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The Congressional Budget Office (CBO) has prepared this report as part of its continuing analysis of the Administration's and other health care reform proposals. The report contains a general view of the provisions in the Administration's proposal that concern pharmaceutical benefits and costs. It also examines the effect of those provisions on the demand for drugs and on the incentives they offer pharmaceutical companies to invest in research and development. In keeping with CBO's mandate to provide nonpartisan analysis, the report includes no recommendations.

Anna Cook and Philip Webre of CBO's Natural Resources and Commerce Division wrote the study under the supervision of Jan Paul Acton and Elliot Schwartz. Linda Bilheimer of CBO's Health and Human Resources Division provided extensive aid and consultation. CBO analysts Leonard Burman, Sandra Christensen, Robert Dennis, Jon Hakken, Scott Harrison, Harriet Komisar, Charles Seagrave, Paul Van de Water, and Aaron Zeisler also provided valuable comments and assistance. Outside CBO, Sarah Glavin, Henry Grabowski, Gary Guenther, Robert Helms, Alison Keith, Janie Kinney, Joseph Newhouse, B. Randal, F. M. Scherer, Judith Wagner, and Joshua Weiner all provided useful reviews.

Sherwood Kohn edited the manuscript, and Christian Spoor provided editorial assistance. Angela McCollough and Donna Wood typed the many drafts. Kathryn Quattrone and Martina Wojak-Piotrow prepared the study for publication.
 

Robert D. Reischauer
Director
June 1994
 
 

SUMMARY

ONE - INTRODUCTION

TWO - INDUSTRY AND MARKET BACKGROUND

• Structure of the U.S. Pharmaceutical Industry
• Competition in the U.S. Pharmaceutical Market
• Conclusions

THREE - HOW THE ADMINISTRATION'S PROPOSAL WOULD AFFECT THE DEMAND FOR PRESCRIPTION DRUGS

• The Administration's Proposal for Universal Coverage
• Medicare's New Drug Benefit
• Conclusions

FOUR - THE REBATE ON MEDICARE PRESCRIPTION DRUGS AND THE ADVISORY COUNCIL ON BREAKTHROUGH DRUGS

• The Medicare Drug Rebate Agreement
• The Medicare Rebate for New Drugs
• The Advisory Council on Breakthrough Drugs
• Effects on the Pharmaceutical Market
• The Cost Containment Provisions in Perspective

FIVE - EFFECTS OF OTHER PROVISIONS

• Changes in Medicaid
• Shifting Patients to Managed Care Providers
• Constraining the Rate of Growth of Health Plan Premiums

SIX - THE EFFECT OF THE ADMINISTRATION'S PROPOSAL ON THE RETURNS FROM DRUG DEVELOPMENT

• What Previous Studies of the Returns from Drug Development Show
• How the Returns from Drug Development Would Change
• Sensitivity of the Results to the Base-Case Assumptions
• Conclusions

SEVEN - CONCLUSIONS

• Incentives Provided by the Medicare Rebate
• The Changing Pharmaceutical Market

APPENDIXES

A - The Cost of Capital
B - Calculating the Change in Average Returns from Drug Development
C - Sensitivity of Profit Calculations to Product Price Changes
 

TABLES
S-1.	The Effect of the Administration's Proposal on the Present Value of Profits Generated Over the Lifetime of the Average Drug
1.	Primary Source of Health Insurance for the U.S. Noninstitutionalized Population, by Age, 1993
2.	Induced Demand for Prescription Drugs by the Under-65 Population Under the Administration's Proposal for Universal Coverage
3.	Induced Demand for Outpatient Prescription Drugs by Medicare Enrollees 65 and Over
4.	The Cost of Drug Development Compared with Profits for the Average Drug
5.	The Effect of the Administration's Proposal on Average Profits from Developing a Drug: Base Case
6.	The Effect of the Administration's Proposal on Average Profits from Developing a Drug Under Varying Assumptions About Induced Demand
7.	The Effect of the Administration's Proposal on Average Profits from Developing a Drug Under Varying Assumptions About Marginal Cost
8.	The Effect of the Administration's Proposal on Average Profits from Developing a Drug for the 65-and-Over Population Under Varying Assumptions About Producer Price
FIGURES
1.	U.S. Prescription Drug Sales
2.	Prescription Drug Spending as a Percentage of National Health Expenditures
3.	Prescription Drug Spending as a Percentage of Gross Domestic Product
4.	U.S. Consumer Spending on Pharmaceuticals
5.	Research and Development Spending by the U.S. Pharmaceutical Industry (In billions of dollars)
6.	Research and Development Spending by the U.S. Pharmaceutical Industry (As a percentage of sales)
7.	Sales of Ten Companies' Top Three Drugs as a Percentage of Prescription Sales by Each Firm
8.	FDA Approval of New Drugs
9.	How the Change in Average Returns from Developing a Drug Under the Administration's Proposal Varies as the Share Consumed by People 65 and Over Increases
BOX
1.	Measurement Issues in Pharmaceutical Price Increases

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