I’ll save you the suspense: I think it is.
Drug company Merck is suing Medicare. What’s its beef? Merck claims that certain changes in the way Medicare will pay for drugs are coercing Merck, forcing it to sell drugs at below-market prices. But Cato health economist Michael F. Cannon disagrees. He says that there is no coercion whatsoever. Indeed, Michael’s post is titled “Medicare Is Not Taxing or Coercing Merck, Just Reducing Its Government Subsidies.”
At first I agreed with him. And then I read his post more carefully. Read it too—it’s not long—if you want to understand my objections.
Michael starts with an argument I agree with and I was pleasantly surprised to see him being so radical on the issue of Medicare. He writes, “The price Medicare should pay for all medical goods and services is $0.00.” In other words, he’s saying that Medicare should not exist. You can be sure that if it paid $0.00 for every medical good and service, its budget would be zero. Then the tax that people pay for Medicare, 1.45 percent of all “earned” income for employees and the same tax for employers (and a higher tax for higher-income people) could be zero. Most workers below the age of 40, who are years away from ever getting Medicare benefits, would probably be thrilled.
The key issue, though, is whether Merck and other drug companies are free to say no and not sell drugs to Medicare. If that were so, then Michael would be right.
But my understanding of the law is that it’s not so.
Michael links to a very long document from the Center for Medicare that explains the process. I didn’t have the patience to work my way through it, but I’ll accept that Michael has summarized it accurately. He boils it down to 4 steps:
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If Medicare selects a Merck drug for price negotiation, Merck has until October 1 to enter into an “agreement” to negotiate a “maximum fair price.” Medicare’s opening bid must be at least 25 percent less than the current price.
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If Merck does not enter into an “agreement” by October 1, “a noncompliance period would begin” that could result in “excise tax liability” for Merck.
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If Merck enters into an “agreement,” it must sell the drug to Medicare at whatever price Medicare negotiates/dictates or pay an “excise tax.”
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Merck may terminate the “agreement” for any reason, but the termination does not take effect until 11–23 months after Merck announces it. In the meantime, Merck must continue to sell the drug to Medicare at the price Medicare negotiated/dictated.
To his credit, Michael puts “agreement” in quotation marks because it’s not an agreement. The crucial issue, as I noted above, is whether a drug company is free to engage. Bullet #2 above says that it’s not. A company that refuses to enter an agreement is designated by Medicare as being noncompliant and is taxed for being noncompliant. The tax, by the way, is very heavy.
So how does Michael claim that the drug company is not coerced? He writes:
First, Both Merck and the government are wrong to describe those “excise taxes” as taxes. Merck’s own lawyers admit, “the excise tax is suspended if the manufacturer has no relationship with Medicare or Medicaid.” Taxes are compulsory; these “taxes” are optional. Ergo, it’s not a tax. The correct way to think of those payments is that Merck would be rebating to the government a portion of the subsidies it receives from taxpayers through Medicare and Medicaid. In essence, those rebates are an across‐the‐board reduction in the prices Medicare and Medicaid pay for Merck’s products. No one is taxing Merck, just reducing their government subsidies.
Since those “excise taxes” are not taxes, the government is not compelling Merck to enter an “agreement.” Merck is free to decline. If the resulting rebates Merck must pay mean its government “book of business” is unprofitable, it can walk away from federal health programs.
If Merck and other drug companies really were free to decline, then he would be right that they’re not coerced.
But there’s a big wrinkle and Michael addresses it in his next paragraph, writing:
Not even the 23‐month period that Merck would have to continue selling the drug to Medicare at the Merck‐unfriendly price is coercive. Merck has received plenty of notice of that condition. Merck was aware of that provision as Congress debated the law in 2021. And when Congress passed it. And when President Biden signed it in August 2022. And when Medicare announced in March 2023 how it would be implementing these provisions. Merck has had and will continue to have plenty of opportunities to avoid those conditions. It could have avoided them at any time from when Congress began debating them in 2021 until now. It could avoid them today. It could avoid them by refusing to enter into an “agreement.” At any of these points, Merck could avoid these conditions of Medicare participation without coercion.
Excuse me? Merck received plenty of notice? Yes, that provision was debated and there was reason to think that Joe Manchin (D-WV) would stand his ground and that the Inflation Reduction Act would be defeated. Merck was supposed to anticipate that Larry Summers would convince Manchin that it was a good bill that he should vote for? Really? Once Biden signed it, then, yes, Merck could see the writing on the wall. But let’s do some basic math. August 2022, when Biden signed it, was 10 months ago. So if Merck was already selling drugs to Medicare, it was stuck. 10 is less than 11 and is way less than 23.
Interestingly, Michael makes the point that Medicare announced in March 2023, just 3 months ago, how it would implement those provisions. I think Michael is saying that there was some ambiguity. If so, then Merck had not 10 months, but 3 months. So it’s really stuck. 3 is less than 11 and is way less than 23.
But whether the right measure is 3 months or 10 months, would Michael apply this to other government measures? What if Congress passed a law today, and Biden signed it today, stating that anyone currently working for the federal government could be shipped to Ukraine to fight or serve in some other capacity within the next 11 to 23 months? Would Michael then say that those government workers are not being coerced? Would he go further and say that those workers should have anticipated that provision because it had been debated months and months ago?
I don’t think he would. But if so, what’s the difference in principle?
HT2 Charley Hooper for helpful discussion.
READER COMMENTS
Mactoul
Jun 16 2023 at 11:12am
Is Merck subject to similar negotiations in other countries?
David Henderson
Jun 16 2023 at 12:25pm
Yes. In Canada, the case I know best, the government presents a take it or leave it offer. It offers $x and if the company refuses, it violates the intellectual property rights of the drug company by allowing generics even when the drug is still on patent.
steve
Jun 16 2023 at 3:59pm
This needs to be fleshed out a bit. First, this will apply to a total of 10 drugs in 2023/2024. 30 more will be added in 2025/2026. Merck likely has 2 drugs that might be affected. One of those is Keytruda. In the US we pay $189,000 for the drug. In France $78,000, UK $107,000 and Canada $152,000. At a 25% cut they will still make more than they do in most other countries. They will still make a profit, just less. (Also, specifically on Keytruda Merck paid over $600 million for patent infringement.) Merck and everyone else have plenty of time to stop selling to Medicare.
So maybe they could have done this better, but up until now Medicare was not allowed to negotiate and Merck just charged whatever they wanted and Medicare paid. I would think an economist would think that is a bad idea. (TBH, I wondered if big pharma bribed someone to have this deal pass. Medicare should negotiate prices on all drugs, not just 10.)
Steve
Jon Murphy
Jun 16 2023 at 4:18pm
Whether 10, 30, or 1, it is irrelevant. Coercion is coercion.
To replace a bad idea with a worse idea is not an improvement.
David Henderson
Jun 16 2023 at 5:03pm
I think it’s a great idea for Medicare to negotiate with drug companies and drive hard bargains. That’s not what’s happening here.
Charles Hooper
Jun 16 2023 at 5:26pm
I’m curious. How would Merck go about not selling to Medicare? How does that work in practice? I have worked in the pharmaceutical industry for the past three decades and, maybe I’m not thinking about it clearly, but I don’t know how Merck could actually do such a thing.
steve
Jun 18 2023 at 1:04pm
The easiest way would be to just pull the drug from the market and see only to foreign countries. If they choose to keep drugs on the market it would get pretty complicated.I think on the hospital side you could have the pharmacy not authorize use fo the drug for Medicare payment and on the outpatient side you could direct pharmacies not to accept Medicare payment for the drug in question.
Jon- If you think about it, it’s bizarre that we have not negotiated prices for drugs. The reasons we dont is that the drug companies, a special interest, have successfully lobbied, spending lots of money and handing out cushy jobs, to make sure it didnt happen. They have essentially coerced 100s of billions of dollars out of US taxpayers. Under this proposal Merck will make a bit less profits on 2 drugs. I know which seems worse to me.
Query- Merck is being coerced to negotiate. Suppose they had not been coerced. What happens? Suppose they just said no.
Steve
Jon Murphy
Jun 18 2023 at 1:12pm
True. Irrelevant.
Typically, what happens in a negotiation when one party says “no” is either the declining party makes a counter offer or the other party makes a counter offer. That process continues until either both sides agree or they go their seperate ways. This song from the musical The Greatest Showman is a fun way to see how non-coerced negotiation happens.
NB: this process holds even if one party (or both) have monopoly power. We see it in sports all the time.
Andrea Mays
Jun 19 2023 at 9:40pm
David! I did not know Canada did that— violating patents by permitting generics to produce competing drugs! I hope no one in DC is paying attention.
Also: the technique for getting an “agreement” reminds me of the PPACA requirement to buy a complying health insurance product— buy or else!
Question for Charley Hooper— what % of Merck’s sales are via Medicare? Yikes.
lastly—Jon Murphy I have new found admiration for you as a result of your mentioning The Greatest Showman! All of life’s puzzles are seen in Shakespeare, Broadway musicals or both.
Mark Brady
Jun 16 2023 at 11:32pm
Let us not forget that Merck is a beneficiary of statutory patent law that prevents independent inventors of medicines from reaping the rewards of their own work when Merck gets to the patent office first. Merck is also a beneficiary of U.S. Customs and Border Protection that prevent Merck medicines from being imported from other nations where they are sold at lower prices.
Charles Hooper
Jun 16 2023 at 11:59pm
Of course, Merck wouldn’t allow lower prices in other countries if medicines could be shipped from one country to another. Merck would hold out for a higher price and, if that didn’t succeed, it would block sales to other countries at lower prices.
David Olson
Jun 17 2023 at 12:00pm
What is the true and fair price of a product when there is a monopoly, or a monopsony, or both?
I have heard that the USA consumers pay a price that is pays for the R&D (including FDA regulatory approval) of a drug. So many of those other countries just pay for the cost of producing the drug. If a Big-Pharma company can’t recover the cost of developing a drug, will it bother to R&D a drug to see if it will treat a condition? (Will R&D shift to Congress funding it to meet Act-Up political pressure, and the government own the resulting drug? And only those drugs that pre-have a political constituency will be developed?)
Regarding:
If the production facility for such an unprofitable product has an “accident” stopping production, can or would the government force Merck to repair the facility and resume production for the remaining part of 11-23 months?
sman
Jun 18 2023 at 8:47am
Interesting discussion, but the market for a drug companies drugs is truncated to some extent given Medicare or private insurers really negotiating the price with the pharmaceutical companies.
Perhaps a question to ask related to overall pharma pricing might be this: What pricing that translates in to returns for the investment Pharma has to make is adequate for it to continually attract capital? How much will gov via IRA and Medicare pricing result in lower than historical returns on key metrics of the industry? While this does not address the “coercion issue, it might be a better framing of addressing the controversial topic of drug pricing.
At present the Pharma industry( not Biotech companies) from data of Damodoran has a cost of capital 10.57% and return on capital of 19.58% with an excess return above its cost of capital of 9.01%. OTH, the utility industry is only allowed by regulators to recover its cost of capital. An industry with lots of investment needs, integrated oil and gas companies has an excess return above its cost of capital(WAAC) of 13%.
So, given all the risks , can it be argued that pharmaceutical pricing is excessive?
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