The devastating argument against prescription drug cost shifting

Ezekiel Emanuel made the very popular cost shifting argument in today’s New York Times:

Medicare negotiations would do nothing to contain drug prices for the 170 million Americans who have private health insurance, through their employer, the exchanges, or by self-purchase. Having the federal government negotiate lower prices for Medicare would most likely drive up prices on the private side as drug companies tried to recoup their “lost” profits.

Almost ten years ago I wrestled with exactly this cost shifting idea for the first time while writing a paper about a VA prescription drug plan for Medicare-enrolled veterans.

The VA purchases drugs at prices about 40% below those paid by Medicare drug plans, which are all private plans. Medicare does not use its price-setting power for drugs the way it does for hospital and physician services. Whether it should is a hot topic today, as it was during the run up to the 2003 law that created the Medicare drug benefit, Part D. The market consequences of a VA-Medicare drug plan would be similar to Medicare drug price setting: it would push the price paid for many drugs well below manufacturers’ claimed costs.

This is why drug manufacturers argue against Medicare drug price setting. Their argument frequently includes the claim that if Medicare (or the VA) pays a lot less for drugs, manufacturers will just shift costs to commercial market payers. Premiums will go up for everyone else. (It’s unclear to me why this should bother drug manufacturers, since, by this logic, they get paid either way, if not from Medicare, the VA, or Medicaid, then from commercial market plans. You’d think they’d want to keep quiet about that.)

I worked this cost shifting argument into my manuscript on a VA-Medicare drug plan. When he saw it, one of my co-authors paid me a visit. “Do you buy this cost shifting argument?” he asked.

“Sure,” I said. “If drug manufacturers are paid less by the VA or Medicare, don’t they need to make up for that lost revenue?”

“Well, do you think drug manufacturers are profit maximizing organizations?” His question was a trap.

“Of course! That’s why they cost shift.” I had just fallen right into it.

“Austin,” he said, “if they could profitably raise prices to commercial market payers after government ones pay less, why didn’t they raise those prices before? It suggests they left money on the table.”

There’s no response to this. It’s devastating. More in my cost shifting talk, papers [1 and 2], and blog posts.


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