, disincentivizes landlords to take care of rental units under rent control, and disincentivizes building new housing. Another example is price gouging laws during natural disasters. Rather than help out those who are needy, these price gouging laws end up prolonging the harm caused by the natural disaster because they muffle the market signals that would inform producers that an area needs goods.   

The prescription drug market is not an exception. The United States currently leads in research and development for biopharmaceuticals, but that was not always the case. Up until the 1990s, Europe was the leader in R&D. What changed that dynamic? According to a report from economic consultants at ndp research, price controls were the major culprit of this lag in biopharmaceutical innovation (Pham and Donovan, 2020). 

What was the result of such price regulation in Europe? A report from the National Bureau of Economic Research concluded that it resulted in "about $5 billion in foregone R&D spending, 1680 fewer research jobs, and 46 foregone 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 customers (Golec and Vernon, 2006)." Research from consultancy Vital Transformation also shows that price controls in the European market resulted in 14 percent less venture capital funding for startups, a 7 percent decrease in biotech patents, a 9 percent decrease in biotech start-up funding relative to the U.S., and an 8 percent increase of delay in access to medicine (Schulthess and Bowen, 2021). As such, it would not surprise me that the price controls in the IRA would backfire in a few ways similar to what happened in Europe:

• Increased health spending. While the CBO calculated that the price controls would save money, a couple of economists from the University of Chicago begged to differ (Philipson and di Cera, 2022). As these economists point out, price ceilings create shortages because researchers are incentivized to sell less. This creates loss offsets, which is how much health care spending increases as a result of fewer drugs in the market. This makes sense since drugs tend to alleviate the need for surgeries and hospitalizations. As such, the authors' calculation is that price controls would actually increase health care spending by $50.8 billion over twenty years. That might come out to about $2.5 billion extra over two decades, but it is still worth pointing out since these price controls were meant to lower healthcare costs, not increase them. 
• Less research and development to develop new drugs in the future. The CBO estimated that the IRA would make it so that 15 fewer new drugs would be introduced to the market. This would be a modest estimate considering that CBO does not "predict what kind of drugs would be affected or analyze the effects of forgone innovation on public health." Remember those economists in the previous bullet point? They estimated that 135 fewer new drugs would be produced as a result of the price controls. 
• Fewer new drugs means more dead people. The reduction in drug development will reduce quality of healthcare in the future because we will have access to fewer cures. What does having 135 fewer drugs mean for healthcare? Economists at University of Chicago answered that question in a November 2021 brief when Congress was toying with the idea of price controls for the Build Back Better Act (Philipson and Durie, 2021). They found that the 135 fewer new drugs as a result of the price controls would generate a loss of 331.5 million life years in the U.S. over a 20-year timespan. To put that number in context, 331.5 million life years is 31 times the amount of lives that COVID-19 took at the time of the report's publication in November 2021. In contrast to CBO reporting, the University of Chicago economists were at least transparent about its analysis and methodology. 

Postscript

Economist Milton Friedman once said that one of the greatest mistakes in public policy analysis is to judge policies by their intention rather than their result. In spite of their stated intention, price controls are shown to increase overall healthcare costs. They come with other unintended consequences, including less available medicine, lower research and development spending, less jobs on the biopharmaceutical sector, fewer new drugs on the market, and more dead people. While the drug price controls will be more limited in scope, unintended consequences such as these bother me when combined with the fact that the United States is one of the only developed countries that does not have drug price controls. Implementing these price ceilings will stifle innovation not only for the United States, but for patients across the world. These price controls are not going to stick it to pharmaceutical companies as much as they will the patient who needs improved medical access. There are better ways to fix this country's medical system, but one thing is for certain: price controls are a prescription for medicine shortages, higher costs of drugs, and more death.