The Inflation Reduction Act (P.L. 117-169) did not include any drug pricing provisions directly affecting Medicaid.  But as I have previously written for the Commonwealth Fund, Medicare drug pricing reforms can interact with the highly effective Medicaid Drug Rebate Program, under which drug manufacturers must pay sizable rebates to state Medicaid programs that significantly lower prescription drug costs for the federal government and the states.  So how will the Medicaid drug rebate program and federal and state Medicaid prescription drug spending likely be affected by the Inflation Reduction Act’s historic Medicare drug pricing reforms, including the provisions requiring Medicare to directly negotiate prices with drug manufacturers for certain high-cost drugs and requiring drug manufacturers to pay rebates to Medicare if their prices rise faster than inflation?

The Kaiser Family Foundation (KFF) recently posted a very helpful issue brief exploring some of the potential effects of the Inflation Reduction Act on Medicaid.  In this blog, I build on KFF’s brief to further discuss how the Inflation Reduction Act would likely interact with the Medicaid Drug Rebate Program (MDRP) and in turn, decrease or increase Medicaid prescription drug spending.

How the Inflation Reduction Act Could Produce Medicaid Drug Savings

It is likely that the Inflation Reduction Act would lower Medicaid prescription drug spending in three ways.

• Blocking implementation of the Trump Administration’s drug rebate safe harbor final rule. In November 2020, the Trump Administration finalized a rule that would eliminate the safe harbor in the federal anti-kickback law for rebates negotiated by pharmacy benefit managers (PBMs) on behalf of Medicare Part D plans.  As I have previously noted, the Congressional Budget Office estimated in 2019 that the rule would actually increase federal Medicaid spending by $6 billion between 2020 and 2029.  (CBO did not provide estimates of the impact on state Medicaid spending but based on the state share of drug rebates, CBO’s estimate translated to about $2.9 billion in increased state costs as well.)  According to CBO, if implemented, the rebate rule would increase Medicaid drug spending because the rule would effectively replace the current rebates that drug manufacturers provide in Medicare Part D plans with so-called “chargeback” discounts.  That, in turn, would reduce the mandatory rebates that drug manufacturers must provide to Medicaid under the Medicaid drug rebate program because such chargebacks in Part D would likely have the effect of lowering the Average Manufacturer Price (AMP) of drugs — essentially the average price paid by wholesalers — which helps determine the amount of Medicaid rebates.  The Inflation Reduction Act extends a temporary prohibition against implementation of the rebate rule through the end of calendar year 2031 and thus averts the expected loss in drug rebates that state Medicaid programs could otherwise face over the next decade.  CBO did not specifically break out the Medicaid savings from the overall $122.2 billion in federal savings over 10 years resulting from the rebate rule being blocked under the Inflation Reduction Act.
• Making technical changes to the Medicaid Drug Rebate Program related to Medicare drug negotiation. I have noted that providing Medicare the ability to negotiate lower prices for certain drugs could have the effect of lowering the Medicaid rebates states would otherwise receive for those drugs because one part of the Medicaid rebate program involves a basic rebate for brand-name drugs that is the higher of: a minimum rebate equal to 23.1 percent of the AMP or the best price (further discussed below).  If the negotiated prices lower the AMP for drugs, the minimum Medicaid drug rebate amounts owed by manufacturers for those drugs subject to negotiation would also decline.

The final statutory language of the Inflation Reduction Act, however, includes two important technical adjustments to the Medicaid Drug Rebate Program as part of the negotiation provision (which takes effect in 2026) to help mitigate some of these concerns.  First, it excludes the Medicare negotiated prices from the calculation of AMP.  Second, it counts the Medicare negotiated prices towards Medicaid “best price.”  The best price requirement ensures that Medicaid obtains discounts at least as large as those available to most purchasers in the commercial sector.  If the best price discount exceeds the minimum rebate, the basic rebate equals the best price discount amount.  By including the Medicare negotiated prices in the determination of best price, the Inflation Reduction Act would make sure that Medicaid also benefits from Medicare negotiation if for some drugs, negotiated prices end up lower than the lowest prices now obtained in the private market and Medicaid receives greater best price rebates as a result.  CBO does not delineate any Medicaid drug spending effects due to these two adjustments to the negotiation provision, though unlike its estimate of a 2019 House-passed drug pricing bill, CBO does not show Medicare negotiation explicitly increasing federal Medicaid spending.

• Reducing Medicare Part D clawback payments over time. Under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (P.L. 108-173), which established the Medicare Part D drug benefit, state Medicaid programs are required to permanently contribute to the cost of Medicare Part D through so-called “clawback” payments.  These payments now equal 75 percent of the estimated prescription drug costs states would otherwise have incurred for Medicaid prescription drugs furnished to each “dual eligible” — low-income Medicare beneficiaries also eligible for full Medicaid benefits including prescription drugs — in the absence of the Part D drug benefit.  The annual adjustment for the clawback amounts per full dual eligible is the projected increase in Part D per capita costs.  To the extent that the Inflation Reduction Act’s negotiation and inflation-related rebate provisions together lower Medicare Part D per-capita costs over time (offset, in part, by increased Medicare Part D spending related to Part D benefit improvements and the Low Income Subsidy improvements), the Inflation Reduction Act would also likely have the effect of lowering clawback payments owed by state Medicaid programs over time, relative to prior law.  The CBO estimates, however, do not indicate whether they account for how the Medicare negotiation and inflation-related rebates may affect state clawback payments over time.

How the Inflation Reduction Act Could Increase Medicaid Drug Spending

The Inflation Reduction Act would also likely increase Medicaid prescription drug spending in one way.

• Requiring inflation-related rebates in Medicare. In addition to the basic rebate, Medicaid requires drug manufacturers to also pay higher rebates if their drug prices rise faster annually than general inflation.  The Inflation Reduction Act applies similar inflation-related rebates to both Medicare Part D and Part B, starting in 2023.  This would likely increase net Medicaid costs for two reasons.  First, the Medicare inflation-related rebates would likely help deter overall price increases year-to-year, due to the outsized importance of Medicare as a payer for many drugs.  As prices rise more slowly on an annual basis, drug manufacturers would also pay less in Medicaid inflation-related rebates, relative to prior law.  The reduction in these rebates would likely more than offset the lower Medicaid pharmacy costs resulting from lower price inflation.  Second, according to CBO, the Medicare inflation-related rebates would also create an incentive for manufacturers to launch new drugs at higher prices to offset lower post-launch annual price increases.  (The Medicare negotiation provision may also contribute to higher launch prices but will have less of an impact on launch prices than the inflation-related rebates, according to CBO.)  While higher launch prices would result in higher minimum rebates, CBO expects the higher pharmacy costs resulting from higher launch prices will exceed the increase in rebates.  CBO therefore estimates that the Inflation Reduction Act’s inflation-related rebates will increase federal Medicaid spending by $15.7 billion for the 2022-2031 period.  (That translates to about $7.6 billion in increased state spending as well.)

However, as KFF points out, recent Congressional actions affect how the Inflation Reduction Act’s Medicare inflation-related rebates interact with the Medicaid rebate program.  As part of the American Rescue Plan Act (P.L. 117-2) enacted in 2021, Congress eliminated a cap on total Medicaid drug rebates for both brand-name and generic drugs, under which total rebates previously could not exceed 100 percent of AMP.  That cap effectively allowed some drug manufacturers that have imposed very large price increases over time to not pay rebates equal to the full difference between their price increases and inflation, as the Medicaid inflation-related rebates generally required.  According to CBO estimates of the American Rescue Plan Act, eliminating the cap reduces federal Medicaid spending by $17.3 billion between 2021 and 2031.  (That translates into state savings of about $8.4 billion.)  Those savings, however, have not yet begun accruing to state Medicaid programs.  The elimination of the cap does not take effect until January 1, 2024.

While the two CBO estimates were done at two different times and use two different budget baselines and therefore incorporate different assumptions, they together seem to imply that between now and 2031, state Medicaid programs should see no substantial increase in net costs, relative to their current net costs, despite the impact of the Medicare inflation-related rebates.  Future Medicaid drug savings from the AMP cap would be roughly canceled out by future Medicaid spending increases due to the Medicare inflation-related rebates leading to higher launch prices and lower annual price increases.  (Lower annual price increases reduce the benefit of the AMP cap being lifted because fewer drugs will now end up with total rebates that exceed the 100 percent of AMP threshold or the rebate amounts for some drugs will exceed the 100 percent of AMP threshold by lesser amounts than would have been the case in the absence of the Inflation Reduction Act.)

Overall Assessment of the Medicaid Impact of the Inflation Reduction Act

As discussed above, it is uncertain how the Inflation Reduction Act will ultimately affect Medicaid drug spending over time.  It would clearly be incorrect, however, to point to the CBO estimate of the Medicaid impact of the Medicare inflation-related rebates and definitively conclude that the Inflation Reduction Act, overall, increases federal and state Medicaid spending, relative to current net Medicaid prescription drug costs.

Instead, it appears to be the case that the expected savings from the American Rescue Plan Act’s lifting of the Medicaid rebate cap in 2024 would be roughly canceled out by interactions with the Inflation Reduction Act’s Medicare inflation-related rebates.  Moreover, taking into account the positive effects of blocking implementation of the drug rebate safe harbor rule and making adjustments to the rebate program to reduce adverse interactions with Medicare negotiation, as well as potential reductions in Medicare Part D clawback payments — along with some continued savings from elimination of the rebate cap — could mean that the federal government and the states experience overall Medicaid prescription drug savings, relative to current net costs.   Congress, of course, could make this outcome more certain by taking further steps to reduce federal and state Medicaid prescription drug costs, including, but not limited to, the two sound Medicaid and CHIP proposals discussed here.