In the past few years, anger over the high price of prescription drugs in the United States has reached fever pitch. Many Americans now view Turing Pharmaceuticals former CEO Martin Shkreli, who raised the price of the anti-parasitic drug Daraprim by more than 5,000 percent overnight, as the face of the industry. Parents of children with allergies, though, might assign that honor to the deciders at Mylan Pharmaceuticals, who raised the list price of the EpiPen rescue device from $100 in 2010 to $600 in 2016. Meanwhile, the Senate Finance Committee spent 18 months investigating Gilead, which priced its breakthrough cure for hepatitis C, Sovaldi, at $84,000.

Yet, thus far, Washington has proved to be all bark and no bite. President Trump’s recent speech on the subject touched on some important issues (discussed below) but offered no realistic roadmap for getting from here to there.

Meanwhile, drug price increases continue unabated, with the list prices of the 20 most prescribed drugs outpacing the consumer price index by tenfold over the past five years. Herein, I explain why drug prices are so difficult to contain, how other countries have addressed the issue and what we should do here in the United States.

The Elusive Problem

Americans agree about few things these days, but the price of drugs seems to be an issue that crosses the partisan divide. Some 80 percent of Democrats and 70 percent of Republicans say that prices for brand-name prescription drugs are unreasonable.

Yet the economic drivers underlying the circumstances that have made drugs like Sovaldi and Daraprim infamous are quite different — and in ways that complicate the narrative. Yes, Gilead’s new hepatitis C drugs are expensive. But these drugs are highly effective, truly innovative products that cure a chronic disease. Rather than targeting a maintenance therapy (which might well cost insurers more money over the long term), Gilead developed a cure for a disease that is disproportionately prevalent among poor and marginalized populations (such as illicit drug users).

To be sure, the upfront cost of Sovaldi has strained the budgets of state Medicaid programs and prison systems, which have been rationing the drug’s availability. But unlike many new drugs, Sovaldi is cost-effective.

Martin Shkreli’s Daraprim antics, by contrast, added nothing to society. Quite the contrary: he jacked up the price of a decades-old drug by exploiting regulations designed to keep the public safe. There were no other producers on the market, and potential competitors would need to go through a lengthy FDA approval process before marketing their product.

Sovaldi and Daraprim thus suggest the need for very different policy interventions, if you believe intervention is warranted in both cases. Shkreli’s conduct could be remedied through legal constraints on price increases or through an expedited FDA review program that created competition for Daraprim in short order. One might reasonably argue that Sovaldi only presents a financing problem — that, in the long run, an expensive cure beats an even more expensive treatment that never frees the patient from the malady. But others might argue that the degree of intellectual property and regulatory exclusivity protection that allows Gilead to charge whatever the market will bear is not in the public interest.

Drug prices, it should thus be clear, can be higher than the public expects for a variety of reasons, some more justifiable than others. The conundrum is identifying those reasons and designing policy to constrain prices without undermining incentives to innovate.

When is a price increase a price increase?

Even in the wake of high-profile drug-pricing scandals, some prices increase relentlessly. At the beginning of 2018, Pfizer raised the price of 148 of its drugs by an average of 8.8 percent. Also this year, AbbVie raised the price of Humira — the best-selling drug in the United States, which was already bringing in $16 billion annually — by 9.7 percent. The price is now double what it was in 2012, bringing the cost of a year’s worth of this potent antiinflammatory to $38,000.

And yet a new report by a company that analyzes health care data concludes that total prescription drug spending in the United States grew only 0.6 percent in 2017, and that per capita spending actually fell. How can this be?

These observations are entirely consistent with each other — and the reason helps explain the down-the-rabbit-hole complexity of the drug-pricing debate.

A key to cutting through the rhetorical froth here is the difference between list prices, which are indeed growing rapidly, and net prices, which are rising far more slowly. Pharmaceutical companies will typically offer significant rebates from the list price, with the rebates varying according to the market power of the buyer. They will make concessions to pharmacy benefit managers in exchange for preferred placement on a formulary (the first-line drugs covered by an insurance policy). In some cases, the rebates may be required by law, as with Medicaid and programs administered by the Department of Veterans Affairs.

Therefore, the list price isn’t the “real” price, in the sense that a patient’s insurer will often pay less than list. But it’s also simply not true that, as one pharmaceutical executive put it, “nobody pays the list price.” Some patients are indeed paying the full freight, and they’re being exposed to high — and escalating — prices that force them to think again before seeking treatment.

Increasingly, consumers are finding themselves enrolled in high-deductible health plans designed to expose them to thousands of dollars in cost-sharing out of pocket before their coverage kicks in. When they go to the pharmacy to pick up a prescription, they are often asked to pay list until their deductible is reached, rather than the net price their insurers negotiate.

The confluence of these two dynamics — rising list prices and the growth of high-deductible health plans — largely explains why consumers have become so angry about drug prices over the past few years. All too often, patients are being asked to bear the full (and rising) cost of these drugs, whereas previously the sticker shock had been obscured by more robust insurance coverage.

So if drug prices seem to be rising rapidly, that’s because they are — at least for some patients. Further, the Centers for Medicare and Medicaid Services projects that prescription drug spending will grow by 6.3 percent annually from 2017-2026, outpacing the projected growth of health care spending overall (5.5 percent).

A uniquely American problem

The controversy has exposed the reality that drug prices in the United States are much higher than prices in many other advanced industrial economies. England, Norway, Switzerland and Germany all pay less — often far less.

These countries deploy a variety of tactics to extract a better deal from drug makers, but they’re all based on the leverage gained through market power. First, the government, as the largest pharmaceutical purchaser in most of these countries, demands significant discounts. Then, if the drug company balks, the government can often credibly threaten not to cover the drug at the company’s preferred price.

In the United States, Medicare does not have the authority to negotiate with pharmaceutical companies for the price of drugs that are administered through Part D of the Medicare package. To be sure, private health insurers who design and administer Part D plans are permitted to negotiate, but any one contractor’s patient population is smaller than the large pool of Medicare enrollees, decreasing potential buying power.

A full 90 percent of Americans favor permitting Medicare to negotiate for lower drug prices. There’s just one problem: Medicare is legally required to cover many (and for some conditions, all) FDA-approved drugs. As such, if Medicare does not like the deal a particular pharmaceutical company is offering, it often cannot walk away from the table. Pharmaceutical companies have no incentive to provide discounts if they know our public payers must cover them. This is why the Congressional Budget Office concluded that merely providing Medicare with negotiating authority “would have a negligible effect on Medicare drug spending.”

However, if Medicare had both negotiation authority and the discretion to exclude high-priced drugs, the prices it would pay would likely be very different. For comparison, consider Britain’s National Health Service. Once a drug is approved as safe and effective by relevant pharmaceutical regulators, the National Institute for Health and Care Excellence (NICE) conducts “technology appraisals” and makes recommendations to the NHS regarding reimbursement for the drug.

NICE considers not just the efficacy of the drug, but also whether it represents good value for the money. NICE measures value by comparing the cost of the treatment to benefits, measured in terms of “quality-adjusted life-years” saved. And under current guidelines, it is likely to recommend drugs for coverage where the cost per QALY is below £30,000 (about $40,000) per QALY gained.

If the drug does not offer good value for money, the NHS may choose not to provide reimbursement for it. And under Britain’s single-payer system, the decision not to cover a drug means that the seller will be frozen out of most of the market.

But this is not the only way to control the prices of new products. In Germany, if the government negotiator and pharmaceutical company cannot agree on a price, the issue is settled by an arbitration board that factors in the cost of the drug in other countries. Moreover, if a new drug provides no additional value over a previously available drug, insurers will cover the new drug only at the price of those older products.

The United States could adopt one or more of these strategies, some of which have been deployed on a smaller scale within the United States. For instance, Medicaid is required by law to cover essentially all FDA-approved drugs. But it is also legally entitled to a large statutory discount from the average private market price for those drugs, and it is protected from price increases that outpace inflation. The VA, for its part, is permitted to establish a restrictive formulary, declining to cover drugs if the pharmaceutical industry does not provide a discount the agency deems sufficient.

Thus far, however, Washington has been unwilling to adopt broader strategies like these to curb drug pricing and spending. This reticence is understandable. Apart from forcing a confrontation with a politically powerful industry, these cost-containment strategies might well prevent some patients from accessing optimal treatments — and the idea of explicit rationing of medical care has not been accepted in American health care policy.

The I-Word

Another fear has also loomed large when price regulation is discussed: concern that pharmaceutical companies will stop producing innovative products if their discretion to price them is constrained. Even if regulation could lower costs and improve access now, the industry argues, it would harm Americans in the long run by depressing incentives to invent the next game-changing drug.

Perhaps. But the pharmaceutical industry is the most profitable segment of the health care sector, and pharma often ranks among the most profitable industries in the economy. It is hard to imagine that just limiting the ability of drug makers to increase their list prices many times over would dampen innovation incentives. It is even harder to imagine that limiting the ability of makers of off-patent generic drugs (which, by definition, are not engaged in the development of new pharmaceuticals) to increase the prices of their products arbitrarily would have such an effect on innovation.

But more importantly, the industry’s argument presents a false choice. Innovation is not governed by a simple on-off switch. I have argued elsewhere that well-designed drug-pricing regulation would change the types of innovations that are encouraged, as opposed to deterring innovations in general. Rather than a tradeoff between access to drugs today and innovation tomorrow, we would trade one kind of innovation for another.

This more nuanced policy is sorely needed. Right now, the law encourages particular types of innovations and the development of certain kinds of products that do not align with social value. Changing the way in which we develop, approve and — yes — pay for new drugs is needed to rebalance incentives for innovation with social value.

Take curative therapies as one example. Our current system of reimbursing pharmaceuticals biases commercial R&D toward the development of maintenance therapies rather than cures for common chronic conditions like diabetes and rheumatoid arthritis. Drug companies can expect to earn more from developing drugs that many patients will take every day for the rest of their lives than they could from inventing cures. A Goldman Sachs report from April of this year put it succinctly, asking: “Is curing patients a sustainable business model?” Promoting market incentives that align reimbursement with social value might well right this imbalance.

Another example of a potential fix is linked to the highly fragmented nature of our American reimbursement system. Essentially, we have created a tiered pricing system in which pharmaceutical companies can expect to make more money from drugs prescribed to privately insured patients or to Medicare recipients than from drugs prescribed to Medicaid recipients. The large discounts available to Medicaid importantly allow the program to provide more comprehensive care to more low-income Americans. But from an innovation perspective, they discourage companies from investing in drugs for conditions that disproportionately affect the poor. Fixing this income-based disparity might encourage industry to invest more in underserved markets.

More generally, our hybrid system of drug reimbursement has been constructed from a series of messy political compromises over decades. It is no surprise that it is not optimized for innovation or access. It is surely possible that extreme or thoughtless price controls on drugs would dampen incentives to innovate, though the constant repetition of this argument against controls renders it suspect. But it is possible — even likely — that we could redistribute, not just decrease, incentives for innovation in ways that are socially valuable.

Progress in inches, not miles

What should be done? I am tempted to hide behind the law professor’s answer: it depends. Solutions built around the luxury of starting afresh, after all, may not resemble ones that start from where we find ourselves. But it is possible to craft a particularly American set of solutions, one that accounts for our hybrid federal-state, public-private system.

Possible reforms might well be piecemeal, but they could also be quite meaningful. As one example, consider the demonstration project for Medicare Part B (which mostly covers physician services) proposed by the Obama administration. At present, many expensive biologic drugs — the complex “large molecule” drugs derived from living cells – are administered in physicians’ offices and are reimbursed under Medicare Part B rather than Part D (the optional pharmacy benefit coverage). Yet experts have argued that the way Part B pays for drugs, in which physicians are reimbursed based on the drug’s price rather than its clinical value, may encourage physicians to prescribe more expensive drugs than are medically necessary.

Moving toward a flat-fee or paying-for-value system would nudge providers in a positive direction. Not surprisingly, though, the pharmaceutical industry argued that this change would discourage investment in new biologic therapies; the initiative was abandoned. The Department of Health and Human Services has recently suggested that some Part B drugs should be subject to the kind of negotiations already existing in Part D, but the administration has not yet taken concrete action to this end, and industry may similarly oppose this idea.

More recently, Massachusetts has requested a waiver from federal Medicaid regulation, which would allow the state to refuse to pay for drugs that have not yet demonstrated sufficient efficacy. Specifically, Massachusetts is worried about its lack of discretion with new pharmaceuticals that come to market through the FDA’s accelerated approval pathway — many of which have only completed clinical trials involving surrogate endpoints. Right now, Medicaid is legally required to cover these drugs, many of which have list prices in the hundreds of thousands of dollars, even though evidence of their efficacy has yet to be firmly established.

There would be a social cost in granting the waiver: some patients might lose access to drugs they really need, at least while clinical trials are ongoing. But the proposal does seem tailored to minimize patient burdens, even as it saves taxpayers’ money and pushes drug makers to accelerate the completion of clinical trials.

Perhaps most interestingly, last year the VA announced a collaboration with the Institute for Clinical and Economic Review, or ICER — sometimes referred to as America’s NICE — to support the VA’s efforts to assess the value provided by pharmaceuticals. ICER will provide the VA with additional resources and information as it decides which drugs it will cover and how much of a discount from list price it will demand from drugs that pass muster.

There is one ironic advantage to being ensnared by the Rube Goldberg machinery of drug pricing in America. It may provide us with the opportunity to consider many different models of drug-pricing reform at once— some on the state level and others on the federal level, some in the private sector and others in the public sector. In the best of possible worlds, the most successful experiments would be scaled to meet national needs. Although it is hard to be optimistic about breaching the political and practical barriers that have boxed us in thus far, payers and patients are demanding real change, and they may yet prevail.