President Trump recently signed an executive order aimed at reducing the prices Medicare pays for prescription drugs. The move has received criticism from both sides of the political aisle, with Democrats calling it a symbolic effort intended to help the president’s reelection campaign and conservatives calling it socialism.
Instead of basing Medicare prescription reimbursements off of average sales prices in the U.S. private market, as is done now, Trump’s executive order would base Medicare reimbursements on the lowest prices paid by healthcare systems in developed foreign countries.
Pharmaceutical companies say the order is “irresponsible and unworkable.” Conservative groups, such as Freedom Works, Americans for Tax Reform, Taxpayers Protection Alliance, and many others, have gone further to portray the order as “importing socialism.”
Those groups are right to resist socialism, but this order is not a mandate on firms. Medicare is a massive customer for prescription drugs on behalf of its members and accounts for over 35% of the total U.S. prescription market and about 16% of global pharmaceutical spending. By changing how the government sets what it is willing to pay for drugs, the order would prevent Big Pharma from overcharging Medicare for the same drugs it sells other governments for a fraction of the costs abroad. And since price hikes overseas will be constrained by market realities and regulations there, the order could lead to big reductions in U.S. government spending on Medicare.
“Trump is right to reduce the prices Medicare is paying for Part B drugs,” tweeted Cato Institute healthcare scholar Michael Cannon. “He is taking on Big Pharma. He is proposing to reduce government spending.”
Additionally, the executive order doesn’t put a limit on the private market. Trump was wrong in the first presidential debate against Joe Biden to claim drug prices would drop 80-90%, but the White House estimates that Trump’s executive order would reduce Medicare prescription spending by 30%, $43.8 billion a year in taxpayer savings. These types of government estimates are always wrong, but tens of billions of dollars in savings is a reasonable estimate. And regardless, people with private insurance could actually be the biggest winners of his order.
Critics argue that Medicare reimbursements are dictated by America’s “free market” prices, while in reality, America’s unfree market is based on maximizing Medicare reimbursements. Pharma is currently charging prices above market rates in the private market to secure higher reimbursements from Medicare. This means some drug prices are so high that pharma is actually making less money in the private market because it can make so much more money off of gouging taxpayers with artificially high Medicare reimbursements.
If you bear with me for some quick math, it will all make sense.
Assume you have 100 people in the private market and 100 people on Medicare purchasing a drug. If the average free-market price is $5, then pharma makes $1,000 total, that is $500 on private insurance and $500 on Medicare. However, if pharma artificially increases the price to $100, even if only one person with insurance buys the drug, which would be a $400 loss in the private market — every single Medicare reimbursement would equal the new average price of $100, and pharma then makes $10,100 total — a 1,920% increase in revenue.
That’s exactly why insulin medicines that cost $17 in Mexico can cost $540 in the United States. Pharmaceutical companies aren’t making a killing on privately insured patients, who often look for cheaper options. Pharma is primarily gouging federal taxpayers by gaming the private market to maximize reimbursements from Medicare and Medicaid, which is reimbursed similarly.
Unlinking the U.S. private market’s prices from Medicare is what Trump’s executive order tries to accomplish by instead linking the prices to other countries.
This relationship is not theoretical, it’s present in the data. For example, Medicare Part D almost doubled its spending on Novo Nordisk’s NovoLog-branded insulin products from 2013 to 2017, despite filling approximately the same number of orders. It’s no coincidence that the market price almost doubled during this period, yet some of the largest private providers like Express Scripts actually responded by completely removing Novolog coverage.
With this executive order, foreign governments may start paying their share of the research and development costs currently subsidized by people in the U.S., and U.S. private prescription drug coverage will edge a little bit closer to resembling a free market. The Brookings Institution confirms that it’s not possible for pharma to recoup its loss in Medicare revenue by increasing private prices for private insurance, and it’s likely drug prices paid by all types of payers in the U.S. would drop.
Importantly, however, what Trump has ordered might not be legal. The president can’t make an order explicitly contradicting what Congress has written into law, as is the Medicare average sales price reimbursement mechanism. Ironically, Trump is attempting to use a provision in Obamacare (which he’s also trying to repeal) to justify his order. The Centers for Medicare & Medicaid Services are currently allowed to perform reimbursement demonstrations if it thinks an alternative pricing scheme might reduce prices for a target group of people — and Trump is attempting to justify targeting the entire U.S. population. Going forward, it would be more appropriate to attempt to achieve this policy change by having Congress pass legislation that does the same thing and extends the idea to Medicaid as well.
Big Pharma’s stranglehold on dictating regulations is one of the most pernicious corruptions in politics. The healthcare system needs more competition, and, so far, there haven’t been enough steps to get us there. But Trump’s Medicare executive order is certainly one of them.
Jacob James Rich is a policy analyst at Reason Foundation and a Young Voices Opportunity Fellow.
