Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Drug Price Negotiation Actually Works
Transcript
- Lucas: So, the Inflation Reduction Act gave Medicare the power to negotiate drug prices for the first time. That's a huge shift — the government spends about 145 billion dollars a year on prescription drugs through Medicare Part D and Part B, and for decades it was legally prohibited from using its buying power to get better prices. Luna: Right, the non-interference clause. That always struck me as odd — the biggest single buyer in the market is told it can't haggle. Lucas: Exactly. And we're now two years into the implementation. In August 2023, the Centers for Medicare and Medicaid Services announced the first ten drugs selected for negotiation. These are high-spend, brand-name Medicare Part D drugs with no generic competition — things like Eliquis for blood clots, Jardiance for diabetes, and the blood thinner Xarelto. Together, they accounted for about 50 billion dollars in Medicare spending between 2022 and 2023. Luna: And the negotiation process itself — it's not like haggling at a flea market. There's a specific framework. Lucas: It's highly structured. CMS publishes a 'maximum fair price' based on a formula that considers the drug's average sales price in the commercial market, the manufacturer's research and development costs, and a few other factors. The manufacturer can either accept that price or face a steep excise tax — starting at 65 percent of the drug's sales in the first quarter and climbing to 95 percent. So effectively, participation is mandatory. Luna: But is that really 'negotiation' if the alternative is crushing penalties? It sounds more like administered pricing. Lucas: That's the debate. The Congressional Budget Office projects the policy will save Medicare 98.5 billion dollars over a decade. But manufacturers argue it's a price control that will reduce revenue, forcing them to cut research and development. The drug industry trade group PhRMA has already sued, saying the process violates the Fifth Amendment because it amounts to an unconstitutional taking of property. Luna: So the legal challenge is still pending? Where does that stand? Lucas: Multiple lawsuits were filed — by Merck, Bristol Myers Squibb, Johnson & Johnson, and others. In late 2024, a federal judge in Ohio dismissed some of the claims, but appeals are ongoing. The most recent ruling in early 2026 upheld CMS's authority, so the negotiations are moving forward. The first set of negotiated prices takes effect in January 2027. Luna: So for a drug like Eliquis — which is a blockbuster, about 16 billion in global sales — what's the price cut likely to be? Lucas: CMS hasn't disclosed the specific numbers yet, but independent analysts at the Kaiser Family Foundation estimate the discounts could range from 25 to 60 percent off the list price, depending on the drug. Eliquis is particularly interesting because there's a generic version available in some European markets at a fraction of the U.S. price — about 90 percent less in France. So there's a huge gap. Luna: And the negotiation only applies to drugs that have been on the market for a certain number of years — seven for small-molecule drugs, eleven for biologics. So it's aimed at drugs that have already recouped most of their R&D costs. Lucas: Right. The policy is designed to target drugs that are past their patent exclusivity cliff, essentially. But here's the twist — manufacturers can delay the negotiation by launching a slightly modified version of the drug, like a new dosing form or a combination pill. That can reset the clock. Critics call this 'patent thicketing.' Luna: So there's a cat and mouse game. The government tries to negotiate, and the drug companies try to keep their products out of scope. Lucas: Exactly. And that brings us to the broader question: is this policy actually going to lower overall healthcare spending, or will it just shift costs? Some economists argue that if drug companies lose revenue in Medicare, they'll just raise prices in the commercial employer-sponsored market, where there's no negotiation. Luna: That's the 'waterbed effect' argument — squeeze one side, the other side bulges. But does the evidence support that? Lucas: Mixed. A study by the National Bureau of Economic Research looked at previous price controls in other countries — like in Canada or the UK — and found that yes, launch prices in the U.S. tend to be higher as a result. But the Inflation Reduction Act also includes an inflation rebate provision that penalizes drug companies for raising prices faster than inflation across all payers, not just Medicare. That might limit the spillover. Luna: So it's a two-pronged approach: negotiation on the front end, inflation caps on the back end. And the Congressional Budget Office says the whole package — including the inflation rebate — saves another 56 billion. So combined, we're talking over 150 billion in savings over ten years. Lucas: Which is real money, even in federal budget terms. But it's important to note that those savings are relative to a baseline where drug prices keep rising. The actual dollar amounts that Medicare beneficiaries pay out of pocket might still go up, just more slowly. Luna: And that's the key, right? For voters, it's about what they pay at the pharmacy counter. The policy includes a 2,000-dollar annual cap on out-of-pocket drug costs for Part D enrollees starting in 2025. That's a big benefit for patients with high-cost drugs like cancer treatments. Lucas: That cap is actually separate from the negotiation — it's part of the same bill but a different mechanism. And it's already in effect as of January 2025. So someone with a 10,000-dollar a month cancer drug now pays at most 2,000 a year. That's a concrete change. Luna: Let's zoom out to the fiscal angle. The government's ability to negotiate drug prices is essentially a way to reduce federal spending on a major entitlement program. But it also creates new administrative costs — CMS has to hire negotiators, economists, and lawyers. And there's the risk that fewer new drugs come to market, which could increase other healthcare costs down the line. Lucas: Yeah, the dynamic is complex. The CBO estimated that the negotiation provision alone would result in about 1 fewer drug coming to market over the next 30 years, out of an average of about 40 new drugs per year. So the impact on innovation is small but not zero. Critics say that's one too many if that drug is a lifesaver. Luna: But if the savings are reinvested in other health programs, like funding NIH research, you could argue the net effect on health outcomes is neutral or even positive. Lucas: That's the optimistic view. The reality is that the savings are currently earmarked for deficit reduction and extending the solvency of the Medicare Trust Fund. So there's no direct link to more R&D funding. But it does free up fiscal space. Luna: And speaking of fiscal space — this show is ad-free, and listener support is what keeps it that way. If walking through the economy with us has made something click, you can help us keep doing it at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that goes a long way for a show like this. No pressure — just if you find value in it. Luna: So back to the actual negotiation — what happens next? The first prices take effect in 2027. What's the timeline for the next round? Lucas: CMS selects up to 15 additional drugs each year. In 2025, they'll pick the next batch for 2028 implementation. And the list grows over time — by 2029, they'll be negotiating up to 20 drugs per year. By the early 2030s, most high-spend brand-name drugs without generic competition will be subject to negotiation. Luna: So this is a slowly unfolding revolution. It's not a single day of price cuts — it's a gradual process that builds over the decade. Lucas: Exactly. And the outcome depends on how the courts rule, whether Congress expands the policy to include Part B drugs — which are administered in doctors' offices, like many cancer infusions — and whether future administrations enforce or weaken the rules. But for now, the mechanism is in place, and the first set of prices is locked in. Luna: I think the real test will be 2027. If patients actually see lower co-pays and the government saves money without a noticeable drop in new drug approvals, the political calculus flips. And more drugs get added. Lucas: Right. And if there's a shortfall in new drugs for certain rare diseases, the backlash could be severe. But the policy was designed with exemptions for orphan drugs — those with fewer than 200,000 patients — so most rare-disease drugs are shielded. Luna: So the negotiation is focused on the blockbusters, the top sellers. That's where the government can squeeze the most savings with the least political cost. Lucas: Exactly. The top 10 drugs by Medicare spending account for about 20 percent of total Part D spending. So the first round alone covers a big chunk. And as the list expands, the government will eventually hit the drugs that are critical for smaller patient populations. That's where the political trade-offs get harder. Luna: And that's the story we'll be watching unfold over the next five years. For now, the mechanism is live, the first prices are set, and the legal challenges are winding down. A concrete shift in how the government spends taxpayer money. Lucas: Yeah. And for anyone who wants to dig into the details, the CMS website has the full list of drugs, the formula for the maximum fair price, and the public comments from manufacturers. It's surprisingly readable for a government document.