Three Strikes and It’s Out: Drug-Price “Negotiation” Scheme is Bad Economic, Health Care, and Tax Policy

The Biden administration’s gleeful announcement last week of the first 10 prescription drugs that will fall victim to the federal government’s new “price negotiation” power for Medicare Part D has serious health policy implications. The discredited negotiation process became mandatory after passage of the inaptly-named Inflation Reduction Act (IRA) last year. But like its parent legislation, the new negotiating power claimed by the federal government is a debacle on many levels.
Often overlooked, for example, are the further risks the negotiation law will create for the already dwindling integrity of the U.S. tax system. Drug manufacturers that choose not to participate in the coercive negotiating trap face a federal excise tax of up to 95 percent on all their U.S. sales of the targeted drug. Although it technically satisfies authoritative definitions of an excise tax, i.e., “a direct and fixed charge placed on goods,” this transparently absurd penalty on firms that won’t be cowed by Washington’s price dictates makes a mockery of the principles behind true excise taxes. 
There is no pretense of a given product being routinely sold between a private sector business and customer, and therefore a flow of commerce; the rate is consciously designed to force companies to the government’s price negotiating table. Nor is the tax designed at a level to specifically offset the cost of providing government service (e.g., sporting equipment excises that fund federal fish and wildlife programs, or airline ticket taxes that are put toward the Airport and Airway Trust Fund).
Nor is the tax firmly linked to a quantifiable externality, such as providing routine law enforcement or funding harm reduction. In the highly unlikely event that any receipts would ever accrue from the new drug excise, so far there appears to be little indication as to the mechanism for how such collections would be applied to staving off the looming bankruptcy of Medicare Part A, or to reducing Part D’s overhead costs.
Indeed, the top 95 percent rate, in itself, should be an indicator that this tax is an extreme outlier. Few other products subject to U.S. excise taxes currently face anything close to such a punitive rate. Hunting and sporting equipment, for example, have excises in the 10-11 percent range, while airline tickets face (among many other charges) a 7.5 percent excise. Pigouvian, or so-called “sin” taxes on widely-enjoyed legal products such as cigars or alcohol beverages impose higher rates that can reach 50 percent or more, but even these are designed to raise revenue for the federal government.
According to agencies such as the Joint Committee on Taxation, the drug excise (along with its cousin, a 10x penalty on the spread between a manufacturer’s price and the government’s “maximum fair price”) isn’t even assumed to contribute to the Treasury’s coffers in any meaningful way.
And for good reason – the advertised top statutory rate is an understatement. The Tax Foundation’s Erica York recently calculated that the tax-exclusive, effective rate on drugs falling under “negotiation” could go as high as an astonishing 1,900 percent.
If taxpayers are confused about the real purpose of this tax and how they are supposed to comply with it, so far the Internal Revenue Service (IRS) has only been able to provide limited clarity. On August 4, the Service issued a notice to furnish guidance on Section 5000D. In summary, the five-page, double-spaced document did the following:
  • Recapped provisions of the drug negotiation law and the tax it created under what is now known as Section 5000D of the Internal Revenue Code;
  • Explained the law’s detail of how the rate of tax is calculated, and (helpfully at least) announced that “forthcoming proposed regulations” won’t force a manufacturer to embed the tax in the invoice price of a drug;
  • Stated the Service’s general intent to issue “forthcoming proposed regulations” that will “propose a method for taxpayers to calculate their § 5000D liability”;
  • Declared that “generally” the existing procedural regulations surrounding other kinds of excise taxes will apply to Section 5000D, “with some limited exceptions”; and
  • Prescribed standard quarterly filing and payment deadlines for Section 5000D excise taxes, though warned taxpayers there will be “a new form that taxpayers would be required to attach” to the current excise tax return.
So, taxpayers will have to stay tuned for additional, more substantive details. Whatever those details may be, this excise cannot credibly be called a “tax” in the sense that it is an exaction on manufacturing, sales, or consumption designed to raise revenue for a purpose. Instead, it could be more aptly classified as a threat which, if carried out against a company, would substantially harm that company’s ability to do business here or abroad.
NTU would argue that this new section of law imposing what is called a tax could be a violation of the U.S. Constitution’s Eighth Amendment, which states that “Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.” Our research arm’s Taxpayer Defense Center has participated in legal proceedings involving taxpayers for whom the “excessive fines” clause is at issue.
Given the many lawsuits against the drug negotiation scheme currently wielding their way through the justice system, taxpayer advocates could make arguments about constitutionality at appropriate points in the process. If the tax is allowed to stand in its current form, the door could be open for the government to employ similar tactics across the economy for causes of virtually any kind, from forcing manufacturers to abandon internal combustion engines, to wiping out cryptocurrency trading.
These controversies over the nature of Section 5000D aside, taxpayers have many other reasons to be concerned about the government’s new power to effectively dictate the prices for Medicare Part D drugs.
In a 1971 conversation recorded on his infamous taping system, President Richard Nixon remarked to Treasury Secretary John Connally that “The difficulty with wage-price controls and a wage board as you well know is that the [expletive deleted] things will not work. They didn’t work even at the end of World War II.”
Economists with many ideological views tend to agree. But Nixon chose politics over economics, not to mention sacrificed the longer term well-being of millions of Americans, by plowing ahead with a wage and price control plan anyway. Predictably, millions of Americans suffered after a small dose of temporary relief soon gave way to shortages, economic slowdowns, and lost opportunities to develop new goods and services that could have benefitted all societies.
Nixon, and now Biden, are actually just two of many political figures to ignore history. As an NTU-led open letter from 163 economists in 2018 addressed to policymakers in the Trump administration flirting with drug price controls warned
In general, setting price controls at below-market rates leads to shortages, squeezes the cost bubble toward some other portion of the economy, and imposes a deadweight cost on society. In this case, price controls can lead to a reduction in patient access to certain drugs, less investment in the research and development of new drugs, and cost-shifting that raises the prices of other therapeutics. Ultimately, patients will suffer as cures are delayed or entirely undeveloped, while taxpayers will be denied potential savings from drugs that could obviate more expensive treatments in government healthcare programs, and the investment of capital in development of new medicines.
As the economists pointed out, at work here is the cynical calculation that Americans can't miss the things they never saw or had in the first place. Of course, price controls lead to slower rises or mandated reductions in the cost of a consumer good; not immediately noticed is the increased scarcity of that good over time. Even less noticed is what might have been: new goods or services that will never be discovered, as innovators become more reluctant to take risks on behalf of payoffs that governments will limit or claw back in the future. 
The Tax Foundation’s Erica York neatly summarized this dynamic by writing:
The reduction in R&D, innovation, and new drugs is why the nonpartisan CBO, when analyzing past versions of drug pricing legislation, found, ‘The overall effect on the health of families in the United States that would stem from increased use of prescription drugs but decreased availability of new drugs is unclear.’ In other words, it is not a clear win for Americans’ health to force lower prices for certain existing drugs today at the expense of the development of new drugs tomorrow.
Others, have conducted even more alarming analyses of how bad the “decreased availability” problem could get. Two years ago, a University of Chicago study projected the “mid-range” impact of a bill similar to the drug provisions of the Inflation Reduction Act would be a “44.6 percent decline in R&D and 254 fewer new drug approvals” over less than a two-decade period.
For taxpayers, too, the undiscovered cures will make a palpable, quantifiable difference in the finances of government health programs. Private sector investment in new drug development was already showing signs of reacting negatively to the negotiation scheme prior to today's announcement. Further reversals in blockbuster drug research could deprive patients and taxpayers of the medicines that ease costlier hospital stays and surgeries.
NTU has amply documented this phenomenon of substituting cheaper drugs for more expensive therapies and the resulting taxpayer savings. Hundreds of billions of dollars that might otherwise bend the health cost curve without rationing care for patients or raising taxes are now at risk. Among the research we uncovered:
  • Discoveries of medicines have yielded trillions of dollars in benefits to the U.S. economy over the past several decades.
  • These have translated into considerable dividends for taxpayers. In 2019, a Health Affairs study pegged the average savings from second-generation drugs for hypertension, diabetes, and high cholesterol slowed per-capita Medicare spending an average of $824 in the 2000s.
  • Long-term savings of tens of billions are feasible for taxpayer-backed health care programs if anti-obesity medications are aggressively deployed; even more costs could be avoided if effective treatments for Alzheimer’s are developed and marketed quickly.
Such a dynamic has only been possible so far in the United States, which has pursued tax, health care, and other economic policies that allow innovator drugs to be developed while also fostering affordability through generic medications. The Inflation Reduction Act, through the price negotiation ploy and several other policies, is already eroding this uniquely American advantage. Thoughtful public officials in both parties need to call strikes on these policies now, before it’s “game over” for patients as well as taxpayers.