Congress and the Biden administration are currently pursuing major drug-pricing reforms as part of the reconciliation legislation expected to move this fall. The reforms under consideration include allowing Medicare to directly negotiate prices with drug manufacturers and requiring manufacturers to pay rebates to Medicare if their prices rise faster than inflation. One largely overlooked aspect of these proposals, however, is how they may interact with the Medicaid Drug Rebate Program, under which manufacturers pay rebates to Medicaid programs, significantly lowering prescription drug costs for states and the federal government.

Under this highly effective program, drug manufacturers must provide rebates to the federal government and states as a condition of having their drugs covered by Medicaid. These rebates are substantial. In 2019, for example, data from the Medicaid and CHIP Payment and Access Commission indicate they lowered gross Medicaid prescription drug costs by 55.7 percent. In contrast, data from the Medicare Trustees report show that rebates negotiated by Medicare Part D plans reduced Medicare spending by only 26.7 percent. Moreover, a recent Congressional Budget Office (CBO) analysis compared prices, net of rebates and discounts, for the top-selling and highest-price Medicare Part D brand-name drugs across select federal programs and agencies including Medicaid, Medicare Part D, the Department of Defense, and the Department of Veterans Affairs (VA). It found that Medicaid obtains the lowest prices, net of rebates and discounts, among the programs and agencies examined. The net prices were substantially below those in Medicare Part D plans and below even the prices negotiated by the VA. By lowering state and federal Medicaid prescription drug costs, the rebate program consequently reduces fiscal pressures on states that could lead to budget cuts that reduce low-income beneficiaries’ access to needed medications as well as other health care and long-term services and supports.

Medicare negotiation and inflation rebates would likely have the unintended effect of modestly lowering the rebates manufacturers must now pay state Medicaid programs, thereby raising federal and state Medicaid prescription drug costs. The CBO cost estimate of the Elijah E. Cummings Lower Drug Costs Now Act (H.R. 3), which the U.S. House of Representatives passed in 2019, demonstrates how Medicare negotiation and inflation rebates would likely interact with the Medicaid rebate program. 

According to the CBO estimate, H.R. 3’s negotiation provision would increase federal Medicaid spending by about $1.2 billion over 10 years. Here’s why. Medicare negotiation would likely result in lower overall prices for drugs newly subject to negotiation because Medicare is such a large part of the prescription drug market. Lower prices would benefit Medicaid as well because Medicaid would then pay pharmacies less for the drugs they dispense to beneficiaries. But lower overall prices also would lower the Medicaid rebate amounts states would receive for those drugs, compared to their current rebates. One part of the formula involves a minimum rebate that is equal to a percentage of the average price paid by wholesalers. If that price goes down, the minimum rebate amount also declines. Another part of the formula involves an inflation-related rebate — manufacturers must pay rebates equal to the amount that prices exceed general inflation. For some drugs, manufacturers are now paying inflation-related rebates equal to a very large percentage of the price. But if prices rise more slowly, manufacturers will owe less in rebates. In addition, Medicare price negotiation also would result in higher launch prices for some new drugs, as a way for manufacturers to offset reduced revenue resulting from negotiation. That would increase pharmacy costs for those drugs.

Higher costs from lower rebates and higher launch prices could exceed the pharmacy savings for state Medicaid programs, according to CBO. The CBO estimate does not include the expected increase in state Medicaid spending but $1.2 billion in higher federal Medicaid drug spending would translate to roughly $600 million in higher state spending.

The H.R. 3 inflation rebate provision would raise federal Medicaid spending by another $1.3 billion over 10 years, CBO found. Medicare inflation rebates would have the intended effect of reducing future overall price increases, relative to current law, because of Medicare’s importance as a payer in the prescription drug market. But as explained above, because Medicaid already receives similar rebates, smaller overall price increases could reduce the inflation-related rebate amounts. Again, CBO does not include the expected increase in the state share of Medicaid prescription drug costs in its estimate, but state costs would likely be about $700 million higher over the next decade.

These estimated increases in Medicaid prescription drug spending because of Medicare negotiation and inflation rebates are small. Under the same CBO estimate of H.R. 3, Medicare negotiation is expected to reduce overall federal spending by about $455 billion over 10 years. Nevertheless, Congress and the Biden administration could address interactive effects by ensuring that any package of drug-pricing reforms does not inadvertently raise Medicaid drug costs. This could be accomplished by including other drug-pricing provisions that lower state and federal Medicaid prescription drug spending, thereby offsetting the increased costs from Medicare negotiation and inflation rebates.