A proposal to control prescription drug costs

I have said that I believe that prescription drugs are the best value in healthcare.  I believe this is still the case, but the rise in the cost of prescription drugs recently has put that value proposition at risk.

In the article “A Primer on the Cost of Prescription Drugs” I laid out some of the factors driving increased cost: specialty drugs, unregulated pricing, lack of marketplace incentives for lower prices, and yes, even competition within drug classes.  Pharmaceutical manufacturers have successfully argued that regulated pricing would discourage research and development investment, which is more and more focused on specialty drugs.  This is important, because many specialty drugs are providing breakthroughs in the treatment of conditions that previously had few if any treatment options.  As a result, there are a lot of advocates supporting specialty drug research and development.  But without some regulation or marketplace influence on pricing, we will reach a point where access to important prescription drugs will be limited because of cost.  This will occur because patients can’t afford out-of-pocket costs, payers restrict access, or government programs just don’t cover.   If you think that the government programs would have to cover medically necessary drugs, you should look at the European Union models, and you should know that state Medicaid programs already don’t pay for drugs when there is no money in the budget.

There is a relatively simple solution to control prescription drug pricing trends.  It avoids government control of pricing, which can result in putting politics and cost ahead of patient benefit.  It provides an incentive for pharmaceutical manufacturers to set prices responsibly.  And it provides a potential revenue stream for the federal government.   Something for everybody.

The solution I propose is the implementation of a graduated federal excise tax on prescription pharmaceuticals based on an assessment of incremental cost-effectiveness.  A value-added tax (VAT) is an excise tax commonly used in Europe, that taxes the value of goods based on their added value (margin) at each step of the supply chain. For U.S. prescription pharmaceuticals the excise tax would be more accurately called a “value not added tax”. Let’s call it a “Price Over Value” (POV) tax.

Incremental cost-effectiveness is the comparison of the cost and health benefit of a new therapy to the cost and health benefit of a previous standard of care.  Incremental cost-effectiveness is generally calculated as an incremental cost-effectiveness ratio.  Health benefit is usually estimated using quality adjusted life years (QALYs).  There are sophisticated models that calculate QALYs.  Basically, a new therapy that has the potential to extend life for 1 year with excellent quality of life has a value of 1.  A therapy with the potential to extend life for 1 year, but with moderate side effects, might have a QALY of .75. 

There are a number of organizations that already provide incremental cost-effectiveness assessments for prescription drugs.  In the United Kingdom, the National Institute for Health and Care Excellence has used an incremental cost-effectiveness model for evaluating new drug therapies for over 20 years.  It establishes a price that the National Health Service uses to negotiate whether or not a new therapy will be covered by the National Health Service.   The Institute for Quality and Efficiency in Healthcare in Germany does the same thing, using a methodology that allows for different cost-effectiveness thresholds for different therapeutic areas.  In the US, the Institute for Clinical and Economic Review (also known by the acronym ICER) has provided reports on incremental cost-effectiveness of drug therapies since 2006.  ICER is an independently funded organization created at Harvard Medical School.  Increasing support over the years, especially from payers, has expanded their capacity to produce reports and refine their assessment models.   ICER has recently expanded their cost threshold range to accommodate the high cost of drugs for rare diseases.  Importantly, ICER also created a model assessing price increases for drugs already on the market, and issued a report “Unsupported Price Increases” in 2019.  Basically, the model argues that price increases should be supported by new evidence of clinical benefit.

Any of these incremental cost-effectiveness models can be used to assess the value of prescription drugs.   The ICER cost-effectiveness threshold ranges from $50,000 to $200,000 per QALY provide a reasonable benchmark for prescription drug value.  

How would a federal excise Price Over Value (POV) tax work to incentivize responsible drug pricing by pharmaceutical manufacturers?  The POV tax would differ from a value-added tax in that pharmaceutical manufacturers would pay a tax on the drug’s full Actual Sales Price (ASP).  As an example, the POV tax could graduate from 10% to 15% and finally 25% based on how much the drug price exceeds the calculated cost-effectiveness threshold.  Here is how it might work:

• A drug that exceeds the cost-effectiveness threshold by 25% is assessed a POV tax of 10% paid by the manufacturer on the actual sales price.
• A drug that exceeds the cost-effectiveness threshold by 50% is assessed a POV tax of 15% paid by the manufacturer on the actual sales price.
• A drug that exceeds the cost-effectiveness threshold by 100% is assessed a POV tax of 25% paid by the manufacturer on the actual sales price.
• Any drug exceeding the cost-effectiveness threshold by 25% or more is also assessed a 10% VAT paid on net profit by the pharmacy benefit manager (PBM) or wholesale to retail distributor.  This provides an incentive for PBMs and wholesalers to use the current marketplace to put additional price pressure on pharmaceutical manufacturers.

You might wonder how many drugs might be subject to this new tax? Extrapolating from ICER data, almost 15% of prescription pharmaceuticals may currently exceed the 100% cost-effectiveness value threshold.

What are the effects of implementing a pharmaceutical Price Over Value tax?  The systematic development of an incremental cost-effectiveness value will provide pharmaceutical manufacturers with a target for responsible pricing.  The tax and resulting reduction in life-cycle income for a product in development will make pharmaceutical manufacturers reconsider development of drugs with marginal clinical benefit, especially new drugs in competitive classes.  This POV tax model can eventually be applied to the price increases of drugs already in the marketplace.  If price increases for a marketed drug result in costs exceeding the incremental value threshold, the POV tax can be applied.  Incremental value thresholds can be adjusted based on new indications that provide increased clinical benefit.  For example, you might see the POV tax removed for cancer drugs that have limited clinical benefit initially in the advanced, metastatic disease setting, but then demonstrate more value in the treatment of early-stage cancer.   The VAT at the PBM and distributor level will provide an incentive for them to create cost-effective formularies and preferred drug lists.  Finally, implementation of the POV tax will provide a revenue stream for the federal government.  And you do all of this without government price controls and without directly restricting pharmaceutical research and development.  

What is needed to implement this proposal?  Obviously, it will take an act of Congress.  First, you have to establish the organization responsible for incremental value assessments and cost thresholds.  ICER is already doing this work, but it is an independent organization not sanctioned by the federal government.  The Patient-Centered Outcomes Research Institute established by the Affordable Care Act in 2010 would be an obvious choice to assume this role.  Second, the taxing structure must be legislated.  Third, how and when the tax is applied will have to be decided.  Value assessments for new drugs can begin as soon as the clinical benefit data are available from clinical trials.  There will need to be agreement on how new clinical data are provided to the organization providing the value assessment.   Ideally, a cost threshold would be available before the launch of a new product so that manufacturers can consider the threshold when setting prices.   Prescription drugs already marketed can also be assessed to establish value thresholds and consider price increases.  Manufacturers could use discounts and rebates to lower drug ASPs below tax assessment thresholds.

Let the arguments begin.