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Medical Progress Report
No. 1  December 2004

Are Drug Price Controls Good for Your Health?


  1. Financing of the drug insurance program will come from sizable federal subsidies paid to the insurance companies and from annual premium payments of $420 from Medicare recipients (all figures are for the year 2006). Moreover, most Medicare beneficiaries will be required to pay a deductible of $250 and a 25 percent coinsurance rate when purchasing prescription drugs, at least up to a predetermined expenditure level of $2,200. After that amount of drug expenditure, the coinsurance rate will increase to 100 percent until a catastrophic expenditure level of $5,100 sets in, in which case the coinsurance rate will fall to 5 percent. Another feature of the drug bill is that the poorest of the poor will be eligible for varying amounts of premium and cost-sharing assistance from the federal government.
  2. Schwartzman (1976) and Comanor (1986) both point out that the pharmaceutical industry has continued to face close scrutiny from the government since the Kefauver hearings in the late 1950s.
  3. Sometimes threats turn into realities. Since 1974, the federal Maximum Allowable Cost (MAC) program has mandated drug substitution in government programs such as Medicare and Medicaid, limiting reimbursement for multiple-source drugs to the lowest cost at which chemically equivalent drugs are generally available, plus a reasonable fee for dispensing a drug (Schwartzman, 1976).
  4. Center for Medicare and Medicaid Services, at
  5. The AMP is the average price paid by wholesalers for products distributed for retail trade.
  6. Prescription Drugs: Expanding Access to Federal Prices Could Cause Other Price Changes, GAO/HEHS-00-118.
  7. The multiple regression results can be viewed in Appendix 1.
  8. This elasticity estimate is highly consistent with other study estimates. For example, Scherer (1996) and the DHHS (1994) obtained elasticity estimates of 0.61 and 0.54 to 0.68, respectively.
  9. Because our model is dynamic (in the sense that we are estimating growth rates and not levels), the principal effect of our simulation is achieved by simply constraining to zero the growth rate of government’s share.
  10. Because the government will not be purchasing all these drugs, the estimate of 60 percent does not perfectly coincide with our definition of our PUB variable (i.e., the government share of total drug purchases). Nevertheless, the fact that the government will be overseer of these drug purchases implies that it will still be exerting its considerable influence on these purchases. This important difference with our retrospective analyses should, however, be kept in mind.
  11. The first assumption allows us to circumvent the difficulty (impossibility) of forecasting all future values of our regression models’ independent variables. In a recent study by Scherer (2001), the real annual growth rate of pharmaceutical R&D expenditures was calculated to be 7.51 percent from 1962 to 1996. Therefore, in our forthcoming calculations, we will use this rate to predict future growth rates of R&D. For the second assumption, we will employ a real cost of capital of 11 percent (DiMasi, Hansen and Grabowski, 2003). The present value of R&D growing at a constant rate, g, in perpetuity, and discounted at the cost of capital, r, is simply R&D expenditures in period t+1 divided by r-g. In 2004, the Pharmaceutical Research and Manufacturers Association (PhRMA) reported that total member-firm expenditures on pharmaceutical R&D were $33.2 billion (for fiscal year 2003). Growing at a real rate of 7.51 percent, this would place 2008 R&D expenditures at approximately $47.7 billion, and present value R&D expenditures in perpetuity (in 2007) would be $1.37 trillion. We do not include the expenditures of biotechnology firms or venture capital funds, which provide an additional $30–40 billion in R&D investment per year that would also be influenced by government purchases and pricing regulation.
  12. For consistency with our model specifications, the percentage increase in the government’s share is calculated as the difference in logarithms of government’s share pre- and post-policy.
  13. This percentage decrease in price is calculated within the context of our constant-elasticity model specification; that is, we measure percentage changes as the difference in natural logarithms of real drug prices pre- and post-MMA enactment. When expressed as a percentage reduction off of pre-policy real drug prices, it results in roughly a 49 percent reduction in real drug prices.


Center for Medical Progress.


MPR 01 PDF (92 kb)


Rx Price Controls Would Be Disastrous For Innovation, Study Says, 12-15-04
Price Controls on Medicare-Covered Drugs Would Mean Less Innovation, Report Finds
BNA, 12-9-04
Report Warns of Drug Price Controls Washington Times, 12-8-04

Critics of the new Medicare drug benefit have called for the government to use its increased purchasing power to drive down drug prices. This study examines the effects of government pressure on pharmaceutical prices and R&D from 1960-2001. During that time, it finds that the government induced a loss of capitalized pharmaceutical R&D expenditures of $188 billion, resulting in 140 million lost life years due to the absence of new medicines. Applying this same analysis to the future, it finds that if government tries to use its new buying power to reduce drug prices R&D spending will drop by nearly 40%, resulting in a loss of 277 million life years. Consequently, policymakers should consider the trade-offs between lower drug prices now and the future health benefits of increased R&D spending.




The MMA and the Noninterference Clause

The Original Medicare Act and the Noninterference Clause

Drug Price Controls and Innovation

Purpose of This Study


Mechanisms of Government Influence

Impact of Government Influence on Drug Prices, 1960 to 2001

Simulated Real Drug Prices with and without Government Influence, 1960 to 2001

Figure 1: Simulated Impact of Government Influence on Real Drug Prices


Figure 2: Estimates of Lost R&D Because of Government Influence on Drug Prices

Figure 3: Effect of Lost Life Years on U.S. Economy

The Potential Future Costs of the MMA

Figure 4: 2004 Estimated Present Value Cost of the MMA’s Negative Impact on Pharmaceutical Innovation







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