Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Health Programs Pay Double for Generic Drugs
Transcript
- Lucas: You ever notice how the same bottle of ibuprofen costs eight dollars at a pharmacy but three dollars at a big-box store? The government has the same problem — except we're talking about billions of dollars, not pocket change. Luna: I've heard that Medicare pays more than private insurance for some drugs, but is it really that much more? Lucas: It is. A Government Accountability Office report from late 2025 looked at forty common generic drugs covered by Medicare Part D. The finding: Medicare paid an average of 2.3 times what commercial health plans paid for the exact same pills. Luna: Two point three times? That's not a rounding error. Lucas: No. The GAO estimated that if Medicare had paid the same rates as commercial plans in 2023, taxpayers would have saved about one point eight billion dollars — just on those forty drugs. Luna: So what's causing the gap? Is it a negotiation problem, or is the system rigged somehow? Lucas: A bit of both. The core issue is that Medicare Part D's reimbursement formula was designed decades ago for brand-name drugs with high list prices and big rebates. For generics, which have low list prices, that same formula produces weird outcomes. Lucas: Specifically, Part D plans get reimbursed based on a national average of list prices minus rebates. But generic rebates are tiny — often less than five percent — while commercial plans negotiate much steeper discounts directly with pharmacies. So Medicare ends up paying closer to the full list price. Luna: Wait — if Medicare is the biggest buyer, shouldn't it have the most leverage? Lucas: You'd think so. But the Part D program is run by private insurers who contract with pharmacy benefit managers, or PBMs. Those PBMs have little incentive to drive a hard bargain on generics because their profit comes from rebates on brand-name drugs. Generics just don't move the needle for them. Luna: So the middlemen are prioritizing the high-dollar stuff and letting generic costs slide. Lucas: Exactly. And there's another structural problem: a statutory provision called the 'generic effective rate' — a floor on how low reimbursement can go. It was meant to ensure pharmacies don't get underpaid, but in practice it's set above what many pharmacies would accept in a competitive market. Luna: So the government is essentially guaranteeing a minimum price that's too high. Lucas: Right. And because the formula is based on list prices, manufacturers have an incentive to keep those list prices artificially high — even for generics that cost pennies to produce. That inflates the benchmark for everyone. Luna: So it's not that government can't negotiate — it's that the Part D structure actively prevents it. Lucas: Bingo. That's the big takeaway. The VA uses a centralized procurement system with a single formulary. They go to manufacturers and say, 'Give us your best price across all our facilities, or you're not on the list.' That's real leverage. Lucas: Medicare Part D, by contrast, has dozens of private plans, each with its own formulary and its own PBM. They're negotiating in silos, and none of them has the scale to demand the kind of discounts the VA gets. Luna: What about the bipartisan bill I saw in the news — the Senate Generic Drug Pricing Act? Is that supposed to fix this? Lucas: That's the one introduced in March 2026. It proposes capping Medicare Part D reimbursements for generics at 150 percent of the national average commercial price. The Congressional Budget Office estimates that would save about two point three billion dollars over ten years. Luna: That's real money, but it's a fraction of the total overpayment. Lucas: True. The GAO's one point eight billion was just for one year on forty drugs. The full overpayment across all generics is probably much higher. But even this bill faces headwinds — PBMs and pharmacy chains are lobbying hard against it, arguing it would cut their margins and force some pharmacies to close. Luna: Which is a classic lobbying argument: any reform that reduces costs for taxpayers also reduces profits for intermediaries. Lucas: And it's not entirely without merit. Some rural pharmacies operate on thin margins and rely on those Part D reimbursements. But the VA model shows you can have both low prices and viable pharmacies — the VA's network covers the whole country. Luna: So the deeper issue might be that we've outsourced drug pricing to private middlemen with conflicting incentives. Lucas: That's exactly it. And when you think about it, this is a classic fiscal policy failure: a well-intentioned program — Medicare Part D — created a complicated payment system that layers public money through private actors, and nobody is accountable for the total cost. Lucas: Walking through these inefficiencies with you every week is exactly what keeps this podcast interesting — and it's also why we keep it ad-free. If that kind of public finance deep-dive has made something click for you, we'd be grateful if you supported the show at buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small way to keep these conversations going without any sponsor pressure. And we really appreciate everyone who chips in. Lucas: So back to the reform discussion — one interesting angle is that the Senate bill also requires PBMs to report their generic reimbursement rates transparently. Right now, those contracts are proprietary, so even the GAO had to rely on limited data. Luna: Transparency alone might not fix the pricing, but it would at least show where the money is going. Lucas: And that's often the first step. Once you can see the spread between what Medicare pays and what commercial plans pay, it's harder to defend the status quo. Luna: What about state-level efforts? Have any states tried to cap generic drug prices in their Medicaid programs? Lucas: A few. California passed a law in 2024 that ties Medicaid generic reimbursements to a percentage of the federal Maximum Allowable Cost list. Early data shows savings of about 12 percent — but implementation has been messy because pharmacies challenged it in court. Luna: So even when there's political will, the legal and contractual landscape makes change slow. Lucas: Exactly. And that's the story of fiscal policy reform: it's never just about the numbers. It's about the web of interests — PBMs, pharmacies, manufacturers, patient advocates — all pulling in different directions. Luna: Okay, so if you had to give one concrete takeaway from this episode — what should a listener remember? Lucas: That the government is systematically overpaying for generic drugs — not because of corruption, but because of a payment formula designed for a different era. And there's a straightforward fix: cap reimbursements at a reasonable markup over commercial prices, the way the VA already does. The savings could be in the billions. Luna: And the next time you fill a prescription, you might wonder what the person next to you with a different insurance card is paying for the exact same bottle. Lucas: Exactly. That's the hidden price of fragmentation in public spending.