Mandatory Spending

Function 570 - Medicare

Require Manufacturers to Pay a Minimum Rebate on Drugs Covered Under Part D of Medicare for Low-Income Beneficiaries

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2019-
Change in Outlays 0 0 -4 -21 -25 -26 -22 -22 -19 -15 -50 -154

This option would take effect in January 2021.


Medicare Part D is a voluntary, federally subsidized prescription drug benefit delivered to beneficiaries by private-sector plans. Federal subsidies for Part D drug benefits, net of the premiums paid by enrollees, totaled about $77 billion in calendar year 2015. (That amount includes payments to stand-alone prescription drug plans and Medicare Advantage plans; it excludes subsidies to employers for providing prescription drug coverage to retirees outside of Part D.) Private drug plans can limit the costs they incur for providing benefits to Part D enrollees by negotiating to receive rebates from manufacturers of brand-name drugs in return for charging enrollees smaller copayments for those drugs. The negotiation of rebate amounts is a business strategy for a Part D plan that is most effective when a few manufacturers' drugs are competing for market share in the treatment of a particular medical condition. The Congressional Budget Office estimates that in 2015, manufacturers' rebates paid to Part D plans amounted to about 22 percent of gross spending on all brand-name drugs under Part D.

Before Part D took effect in 2006, most dual-eligible beneficiaries—Medicare beneficiaries who were also enrolled in Medicaid—received drug coverage through Medicaid. Under federal law, drug manufacturers that participate in Medicaid (which is a joint federal-state program) must pay a portion of their revenues to the federal and state governments through rebates. In 2010, those rebates increased from 15.1 percent to 23.1 percent of the average manufacturer price (AMP) for a drug. (The AMP is the amount, on average, that manufacturers receive for sales to retail pharmacies.) If some purchasers in the private sector obtain a price lower than 23.1 percent off of the AMP, then Medicaid's basic rebate is increased to match the lowest price paid by private-sector purchasers. If a drug's price rises faster than overall inflation, the drug manufacturer pays a larger rebate. And those inflation-based rebates can be significant: In 2015, for example, the average inflation rebate under Medicaid, weighted by the dollar amount of brand-name drug purchases, was 37 percent of the AMP.

When Medicare Part D was established, dual-eligible beneficiaries were automatically enrolled in its Low-Income Subsidy (LIS) program, which typically covers premiums and most cost sharing required under the basic Part D benefit. LIS enrollees—most of whom are dual-eligible beneficiaries—accounted for about 30 percent of Part D enrollment in 2015, and their drug costs represented about 50 percent of total spending for Part D enrollees' drugs in that year. Currently, the rebates on drug sales to LIS enrollees and to other Part D enrollees are set through negotiations between the Part D plans and the drug manufacturers.


Starting in 2021, this option would require manufacturers to pay a rebate to the federal government for brand-name drugs sold to LIS enrollees. The rebate would be 23.1 percent of the drug's AMP plus an additional, inflation-based amount, if warranted. (This option does not include the provision in the Medicaid program that would increase the rebate to match the lowest price paid by private-sector purchasers.) In many cases, a manufacturer might already have negotiated discounts or rebates that applied to all Part D enrollees equally. In those instances, any difference between the negotiated amount across all beneficiaries and the amount of the total rebate owed by the manufacturer would be paid to the federal government. If, however, the average Part D rebate for the drug was already more than 23.1 percent of the AMP plus the inflation-based rebate, the federal government would receive no rebate. Participation in the program would be mandatory for manufacturers who wanted their drugs to be covered by Part B (Medical Insurance) and Part D of Medicare, by Medicaid, and by the Veterans Health Administration.

Effects on the Budget

CBO estimates that implementing this option would reduce federal spending by $154 billion between 2021 and 2028 because, on average, the rebates negotiated for brand-name drugs are smaller than the statutory discounts obtained by Medicaid. (CBO projects, on the basis of historical data, that the effect in 2021 would be smaller than in other years because it would take some time to collect the rebates after the assessment date.) However, drug manufacturers would be expected to set higher "launch" prices for new drugs as a way to limit the effect of the new rebate, particularly for new drugs that do not have close substitutes. Over time, that response would reduce the savings to Medicare from this option. However, the size of that response is uncertain for two reasons: First, the amount of spending on new drugs that would be subject to higher prices is unclear. Second, the amount of the rebate that would be offset is uncertain because it would depend on the extent to which purchases of drugs subject to the inflation rebate were replaced by drugs with higher launch prices as a result of competition in the market. The higher launch prices also would affect other drug purchasers. Employment-based health insurance plans would probably negotiate larger rebates to offset a portion of the higher prices, but state Medicaid programs would pay more for new drugs, which in turn would tend to increase federal spending. (Those effects on federal spending for the Medicaid program are included in this estimate.)

In addition, this option could change manufacturers' incentives to offer rebates to Part D plans for existing drugs. However, because the pressures on those rebates would push in both directions, CBO expects that the average rebates would not change appreciably. In general, manufacturers offer rebates in exchange for preferred coverage of their drugs in order to increase sales and market share. A key provision of the option is that the amount of a rebate that a manufacturer paid to a Part D plan would count toward the total rebate that manufacturer owed the federal government. On the one hand, that provision would make it less costly for manufacturers to increase their rebates as a way to boost sales to non-LIS enrollees. On the other hand, the higher required rebate for sales of drugs to LIS enrollees would reduce the benefit to manufacturers of increasing those sales. The net effects of the reductions—in terms of both the costs and benefits of offering rebates—are unclear and would vary by drug. But the overall effects on rebates for existing drugs would probably be negligible, in CBO's estimation. If this option was expanded to include most of the Part D population, there could be adverse effects on the incentive for plans to use other tools such as formula tiers, prior authorization, and step therapy to hold down costs. However, if the option included a subset of the LIS population, the savings would be smaller and the incentives would remain unchanged.

Other Effects

An argument in favor of this option is that the Part D benefit could provide the same amount of drugs to Medicare beneficiaries at lower total cost, particularly for brand-name drugs that have no close substitutes and whose prices are less subject to market competition. An argument against the option is that the lower revenues that manufacturers receive for drugs under Part D could cause them to reduce their investments in research and development.

The development of "breakthrough" drugs would be least affected by any decline in investment, CBO expects, because purchasers of those drugs tend to be willing to pay more for them. Manufacturers initially can set a higher price for a breakthrough drug, which can offset a portion of the new rebate without substantially affecting sales. Consequently, Medicare's savings under this option would be limited for new drugs because of their higher launch prices, and, eventually, the savings on existing brand-name drugs would dissipate as those drugs lost patent protection and were replaced by less expensive generic versions.

The effects of the option on rebates and investment incentives would be larger than when rebates were required in the past. Before 2006, manufacturers were already paying rebates to Medicaid for drugs purchased by the dual-eligible population (who were then enrolled under Medicaid's drug benefit). However, the new rules also would apply to drugs purchased by LIS enrollees who are not dual-eligible beneficiaries, and therefore (all else being equal) the total required rebate would be larger than it was when dual-eligible beneficiaries received drug coverage through Medicaid. In addition, because of the 2010 increase in the rebate required for the sale of drugs covered by Medicaid, the reduction in manufacturers' incentives to invest in research and development would probably be greater under this option than under the earlier system.