Can Price Ceilings Increase Prices? Reference Pricing and the Inflation Reduction Act

Abstract: The Inflation Reduction Act (IRA) of 2022 marks a significant shift in Medicare’s approach to purchasing prescription drugs by mandating price negotiations between the federal government and drug manufacturers. This paper presents a theoretical model of manufacturer pricing behavior under the IRA and provides empirical estimates of the likely price response. If negotiated prices are set at 50 percent of reference prices, Part D and Part B drug prices will rise by 11 percent and 2 percent, respectively, cutting projected Medicare savings in half. Enrollee savings from a fully phased-in IRA pricing policy are minimal. Medicare already covers almost all cost-sharing and premium payments for low-income enrollees, so their savings are minimal. For middle- and upper-income households, the savings amount to less than 0.1 percent of household income. The reduced innovation from the price regulations imposes significant long-term costs. Shortening the reference period further amplifies price increases with little additional benefit for the federal government or Medicare recipients.

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