TL/DR –
The Inflation Reduction Act (IRA) allows the federal government to negotiate Medicare prescription drug prices and puts policies in place to control the growth of these prices. There is disagreement about the effects of the IRA, with some suggesting it could accelerate innovation because of increased demand, while others believe it could slow down the development of new therapies due to price restrictions. A quasi-experimental study found that greater Medicare exposure is associated with increased research and development (R&D) activity in the post-IRA period, suggesting the law may have increased R&D instead of reducing it.
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Overview
The newly endorsed Inflation Reduction Act (IRA) has given the federal government the power to negotiate the prices of prescription drugs for Medicare. This legislation has introduced measures that control the escalation of prescription drug prices. It has simultaneously increased the generosity of Medicare’s drug benefit and provided more subsidies for low-income Medicare beneficiaries. Therefore, these modifications have changed the economics of the prescription drug market, making it more economically accessible for Medicare beneficiaries. This potentially increases the demand for certain drugs, while also decreasing the price of some branded drugs.
Controversial Impacts
The IRA has sparked intense debates regarding its impact on innovation. Advocates posit that the increased affordability of life-saving drugs will drive up their demand, potentially fast-tracking innovation. In contrast, critics worry that the law’s price controls may hinder the development of new products including new cancer drugs and novel cell and gene therapies.
Research Approach
To discern the most accurate representation of the IRA’s impact, we leveraged quasi-experimental evidence. We chose to view investment decisions in pharmaceutical research and development (R&D) in a conventional manner, where they are based on the expected cash flow generated by the investment projects. The IRA’s impact is then considered in terms of how the legislation influences this cash flow, specifically from successful R&D projects. Primarily, it does this by altering the revenue firms expect to generate through selling drugs to Medicare beneficiaries.1
Assessing Investment Decisions
Our investigation into the effect of the IRA on investment decisions adopts a difference-in-differences approach. This involves observing changes in investment decisions made by companies with higher vs. lower proportions of their revenue coming from Medicare in 2019. As we have found that Medicare exposure remains consistent over time, firms with higher Medicare exposure were likely more impacted by the IRA whereas those with lower Medicare exposure were presumably less affected. We measured outcomes using R&D intensity, the ratio of R&D spending to total revenues, a widely used metric of R&D activity (Hughes, 1988). Additionally, we estimated models where outcome variables are log R&D spending.
Findings
The results from both models reveal that an increased Medicare exposure correlates with larger increases in R&D activity in the post-IRA period. However, these estimates only reach statistical significance when analyzing log R&D expenditures. The findings do not support the argument that the IRA has led to a reduction in R&D activity. In fact, the results suggest the possibility that the law may have increased R&D.
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