cent in 1995 (reflecting the slight lag in
(PL 102-185) increased the bargaining power
implementing R&D investment decisions)
of the Department of Veterans Affairs and
before returning to double-digit percentage
other federal agencies (the Department of
annual levels for the rest of the decade as the
Defense, the Public Health Service, and the
political threat to pharmaceutical industry
Indian Health Service) that administer
profit margins receded.139 In 2001 U.S.
health programs. It required drug manufac-
industry R&D rose 17 percent, compared to
turers to make their innovator drug prod-
ucts142 available on the Federal Supply
just 2 percent for American companies in
much more heavily regulated Europe.
Schedule (FSS) when those products are eli-
John Vernon of the University of Pennsyl-
gible for Medicaid reimbursement. The legis-
vania's Wharton School finds that the larger
lation required drug manufacturers to sell
the proportion of a firm's pharmaceutical sales
their products to the four federal agencies at
that are subject to price regulation, the smaller
a discount that amounted to the greater of
its R&D expenditures will be as a proportion of
(1) 24 percent off their nonfederal average
its sales. Price controls and other equivalent reg-
manufacturer price, known as the federal
ulations clearly reduce the expected return on
ceiling price--or (2) the lowest price given to
a comparable nonfederal purchaser.143 The
investment. Vernon estimates that if U.S. policy
The larger the
mandated price regulation that was identical to
actual pricing calculations required under
proportion of a
the "average" degree of price regulation present
the law to determine the final FSS price are
in other pharmaceutical markets outside the
more complex than this simplified descrip-
firm's pharma-
United States, it would lead to an approximate
tion, but in most cases the FSS price is the
ceutical sales that
federal ceiling price.144
46.5 percent reduction in drug industry R&D
are subject to
investment intensity and correspondingly high
By tying participation in the FSS to
costs in terms of foregone medical innova-
Medicaid reimbursement eligibility, the
price regulation,
tion.140
Veterans Health Act provided the Department
the smaller its
of Veterans Affairs, as the largest single FSS
Mandatory Discounts
purchaser, greater leverage in negotiating FSS
R&D expendi-
Within the past decade, a more limited
prices. However, drug manufacturers soon
tures will be as a
version of price controls has crept into the
responded by limiting most of their discounts
proportion of
U.S. health care system in the form of
for private buyers to no more than the mini-
mandatory "best price" discounts for several
mum Medicaid-mandated discount of 15.1
sales.
federal health care programs. Medicare's cov-
percent. The General Accounting Office
erage of prescription drugs is generally limit-
found that between 1991 and 1993 the medi-
ed to those administered to hospital patients,
an discount for private buyers declined from
but Medicaid uses extensive price controls
24 percent to 14 percent for HMOs and from
through the "mandatory" discounts that it
28 percent to 15 percent for group purchasing
organizations.145 The Congressional Budget
imposes on drug reimbursements. Those dis-
counts then are leveraged into similar price
Office similarly found that the weighted aver-
controls for other federal government health
age "best price" discount in a sample of brand-
programs.
name drugs declined from 37 percent in 1991
to 19 percent in 1994.146 Although these best
The Omnibus Budget Reconciliation Act
of 1990 (OBRA) required drug manufactur-
price discounts probably saved the federal gov-
ers to give state Medicaid programs price dis-
ernment and state governments some money
counts that (following several initial phase-in
in their respective financial shares of drug
years) amounted to the greater of (1) 15.1
reimbursement costs, they caused drugmak-
percent off the average manufacturer price
ers to raise their prices for private sector pay-
charged to wholesalers, or (2) the best price
ers. In short, OBRA shifted costs instead of
given to any private customer.141 Two years
reducing them.
later, the Veterans Health Care Act of 1992
Drug manufacturers generally put up with
15