How Inflation Rebates Can Curb Drug Price Increases

Concern over prescription drug costs has been growing amid steep list price increases of many brand-name drugs. Before the Inflation Reduction Act (IRA) passed in 2022, drug manufacturers increased prices an average of 4.2 percent on more than 900 brand-name drugs — a new record. To discourage such price hikes, the IRA requires manufacturers to pay inflation rebates to the Medicare program when they increase certain drug prices faster than inflation. This rule was modeled off a longstanding policy in the Medicaid program.

This year, 2025, will be the first in which drug manufacturers will be invoiced for any rebates they owe the federal government under the new policy.

How do the inflation rebates work in the Medicaid program?

Medicaid has had an inflation rebate in place since 1993. If manufacturers increase prices for brand-name prescription drugs or for generic drugs (later added by the Affordable Care Act) faster than inflation during a calendar quarter, then they owe state Medicaid programs the difference, in the form of a rebate.

The Medicaid rebate is calculated based on the difference between a drug’s current-quarter average manufacturer price (AMP) and its baseline AMP, adjusted to inflation for the same period. State Medicaid programs collect rebate payments from manufacturers, and a portion of the rebates is shared with the federal government.

The rebate policy has been successful in holding down costs. In fact, it’s one of the reasons why Medicaid pays the lowest drug prices of any federal health program. A 2022 analysis found that inflation rebates on brand-name drugs reduced Medicaid gross spending on prescription drugs by over 23 percent.

How do the new inflation rebates work in the Medicare program?

The Medicare Inflation Rebate Program applies to certain physician-administered drugs paid for under Medicare Part B — namely single-source drugs and biologic products, including brand-name drugs and certain generic and biosimilar products. For Part B drugs, generally, the Medicare rebate is calculated based on the difference between a drug’s average sales price (ASP) and its baseline ASP, adjusted to inflation for the same period.

Inflation rebates also apply to retail prescription drugs covered under Medicare Part D. This includes most brand-name drugs, some generics, and vaccines. For Part D drugs, generally, the Medicare rebate is calculated based on the difference between a drug’s 12-month annual manufacturer price (AnMP) and its baseline AnMP, adjusted to inflation for the same period. Rebates paid by manufacturers are deposited in the Federal Supplementary Medical Insurance Trust Fund, which helps fund Medicare.

Medicare began invoicing manufacturers for the Part B inflation rebates they owe in September 2025 and will invoice them for the Part D inflation rebates they owe no later than December 2025. The Congressional Budget Office (CBO) estimated Medicare will save $71 billion over the next 10 years from the rebates.

What about the effect on drug prices in the commercial market?

Ultimately, time will tell what impact the Medicare Inflation Rebate Program — still early in its implementation — will have on the commercial market.

The CBO’s analysis of the Medicare Inflation Rebate Program indicated that drug prices in the commercial market would decrease and that employers would raise wages as a result.

The benchmarks used to calculate the inflation rebates, such as ASP and AnMP, are based on commercial prices. Both ASP and AnMP are the net prices that drugmakers report. They reflect the prices they’ve negotiated with private payers, including employer plans. If growth in those prices is limited by inflation rebates, the CBO assumes that employers are reinvesting those funds into other areas, such as wages.

While not citing the policy specifically, an analysis of brand-name drug net prices (actual prices after manufacturer discounts and other price reductions) suggests that prices are decreasing or stable year over year. However, a different study concluded that the Medicare inflation policy could result in modest price increases in the commercial market.

How could inflation rebates affect prices of drugs yet to be launched?

The CBO and others have raised concerns that limiting price increases could put upward pressure on launch prices for prescription drugs. This is because there are not limitations on launch prices for prescription drugs in the United States.

Several studies have found that launch prices are increasing for retail prescription drugs by as much as 20 percent annually. Policy options to address launch prices include: 1) allowing Medicare to negotiate prices when prescription drugs come to market; 2) benchmarking prices in the U.S. to those in other high-income countries; 3) establishing a health technology assessment system in the U.S. to evaluate the public and patient benefit of a new prescription drug to help payers establish fair prices.

Could inflation rebates also be applied to commercial market drug sales?

With both Medicaid and Medicare implementing policies to address price increases that exceed the overall inflation rate, there has been discussion about whether the commercial market should also be subject to inflation rebates or limits on price increases. Some argue that including only Medicaid and Medicare in inflation rebate policies doesn’t deter manufacturers from increasing prices. To achieve a measurable impact, they say all drug sales should be subject to rebates. A recent analysis found that the first years of the Medicare inflation rebate policy were not associated with smaller price increases among top-selling drugs.

Policymakers may consider extending inflation rebates to commercial sales and have those savings support the future sustainability of the Medicare program. They also could consider additional transparency provisions that require manufacturers to report and provide justifications for annual price increases exceeding a certain threshold.

How could inflation rebates affect generic drugs, and could they exacerbate drug shortages?

In the Medicaid program, most generic drugs are subject to inflation rebates, while some generics are subject to rebates in the Medicare program. Including generics has raised some concerns because of the very tight margins under which generic drug companies sometimes operate and the high likelihood of drug shortages for certain generics.

Under the Medicare Inflation Rebate Program, policymakers sought to address these concerns by allowing CMS to temporarily waive or reduce rebates for drugs in shortage or likely to fall into shortage. However, Medicaid does not have a similar policy. Indirectly, the Medicaid inflation rebate policy may push down the price of a drug so low that manufacturers could decide to leave the market, creating a shortage. To address this issue in Medicaid, policymakers could consider adopting Medicare’s policy — or something similar — for waiving or reducing rebates.