Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How the Government Pays 40 Percent More for Prescription Drugs Than Medicare Should
Transcript
- Lucas: Here's a number that should make you angry. The federal government — the single largest purchaser of prescription drugs in the United States — pays more for many of those drugs than some private insurers do. And in some cases, more than uninsured patients paying cash at the pharmacy. Luna: Wait, how is that possible? The government has enormous buying power. You'd think they'd get the lowest price. Lucas: You'd think. But there's a specific policy quirk that inverts the incentive. It's called the 'best price' rule in Medicaid. And it's a textbook example of a well-intentioned regulation that backfired spectacularly. Luna: Alright, walk me through it. How does this 'best price' rule work? Lucas: So, when a drug manufacturer sells to any private buyer — a hospital, a pharmacy benefit manager, a wholesaler — they often negotiate a discount in exchange for volume or formulary placement. That discount is the 'best price.' Now, under the Medicaid Drug Rebate Program, drug makers must give Medicaid the lowest price they give anyone else. That sounds fair, right? Luna: Sounds reasonable. Medicaid gets the same deal as the biggest private buyers. Lucas: But the problem is, if a manufacturer gives a deep discount to one private buyer — say, a hospital chain that buys in bulk — that price becomes the new 'best price' for Medicaid. And if that discount is too deep, the manufacturer might have to pay Medicaid a rebate so large that the drug becomes unprofitable. So what do they do? Luna: They stop offering those deep discounts to anyone. They keep prices high across the board. Lucas: Exactly. The 'best price' rule actually discourages manufacturers from offering aggressive discounts. Because any discount they give to one buyer automatically applies to Medicaid, which covers about 80 million people. So they'd rather keep list prices high and give smaller, more controlled rebates. The result is that the government ends up paying a higher price than it should. Luna: That's perverse. So the rule designed to get Medicaid the best price actually inflates prices for everyone. Lucas: And not just for Medicaid. That high list price becomes the baseline for other programs, like Medicare Part D, and for patients with high-deductible plans. There's a specific drug that illustrates this perfectly — insulin. Luna: Insulin is a great example. The list price has tripled over the past decade, but the net price after rebates has actually declined for some forms. Lucas: Right. So for a common insulin like Lantus, the list price might be around $400 per vial. But after rebates and discounts, the net price that PBMs and insurers pay is maybe $150. However, the 'best price' that Medicaid gets is tied to that $150 net price. But here's the twist: the rebates are often tied to volume or market share, so the 'best price' isn't really the lowest price a manufacturer is willing to accept — it's a negotiated price that depends on the deal structure. Luna: And the manufacturer doesn't want to offer a lower price to a hospital or a mail-order pharmacy because then that would become the new best price for Medicaid, and they'd have to give even bigger rebates. Lucas: Exactly. So you end up with a system where list prices are inflated, and the government's actual purchase price is higher than it would be if they could just negotiate directly and aggressively. Which brings me to a related program that adds another layer of complexity — the 340B drug discount program. Luna: Right. 340B requires drug manufacturers to give discounts to hospitals that serve a disproportionate share of low-income patients. But there's been controversy about how those savings are used. Lucas: Yes. The original intent was to allow these hospitals to stretch federal resources. But in practice, many 340B hospitals bill private insurers and Medicare at full price for drugs they acquired at a deep discount, pocketing the difference. And that 'discounted' price becomes part of the 'best price' calculation too — so manufacturers have to be careful not to set the 340B price too low, because then Medicaid would demand that price, and the 340B hospitals would lose their margin. Luna: So the manufacturers try to limit the discounts they give to 340B hospitals to avoid lowering the best price. That defeats the purpose of the program. Lucas: There have been lawsuits over this. Manufacturers have tried to restrict 340B discounts to contract pharmacies, arguing that the discounts were being abused. The federal government has pushed back. But the underlying problem is the same: the 'best price' rule creates a ceiling on discounts, not a floor. And that's before we even talk about Medicare. Luna: Medicare Part D — where the government is explicitly forbidden from negotiating drug prices. That's the non-interference clause. Lucas: Right. Since 2003, the law has said that the Secretary of Health and Human Services 'may not interfere with the negotiations between drug manufacturers and plan sponsors.' So Medicare plans negotiate on their own, but they don't have the same leverage as a single payer. And because of the best price rule, even if they could negotiate, the manufacturers would be constrained by the Medicaid rebate formula. Luna: So you have two programs — Medicaid and Medicare — both hamstrung by the same perverse incentive. And the result is that the government, with all its purchasing power, can't get the lowest price. Lucas: The Congressional Budget Office has estimated that if the government could negotiate prices for a subset of high-cost drugs in Medicare, it could save tens of billions of dollars over a decade. But the non-interference clause remains politically difficult to change, partly because of opposition from the pharmaceutical industry and partly because of concerns about stifling innovation. Luna: But there is some movement. The Inflation Reduction Act of 2022 gave Medicare the power to negotiate prices for a limited number of drugs starting in 2026. That's this year. How's that playing out? Lucas: The first round of negotiations covers ten drugs, including Eliquis, Jardiance, and Xarelto. The negotiated prices are supposed to take effect in 2026. But there's already litigation from drugmakers arguing that the process is unconstitutional. And even if it goes through, the savings are capped — the law limits how much prices can be reduced, and the negotiation only applies to drugs that have been on the market for several years without generic competition. Luna: So it's a step, but not a full solution. Meanwhile, the 'best price' rule in Medicaid remains unchanged. Lucas: Correct. And there's another piece to this puzzle — the way the government accounts for drug spending in its budget. When you look at the federal budget, drug spending is spread across multiple agencies — Medicare, Medicaid, the Veterans Health Administration, the Defense Department, the Indian Health Service. Each one negotiates separately, with different rules and different formularies. That fragmentation weakens the government's bargaining position. Luna: The VA actually does get lower prices than Medicare, because they have a more restrictive formulary and they can negotiate directly. So it's not that the government can't get good deals — it's that the structure prevents it in many cases. Lucas: Exactly. The VA uses a national formulary and can say no to a drug if the price isn't right. Medicare Part D plans have to cover all drugs in six protected classes, and they can't exclude a drug just because it's too expensive. So the leverage is different. Luna: And then there's the issue of transparency. Even when the government knows what it's paying, the public doesn't. The rebates and discounts are often confidential. So it's hard to know exactly how much waste there is. Lucas: The Office of the Inspector General at HHS has done audits showing that Medicare Part D plans sometimes pay more than the VA for the same drug, but the exact magnitude is hard to pin down because of proprietary pricing. What we do know is that the Government Accountability Office has found that the government could save billions with better coordination. Luna: There's also the issue of orphan drugs — drugs for rare diseases. They're often exempt from some of these rules, and they can have astronomical prices. The government ends up paying full freight because there's no competition. Lucas: Right. And the 'best price' rule has exceptions for drugs that are only used by a small number of patients, so manufacturers can give discounts to a few buyers without triggering a Medicaid rebate. But that just means the government has even less leverage for those drugs. Luna: So what would be a better system? Some economists have proposed replacing the 'best price' rule with a fixed rebate percentage or a maximum rebate cap, so manufacturers would have an incentive to lower list prices. Lucas: There have been bipartisan proposals to do exactly that. The 'Creating and Restoring Equal Access to Equivalent Samples Act' — the CREATES Act — was one attempt to address related issues, but it didn't touch the best price rule. More recently, there's been talk of a 'minimum rebate' model, where manufacturers would have to pay at least a certain percentage of the list price back to Medicaid, regardless of what they negotiate elsewhere. That would remove the disincentive to offer deep discounts. Luna: But drugmakers would fight that. They like the current system because high list prices allow them to offer big 'savings' to PBMs and insurers, which then get passed along in the form of lower premiums — but only for people with good insurance. Lucas: Exactly. And the people who get hurt are those without insurance or with high-deductible plans, because they pay the list price. Plus, taxpayers foot the bill for the government's higher prices. It's a hidden tax, essentially. Luna: Which brings us back to the irony: the government is the biggest buyer, but it's acting like a fragmented, price-taking consumer. And the rules it created to protect itself are actually making things worse. Lucas: If today's episode helped you see that dynamic more clearly — and honestly, this is the kind of stuff that makes you want to shake someone — the way we keep these episodes free and ad-free is through listener support. If you found value, you can toss something in the jar at buy me a coffee dot com slash fexingo. That's what lets us keep doing deep dives like this without any sponsors. Luna: Yeah, it really does make a difference. And it keeps the conversation going on these wonky but important topics. Lucas: So back to the policy fix. The Inflation Reduction Act's negotiation provision is a start, but unless the 'best price' rule is reformed, the government will still be paying more than it should for many drugs. And the real question is: will the next administration — whoever that is — take on the political fight to change it? Luna: And whether they'll extend the negotiation authority to more drugs and close the loopholes. Because as it stands, the government's hands are still tied in too many ways. Lucas: Right. And that's the fiscal policy story that doesn't get told enough — the subtle ways that well-meaning rules create perverse incentives, and how those incentives end up costing taxpayers billions. Luna: Something to watch as the first negotiated prices roll out later this year. Thanks, Lucas. Lucas: Thanks, Luna.