Report Confirms Likely Negative Impact of Prescription Drug Excise Taxes on R&D

As Congressional Democrats gear up to potentially include a punishing excise tax on prescription drugs —which would apply to pharmaceutical manufacturers if they refuse to agree to a government-set price for their products— in their reconciliation bill, the nonpartisan Congressional Budget Office (CBO) is out with a new paper that outlines the possible impact such a tax could have on the research and development (R&D) of new drugs.

The top takeaways from the paper are that 1) a 15 percent to 25 percent reduction in the expected financial return manufacturers receive for the top 20 percent of most profitable prescription drugs is associated with an anticipated reduction in new prescription drugs, and 2) this reduction compounds over time, with fewer and fewer new drugs brought to market each decade over a three-decade period following the passage of a policy like an excise tax.

Lawmakers are debating including such an excise tax on prescription drugs in their $3.5-trillion reconciliation package, in part because requiring Medicare to nationally negotiate prescription drug prices in Part D -- and pairing that requirement with the punishing excise tax on companies that refuse a government-set price -- would likely raise revenues (and cut near-term spending) for the federal government. This, in turn, could help Democrats pay for ambitious new spending plans in the reconciliation bill.

The excise tax in H.R. 3 would start at 65 percent of a prescription drug’s gross sales and escalate to as high as 95 percent of gross sales, and would apply to manufacturers that either refuse to submit to ‘negotiations’ (where government has all of the power) or refuse to accept a government-set price for their products.

In December 2019, CBO estimated that such a mechanism in House Democrats’ H.R. 3 drug pricing legislation would reduce the federal budget deficit by $493 billion over 10 years, including Medicare spending cuts, Medicaid spending cuts, cuts to private insurance subsidies, and tax increases.

Of course, $493 billion in reduced federal deficits would come at a steep cost to patients and public health. CBO estimates in their new study that manufacturers would bring fewer drugs to market in the first, second, and third decades after such policies are enacted into law. The reduction is just two fewer drugs in the first 10 years after the policy passes, in part because the process for researching, developing, testing, and receiving approval for a new drug, and ultimately bringing it to market, can take well over 10 years. The policy results in “23 fewer [drugs] over the next decade (a reduction of 5 percent), and 34 fewer drugs in the third decade (a reduction of 8 percent).”

For what it’s worth, CBO’s estimate of the impact a gross reduction in manufacturer revenues could have on the R&D of new products is probably on the low end. A 2004 study cited by CBO in their paper estimated an impact multiple times larger, with a 20 percent decrease in market size “corresponding to an 80 percent reduction in the number of new drugs.” While this study is 17 years old and only covers U.S. entry for new drugs (rather than global entry for new drugs in a more recent 2015 study), it points to the wide variety of potential impacts a confiscatory tax could have on pharmaceutical R&D.

What’s more, existing studies indicate that investments in new prescription drugs have a beneficial impact to the health care system as a whole, preventing more expensive health interventions in the years following the introduction of a new drug. A 2002 National Bureau of Economic Research (NBER) study found “reducing the mean age of drugs used to treat a given condition from 15 years to 5.5 years will increase prescription drug spending per medical condition by $18 for the entire population, but will lower other medical spending by $129.” The NBER abstract continues:

“That yields a $111 net reduction in total health spending per medical condition. Most of the savings are attributable to reductions in hospital expenditures ($80 or 62 percent) and in physician office-visit expenditures ($24). Other smaller savings occur in home health care ($12), outpatient visits ($10), and emergency room visits.”

CBO identified a similar impact in a 2012 paper, examining when Medicare beneficiaries increased their number of prescriptions filled:

“After reviewing recent research, the Congressional Budget Office (CBO) estimates that a 1 percent increase in the number of prescriptions filled by beneficiaries would cause Medicare’s spending on medical services to fall by roughly one-fifth of 1 percent.”

It may be reasonable to expect or predict, then, that the compounding effects of a punitive prescription drug excise tax, over the course of several decades, will increase health care costs elsewhere (such as hospital and physician services) and cut into (or even eventually negate) whatever near-term federal savings could be achieved by controlling the price of drugs in Medicare Part D and in the private sector. Thus, taxpayers could, on net, lose out over the long run.

In short, while even experts and economists find it difficult to predict the magnitude of the impact a prescription drug excise tax will have on R&D in the pharmaceutical sector, the consensus seems to be that heavy taxes on the industry will negatively affect the R&D, and ultimately the introduction, of new prescription drugs. If the magnitude of that impact is on the heavy side, as some experts have predicted, such a tax would have serious and negative implications for the entire U.S. health care system. Lawmakers should scrap plans to levy this tax on prescription drugs, and instead pursue policy options with strong bipartisan support like redesigning the Medicare Part D benefit and protecting seniors with an out-of-pocket cap.