The Case for Letting Medicare Bureaucrats Haggle With Drug Makers

Medicare's new price-setting process for drug purchases is better than its current one if the result is lower government spending.

When is a price control not a price control, extortion not extortion, and a tax not a tax? When drug manufacturers are fighting to preserve their government subsidies.

No one knows what the right price for drugs or anything else should be. That's why we need markets. If Medicare and Medicaid were like Social Security, which subsidizes enrollees with cash, that's largely what we would have. But since Medicare and Medicaid are the nation's two largest purchasers of prescription drugs, those programs dictate the drug prices they pay and distort private prices. 

There are indications that the pharmaceutical industry has captured the process for determining the prices Medicare pays them. In 2018, then–President Donald Trump's Department of Health and Human Services lamented, "the Medicare program pays nearly twice as much as it would pay for the same or similar drugs in other countries."

In an implicit admission that Congress has been and likely will continue to be a terrible drug-price negotiator, that body included in the Inflation Reduction Act (IRA) new powers for Medicare bureaucrats to haggle with drug makers. If a participating manufacturer refuses to negotiate, the law imposes drastic across-the-board reductions in its Medicare subsidies. 

Given these new powers, the Congressional Budget Office estimates that "net prices for selected drugs will decrease by roughly 50 percent, on average." If so, federal spending will be $102 billion lower between 2026 and 2031. By 2031, Medicare enrollees would save $7 billion annually in out-of-pocket spending. 

President Joe Biden announced the first 10 drugs subject to the new process include medications for diabetes, blood clots, heart failure, and gastrointestinal diseases. Manufacturers of those drugs are, to use a technical term, having a cow. Annual gross Medicare Part D spending on one of those drugs, the blood thinner Eliquis, exceeds $16 billion. Imagine being Bristol Myers Squibb's CEO and having to explain an $8 billion loss to your board and shareholders.

That prospect has reinvigorated many of the classic arguments against price controls, takings, and taxes, and in favor of innovation. The problem is that none of those arguments apply here. 

Medicare participation is voluntary. Whatever power Medicare has over pharmaceutical manufacturers stems solely from those firms' free choice to participate and remain in the program. They can leave any time they want, subject to one of the terms of participation—to which they voluntarily consented—that they continue selling their wares to Medicare for a certain number of months after giving notice of their withdrawal. 

It is therefore not a price control when Medicare reduces the price it is willing to pay for a drug. True, the Medicare price is a government-set price—but so are today's excessive Medicare prices. It is not a price control because the manufacturer is free to walk away and sell to other buyers at whatever price the market will bear. 

It is likewise not a taking when Medicare reduces the price it offers. Not even if that price is less than the cost of producing the drug. The manufacturer is perfectly free to reject Medicare's offer. 

Finally, the penalties the IRA imposes on manufacturers who fail to negotiate are not a tax. True, the IRA unhelpfully mislabels those penalties as an "excise tax." But again, manufacturers are free to avoid those penalties by exiting Medicare. Since they can do so without giving up anything that's theirs—they have no moral or legal entitlement to taxpayer subsidies, after all—those penalties are not coercive. What the IRA calls an "excise tax" is instead, effectively, an across-the-board reduction in Medicare subsidies for noncompliant drugmakers. 

Every manufacturer now howling about the IRA's price-negotiation process consented to that process when they remained in Medicare despite knowing they might see drastic reductions in their subsidies. Biden signed the IRA in August 2022, meaning drug makers could have announced their departure and exited Medicare by January 2024—well before these provisions would affect them. If they didn't like the new rules, they had plenty of time to get out of Dodge.

Reason's Ronald Bailey opposes the new price-setting process. "Government-imposed price controls on goods and services always lead to shortages," he argues.

Yet Medicare routinely sets and pays supra-competitive prices for everything from evaluation and management visits to colonoscopies to cataract surgery to long-term care hospital stays to knee replacements. Medicare-set prices create gluts as often as shortages. The excessive prices Medicare pays private Medicare Advantage plans has caused such robust enrollment growth in those plans that they now cover more than half of Medicare enrollees. The OECD reports that "studies conducted in the USA generally conclude that price setting by a regulator…improved hospital financial stability." Should it surprise us that the same thing might be happening with drugs? 

Troublingly, there's also evidence that the excessive prices Medicare currently pays steer manufacturers toward low-value drug innovations. Regardless, the way to encourage innovation is through the patent system, not "a big, dumb price-fixer" like Medicare. That's not why Medicare exists. 

Limited-government advocates should support pretty much any policy change that reduces actual Medicare prices. Lower drug prices mean lower Medicare spending, which reduces the burden the program imposes on taxpayers. And even incremental price cuts will increase dissatisfaction with government-run health care and create demand for alternatives where markets set drug prices.