Abstract
The Inflation Reduction Act (IRA) newly allowed the federal government to negotiate the prices Medicare pays for prescription drugs. It also put in place policies that constrain the growth of prescription drug prices while increasing the generosity of Medicare’s drug benefit and increasing subsidies for low-income Medicare beneficiaries. These changes alter the economics of the prescription drug market. They make prescription drugs more affordable for Medicare beneficiaries, thereby increasing demand for many drugs, while also reducing prices for some brand-name drugs.
The IRA has sparked vigorous disagreement about how its provisions will affect innovation. Some have argued that increased affordability of life-saving drugs will boost demand for these drugs, possibly accelerating innovation. Others fear that the law’s limits on prices will slow the development of new products, such as new cancer drugs or new cell and gene therapies.
We use quasi-experimental evidence to assess which of these competing characterizations of the IRA’s effects is most correct. To analyze the effects of the IRA on pharmaceutical research and development (R&D) investment, we adopt the conventional view that R&D investment decisions are based on the expected cash flow generated by investment projects. The effects of the IRA then hinge on how the law affects the cash flow generated by future successful R&D projects. The IRA affects these cash flows in multiple ways, mainly by changing the revenues that firms can expect to earn by selling drugs to Medicare beneficiaries.1
To assess the effect of the IRA on investment decisions, we adopt a difference-in-differences approach that examines changes in investment decisions made by firms with higher and lower shares of their revenues from Medicare in 2019. Because, as we document, Medicare exposure is persistent over time, firms with higher levels of Medicare exposure were likely more exposed to the IRA, while those with less Medicare exposure were likely less exposed to the IRA. Our outcome variables are measures of R&D intensity, the ratio of R&D spending to total revenues, a widely used metric of R&D activity (Hughes, 1988). We also estimate models where the outcome variables are log R&D spending.
In both sets of models, our point estimates indicate that greater Medicare exposure is associated with larger increases in R&D activity in the post-IRA period, although these estimates are only statistically significant at conventional levels when analyzing log R&D expenditures. These results do not provide evidence supporting the contention that the IRA reduced R&D activity and, if anything, they suggest the law may have increased R&D.
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Authors
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Acknowledgements and disclosures
The authors thank Matthew Fiedler for many helpful comments on earlier drafts. The authors also thank Sam Peterson and Yihan Shi for excellent research assistance, and Rasa Siniakovas and Chris Miller for editorial assistance.
The authors gratefully acknowledge financial support from Arnold Ventures.
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Footnotes
- Below, we focus on the major provisions related to prescription drugs. We do not address various tax policies included in the IRA that might affect the economic choices of pharmaceutical manufacturers, like the new tax on stock buybacks, which could have some effect on the relative attractiveness of R&D spending.
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