In January 2022, President Joe Biden signed off on the Inflation Reduction Act (IRA) — a multifaceted legislative effort intended to curb rising inflation in the United States, lower healthcare costs, invest in clean energy, create jobs, and many other goals (House, 2023a). One of the most significant components of this act was the introduction of price caps on some prescription drugs for Medicare patients. While the act's proponents argue that it will alleviate the financial burden on elderly Americans, critics express concerns about its potential effects on limiting drug innovation.

Steep healthcare expenses have long been an issue in the United States. Compared to other OECD countries, we spend almost double the amount on healthcare — 17.8% of GDP in 2021 — yet still experience some of the worst health outcomes amongst high-income nations (U.S. Healthcare, 2023). With post COVID-19 inflation, healthcare in the US is more expensive than ever. For many Americans, this means poor health and proper treatment are severe financial burdens. According to a 2023 White House statement, an estimated one in three Americans struggle to pay for over the counter medications (House, 2023b).

Thus, in an attempt to address the growing healthcare crisis, the IRA aims to reduce out-of-pocket drug expenses for Americans on Medicare part D and part B. In the act’s press release, the Biden-Harris Administration promises to “beat Big Pharma'' in partnering with drug manufacturers to negotiate and restrict medication prices. In August 2023, the Centers for Medicare and Medicaid Services (CMS) selected ten drugs and their respective manufacturers to participate in the price negotiation program: Eliquis, Jardiance, Xarelto, Januvia, Farxiga, Entresto, Enbrel, Imbruvica, Stelara, and Fiasp. These drugs predominantly treat chronic conditions like diabetes, heart disease, and arthritis. It’s estimated that these ten drugs alone account for $3.4 billion in Medicare patients’ out-of-pocket costs in 2022 (House, 2023b). The IRA promises to partner with up to 60 drug companies over the next four years, which will alleviate some of the financial burden on both individual and government Medicare budgets, increase drug accessibility, and improve medication adherence among elderly Americans. Already, Medicare patients are able to access recommended vaccines at no charge, and monthly insulin costs have been capped at $35. Over the next few years, Medicare enrollees are expected to save $400 to $2,500 annually on prescriptions as price negotiations go into effect (“Inflation Reduction Act,” 2023).

Despite the IRA’s promising goals, critics worry that reductions in drug prices may deter pharmaceutical companies from investing in drug innovation. Because manufacturing companies have historically set drug prices in the United States, the prices reflect and support high R&D costs. Thus, the US’s comparatively high drug costs have helped fund pharmaceutical innovation, and critics — largely economists — worry that the price caps may disrupt this balance and slow drug development. According to a 2020 executive branch report, American consumers account for nearly 70% of global patented pharmaceutical company profits, so if these profits decrease, it’s likely that there will be a weaker drive for drug discovery and advancements (The Council of Economic Advisors, 2020). The price caps could also reduce the potential return on investment for developing new medications, thus discouraging companies from pursuing risky and expensive R&D projects. A policy brief from the University of Chicago estimates that the IRA implies a $232.2 billion reduction in R&D investment and 188 fewer small-molecule medications over the next 20 years (Philipson, 2023). Furthermore, due to the age demographics of Medicare enrollees, it’s likely that drug companies disproportionately halt innovation in elderly-specific drug categories like Alzheimers and cancer, which would affect every patient — not just those on Medicare.

The challenge, therefore, lies in striking a balance between ensuring drug affordability for Medicare patients and maintaining incentives for pharmaceutical innovation. Proponents of the IRA argue that the legislation may introduce market competition that may actually benefit drug innovation. Because some drugs will be negotiated to a lower price, competing products must either choose to also lower costs or risk plummeting sales. When it comes to drug R&D, the IRA’s price cuts reduce incentives for companies to focus on “me too” drugs, or those that are similar to medications already on the market (Wyman, n.d.). Instead, it has the potential to drive manufacturers to expedite novel drug development to be the first to the market and maximize profit potential without competition.

Moreover, the Act could drive discussions on alternative models for drug pricing, such as value-based pricing, which ties the cost of a drug to its efficacy and the benefits it provides to patients. A University of Southern California white paper recommends several approaches, including value-based pricing, in mitigating the IRA’s potential adverse effects on innovation (Dana, 2023). Through directly tying the “maximum fair price” of a drug to its perceived social value, the IRA could further incentivize the industry to focus on genuinely groundbreaking innovations rather than minor variations of existing medications. The paper also suggests delaying price negotiation in drugs with new indications and exempting these manufacturers from the IRA’s inflation rebate penalties, as medications with potential for more indications are inherently more valuable in healthcare. By offering manufacturers small breaks from the IRA’s new policies if a drug is socially valuable, the government can continue to incentivize innovation while prioritizing medicare expense reduction.

As the IRA is executed over the next few years, it’s likely that adjustments will be paramount to maintaining R&D and mitigating long term effects on pharmaceutical innovation. The landscape of healthcare in the United States continues to evolve, and the government must prioritize striking a balance between individual needs and the interests of drug manufacturers.