The Federal Government’s Drug Price Negotiation Program Would Likely Violate Its Own Antitrust Laws

A recent U.S. Court of Appeals for the Third Circuit ruling upholding the federal Inflation Reduction Act (IRA)’s drug price negotiation program has been appealed to the U.S. Supreme Court, one of many challenges to the Act’s constitutionality. The IRA requires drugmakers to sell selected patented drugs to the government for its Medicare Parts B & D programs at a stipulated “maximum fair price”. If they don’t agree to these prices, then they face tax penalties on sales of the drug exceeding their profits from it, or the exclusion of all their drugs from Medicare and Medicaid purchases. This would foreclose access to up to 160 million patients, accounting for around 40% of US prescription drug spending or 20% of global prescription drug spending. US government purchases are valued at $200 billion annually.

Bristol Myers Squibb (BMS) and Janssen Pharmaceuticals argued that (1) the IRA constitutes an uncompensated taking of their property at below-market rates in violation of the Fifth Amendment, (2) that it compels speech in violation of the First Amendment through requiring them to sign an agreement that they “negotiated” a “maximum fair price” for their drugs, and (3) that it imposes unconstitutional conditions on their participation in the program. The appeals court majority rejected these arguments. They concluded that the IRA doesn’t unconstitutionally take property since the drugmakers can choose to forego government purchases even if this would substantially harm their business.

The decision gives the federal government a green light to use its combination of regulatory and market power to depress the value of private intellectual property to secure lower prices for taxpayers. The harms to IP owners are obvious. But lower drug prices in the short-term do not necessarily mean that American patients or even taxpayers will be better off in the long run—the very reason why the Sherman Act prosecutes the abuse of monopsony power by private buyers. And though the federal government is not subject to our antitrust laws, the longstanding economic principles underpinning them offer insight into why policymakers should reconsider the IRA and why the Supreme Court should review and reconsider the appeals court’s decision.

Monopsony: When Lower Prices Don’t Necessarily Leave Us Better Off

The economic goal of antitrust policy is “to promote consumer welfare through the efficient use and allocation of resources, the development of new and improved products, and the introduction of new production, distribution, and organizational techniques for putting economic resources to beneficial use.” A firm gaining or maintaining a monopoly isn’t necessarily bad for competition. It may do so in a way that benefits consumers through different or improved products, innovation or cost efficiency. That’s why our federal antitrust laws, including the Sherman Act, only punish firms for abusing their power over markets through competition that is not “on the merits” – conduct that excludes or restrains (or is likely to exclude or restrain) rivals from competing, without countervailing benefit to consumers.

Monopsony power is market power on the buy-side of the market. This typically results from barriers to entry, including government regulation, that prevent rival businesses from challenging firms that would use their dominant position for anticompetitive ends. Such a dominant buyer in the market for a product could depress the prices that it offers its suppliers, thereby driving them out of business or inducing them to produce less than what they would in a competitive market. Even if that monopsonist buyer passes on its cost savings to consumers in a secondary market through lower prices, those consumers may still be worse off than they would be in a competitive market since they may face less variety, reduced supply, or fewer innovative or new products.

In 2022, the Washington DC Federal District Court blocked the merger of publishing houses Penguin Random House and Simon & Schuster after hearing evidence, including testimony from author Stephen King, that the combined entity, which would have cornered half the U.S. market for “blockbuster” books, could depress authors’ advances. This could reduce competition by lowering the incentive for authors to produce top books or give up other career opportunities to write them, leaving readers worse off. In this case, lower costs for the publisher could have come at the expense of suppressed creative output.

In a similar vein, in 2020, the  U.S. Court of Appeals for the Ninth Circuit held the National Collegiate Athletic Association (NCAA) liable for being “a cartel of buyers acting in concert to artificially depress the price that [student athletes] could otherwise receive for their services” below what would exist in a competitive market, where the buyer’s cartel did not exist. The Supreme Court affirmed this ruling.

In the healthcare context, the merger of insurers Anthem and Cigna was blocked by the DC Circuit Court in 2017 after the majority was unconvinced about the merging parties’ claimed cost savings from the merger. Anthem and Cigna had argued that their superior negotiating power would benefit patients through lower prices, increasing access to care. The DOJ conversely argued that the merged firm would use its control over access to half the patient population of many California counties to depress provider service prices below competitive levels, thereby harming patients through reducing supply. Although the court never ruled on these competing claims, then Justice Kavanaugh, in dicta, opined that the question should have been remanded to the lower court for consideration.

The IRA & Drug Price Negotiation

Drug development is a capital-intensive, high-risk process that is typically funded by profits from the sale of a company’s existing drugs and expected profits from future sales of the new drug. Patent protections provide commercial certainty to investors and drugmakers for researching, discovering, testing and bringing, the next round of cures to market. The estimated pre-tax cost of researching, developing, and bringing a new drug or biologic to market, including the cost of the trials and regulatory approvals process, is $2.870 billion in 2013 dollars. The amount that a drugmaker invests in R&D is a factor of “the amount of revenue they expect to earn from a new drug, the expected cost of developing that drug, and policies that influence the supply of and demand for drugs.” The Congressional Budget Office (CBO) estimates that drugmakers must obtain a profit margin of 62.2% from products that succeed to allow for just a 4.8% return on their overall assets due to the sunk costs of projects that do not yield a commercially successful drug.

Suppressing the price of drugs below market value, or foreclosing substantial sections of the market, is likely to chill investment in developing new drugs. New drugs, especially those targeting lifestyle illnesses, play a significant role in reducing future hospitalizations. Lifestyle illnesses disproportionately drive healthcare costs, and hospitalizations strain healthcare budgets far more than drugs. So, besides potentially denying Americans access to high-demand future drugs, it’s also unclear that Medicare and Medicaid beneficiaries and American taxpayers would benefit in the long run from paying less for patented medicines under the IRA.

Under the status quo, Medicare Part B must pay the average sales price borne by the U.S. private market, and Medicare Part D subsidizes highly regulated private insurers to cover prescription drugs. Although the IRA only purports to require drugmakers to “negotiate” prices for selected drugs, it also imposes restrictions on negotiation outcomes and allows the government to impose sanctions to induce drugmakers into accepting the prices it chooses, arguably rendering negotiations illusory.

Drugmakers that want to continue selling their portfolio of other drugs to Medicare and Medicaid must pay a prohibitive excise tax on both private and government sales of the selected drug if they don’t sell to the government at its stipulated price. This is leverage that even a private insurer covering the same volume of patients would not possess. The IRA also requires the Centers for Medicare and Medicaid Services (CMS) to negotiate the “lowest” “maximum fair price” possible, and places a ceiling on this price that is as low as 45-65% of the current market price for selected drugs that have been on the market for between 12 and 16 years, and 75% for others.

A buyer that ties its purchase of a product over which it has “appreciable economic power” to burdensome conditions that a seller would not accept in a competitive market where a substantial volume of interstate commerce is affected, has engaged in an illegal anticompetitive tying arrangement. This could violate either the Sherman Act Section 1’s prohibition on unreasonable restraints of trade, or Section 2’s prohibition on exclusionary conduct. Various federal circuit courts also require an analysis of competitive effects or evidence of likely consumer harm in the secondary market before holding defendants liable. Given the anticompetitive effects described above, it’s likely that the conditions imposed on drugmakers by the IRA, with its tying of participation in Medicare and Medicaid to price concessions on specific drugs, would violate the Sherman Act if a similarly situated monopsonist private buyer imposed them.

The Supreme Court has held that the government does not act as a mere market participant when it “employs … coercive mechanism[s], available to no private party.” That the tying arrangement would be illegal under the Sherman Act if done by a private party demonstrates that CMS isn’t simply acting as a market participant by negotiating prices, contrary to the Third Circuit court’s reasoning in the Janssen and BMS case. There is significant evidence that it is exercising its monopsony and regulatory powers to depress the value of pharmaceutical patents below what it would be in a competitive market. This could, of course, harm consumers, competition, and innovation by suppressing medical R&D.

Lowering Drug Prices Without Devaluing IP Rights

Frustration around seemingly high U.S. drug prices arises from the fact that Americans pay between three to four times what foreigners pay for the same patented medications. This is largely because other countries’ public insurers use buyer monopsony power to lower prices. Conversely, the U.S. practice of pegging the drug prices that Medicare and Medicaid typically pay to private market prices incentivizes drugmakers to raise prices they charge to private insurers, since drugmakers can secure a higher price for every drug that CMS buys, even if they sell fewer drugs to private plans and patients.

This means that America indirectly subsidizes pharmaceutical innovation for the rest of the world. But it also comes with advantages for Americans, who gain access to the most and newest  cutting-edge pharmaceuticals before the rest of the world. Once patents expire, generic entry rapidly lowers prices of drugs that wouldn’t even exist in the absence of secure patent protections. In fact, a recent study found that when generics are counted, Americans pay significantly less for drugs than Canadians, Britons, Germans, or Japanese. Research also indicates that even with patent rights and current U.S. and global drug prices, drugmakers often internalize and capture just a fraction of the social benefits their products generate.

Trade deals with foreign governments that secure higher payments for U.S. drugs can help balance the global cost burden of R&D while reducing freeriding off American taxpayers. These deals, like the recently negotiated agreement with the British government that will see its National Health Service (NHS) pay 25% more for U.S. drugs, can serve as a ‘carrot’ for securing lower prices at home. And if foreign nations with smaller economies currently lack the political appetite to pay more for drugs, then they may be convinced to do so by a reduction of U.S. trade barriers, including anticompetitive regulations that hurt American consumers and businesses as well as foreign businesses trying to access the U.S. market. This would be a more pro-innovation and legally sound approach than policies like the IRA and the administration’s “Most Favored Nation” (MFN) executive order, which impose price controls through punitive threats. It is also consistent with the administration’s executive order on reducing anticompetitive regulatory barriers.

Image Source: Deposit Photos
Author: iqoncept
Image ID: 61369901