Friday, July 12, 2019

Economic Theory in the White House: The Rebate Rule

The "rebate rule" was proposed by the Dept. of Health and Human Services (HHS) in February 2019.  It would have prohibited rebates in the Medicare Part D prescription drug market.  Chicago Price Theory was intensively used in the White House to project the effects of the rule on market outcomes and the distribution of surplus between senior citizens, taxpayers, and firms at various positions in the supply chain.

HHS described rebates as follows "Prescription drug manufacturers prospectively set the list price ... of the drugs they sell to wholesalers and other large purchasers. Manufacturers also retrospectively pay PBMs or other entities in the drug supply chain, under rebate arrangements, that meet certain volume-based or market-share criteria." (84 FR 2340)  The Part D rebates alone exceed $30 billion per year and this rule by itself was projected to increase the Federal deficit by about $20 billion per year, which is historic as a single regulation.

This proposal to eliminate rebates was obviously controversial, as reported in the news and evidenced by the facts that the rule was proposed, received almost 26,000 comments from the public, and then this Thursday was withdrawn by HHS.  The proposed rule was complicated because it was a vertical (business-to-business) price control in a market that already has nonlinear pricing, nonlinear and interdependent government subsidies, and longstanding price regulations of various kinds.  The President himself described the rule as requiring a 193 IQ in order to understand its effects:
But prescription drugs, look, it's a rigged system, OK, if I told you how crazy it is, the Web, it's the Web, you need 193 I.Q. to even understand.  This web of geniuses, they put this thing to lower drug prices. It has 19 effects here and 27, so we got it down and we're getting it down further. We have the smartest people, the best people in that world working on it.... (President Donald Trump April 27, 2019, Green Bay WI)

[other of the regulations discussed in that speech were analyzed with Chicago Price Theory too.  Several dozen parts of other CEA reports draw closely on specific pages of Chicago Price Theory].

I agree that it would be essentially impossible to understand the economic effects of this rule in a timely manner without the extensive assistance of Chicago Price Theory and Automated Economic Reasoning. An important tool for analyzing nonlinear pricing is affectionately known as "the Murphy football" among Chicago economics students (and I associate with this Klein and Murphy article about competition with nonlinear pricing; see Chapter 5 and Chapter 13 of the text).

The football picture shows, among other things, the distinction between list price and net price (i.e., list minus rebate), but in order to prevent revealing too much of the answer to one of the new book's homework problems, I show it in more abstract form below.

For the same reason, among others, I will not say what was CEA's projected impact of the rule.  But take Chicago Price Theory and perhaps you can join the "web of geniuses."

There is no other textbook that teaches the "Murphy football."

There is no other textbook that brings its students so immediately to rigorous and timely policy applications of economic theory.

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