The Crazy Way the Government Buys Billions of Dollars of Drugs

The U.S. government buys a lot of drugs. Purchases by the Pentagon, Medicare, Medicaid, and other federal programs account for more than a quarter of all U.S. retail prescription spending, which reached $263 billion (PDF) last year. You might think that kind of buying power would entitle Uncle Sam to get the best price all the time. If only that were true. The government pays vastly different prices for medicines depending on which office is buying them, according to a new report (PDF) from the Government Accountability Office.

Medicaid, which provides coverage to poor people through state-run programs, gets the best deal. Medicare Part D, which covers the elderly through private insurance, pays the most for brand-name drugs. And the Department of Defense pays the most for generics, according to the GAO’s analysis of what the government paid for 78 common drugs in 2010.

There are lots of explanations for why this is the case, but no good reasons. By law the Department of Defense and Medicaid get some rebates from drugmakers that lower their costs. The GAO looked at the net cost per dose that each program pays. The prices in the chart above are what the U.S. pays after rebates and after beneficiaries contribute their share. For Medicaid, drugmakers’ rebates cut the price by more than half.

It’s a bit of a shell game. Discounts in one program are often offset by higher prices somewhere else—for either the government or private insurers or both.

The GAO makes this clear. Theoretically, the government could save billions if it got the Medicaid rate for all the pharmaceuticals it buys—69 percent lower than Medicare gets for brand-name medicines—if drugmakers didn’t raise other prices to make up for the lost revenue.

“The magnitude of these potential offsetting price increases could depend on a number of factors,” the GAO wrote. “For example, if a large federal program with many beneficiaries became eligible for the discounts, manufacturers might choose to raise prices by a greater amount than they would if a smaller program with fewer beneficiaries became eligible. Manufacturers might choose to raise prices more for drugs with fewer competitors than for drugs with many competitors. Furthermore, because federal prices are generally based on prices paid by nonfederal purchasers such as private health insurers, manufacturers would have to raise prices to those purchasers in order to raise the federal prices.”

This slippery pricing game can be found throughout the U.S. health-care system. Doctors and hospitals get paid less by Medicare than by commercial insurance, and they get paid even less by Medicaid. Essentially, people and employers who buy private insurance subsidize lower-cost coverage for those on Medicare and Medicaid. Health-care companies manage their “payer mix” to make sure they’ve got enough money coming in from private plans to cover the patients whose coverage pays less.

All this adds another layer of complexity and confusion to the pharmaceuticals marketplace. Medicare’s drug plan, Part D, covered 33 million Americans in 2011. State Medicaid programs insured 71.5 million low-income people, and the military covered 9.7 million. Together the programs spent $71 billion on retail prescriptions. It’s anyone’s guess if taxpayers got their money’s worth.

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