Here’s how we can control drug costs while spurring innovation

Health care is one of the most valuable services that Americans spend their money on, but it also can be the most expensive. Political pressure to do something is enormous. Given the partisan slow boat in Washington, states have started to move with willingness — especially with regard to prescription drugs. This is posing a huge challenge to a rational national policy.

Maryland took the lead this year by establishing a Prescription Drug Affordability Board to “protect State residents” from the high costs of prescription drugs. It will begin work this summer.

Similar legislation to set up prescription drug affordability review boards is being considered in 10 or more states with variations around their mandates to curb excess costs. In most cases, the review boards will allow the states to set pricing caps for certain higher-cost drugs.

Most of the recent legislation is modeled after draft legislation released by the National Academy for State Health Policy. A bill in Massachusetts, for example, would require drug manufacturers to report key pricing information such as research and development (R&D) costs so that the state’s Health Policy Commission can create pricing caps. In Oregon, the proposed Drug Cost Review Commission would determine the excess costs associated with prescription drugs and establish maximum prices. 

Why shouldn’t states take the lead? After all, states were the first battleground in curtailing smoking. They regulate hospitals and health-care providers. We even allow states to serve as laboratories for health policy. Section 1115 of the Social Security Act gives the Secretary of Health and Human Services the authority to approve “experimental, pilot, or demonstration projects” that will promote the program’s objectives.

The problem occurs when states try to regulate markets that cross state borders. When a Californian uses tobacco, the secondary smoke does not affect West Virginians. The same goes for health-care delivery. Most people get their services from local doctors or health-care systems and so it does not naturally cross state lines. But pharmaceuticals are not local or even regional — they are global. Millions of pills are manufactured and shipped around the world every day.

What would happen if every state started regulating prescription drugs? First would come Maryland — no big deal. But then comes Massachusetts, Maine and Minnesota; and suddenly states have started a race to the bottom with reference pricing. No single state would be accountable for the long-term consequences for the global market — and this is bad for innovation.

Calculations by the Schaeffer Center at USC suggest that the U.S. market accounts for as much as 78 percent of all global drug profits. These are the profits that drive innovation and they are coming out of American wallets. Branded prescription drugs are 20 percent to 40 percent cheaper in Europe in large part because its national health plans drive hard bargains. The state-run buyers can impose price caps, or even refuse to allow a drug onto a national formulary if they think it is not worth the cost.

The solution is to let the federal government take the lead, much as it did during the Nixon administration. President Nixon is getting more attention this year because of impeachment, but his administration also presided over some important regulatory accomplishments — including the creation of the Environmental Protection Agency. The EPA regulates air quality because air, like pharmaceuticals, is a national product that easily crosses state and country borders.

Most intriguingly, Nixon helped create the U.S. Federal Office of Technology Assessment (OTA). The OTA informed Congress of the impact of new technologies of many kinds — including health. OTA prepared reports exploring the potential consequences of policy options. Their tools were systems analysis, cost-benefit analysis, market research and consensus methods. The OTA did not have its own labs nor conduct original scientific research; it consisted of diverse expert panels to provide peer-review of major technologies.

The OTA produced good research in the public’s interest. By some estimates, just one OTA report saved the federal government enough money to fund the agency for a century. In the end, though, Congress killed OTA. Concerns that it would ration health care to contain cost, threaten innovation, and jeopardize medicine’s autonomy all conspired against it. (It didn’t help that OTA negatively reviewed Ronald Reagan’s Strategic Defense Initiative.) The OTA’s final death knell was delivered under the leadership of Newt Gingrich, the House speaker, in 1995.

It’s time to bring back the OTA, with a sharper focus on medical innovation. OTA could advise on the appropriate value-based price for new technologies — taking into account the dynamic consequences of innovation. Such a move would preempt state efforts and better inform pricing decisions by private and public payers. It would avoid a patchwork of regulations that could hinder future innovation. A well-resourced OTA would strike the right balance between controlling costs today and spurring innovation tomorrow.

Dana P. Goldman is the Leonard D. Schaffer Chair and distinguished professor at the Sol Price School of Public Policy and School of Pharmacy at the University of Southern California. He is a consultant to Precision Health Economics and owns equity in its parent company.