We have all heard quotes from government leaders, from Thomas Jefferson to Ronald Reagan, about the dangers of granting too much power to the government. Author P.J. O’Rourke expressed this sentiment perfectly: “Giving money and power to the government is like giving whiskey and car keys to a teenage boy.”
Government price controls exemplify this point well.
Douglas Holtz-Eakin, a renowned economist and policy expert, has been a vocal critic of government-imposed price controls. His perspective is particularly relevant in today’s economic climate, where various industries face pricing challenges. Holtz-Eakin’s arguments in a recent study against price controls are compelling; they are rooted in economic theory and supported by historical evidence.
People often complain about the economic power of massive retailers like Amazon or Walmart. Because these companies are so large, they enjoy more pricing power than their competitors. They can demand that suppliers slash prices. If suppliers don’t comply, the giants can cut them off entirely.
While there is some truth in this, also note that Amazon and Walmart, while large, also must compete. They compete with each other. They compete with Target. They compete with thousands of online sites. Ultimately, it is the competition, not the size of the retailer, that drives prices down.
Let’s compare that to the way the government works.
Our federal government never has to compete with anyone for anything. It has the power to tax, which is the power to destroy something. It has the power to regulate, which is also the power to destroy. If it wants to, it can set prices and demand that companies pay those prices.
The debacle known as the “Inflation Reduction Act,” passed in 2022, attempted to do many things. One of its provisions was that it was supposed to control the price of prescription drugs. How? Imposing price controls is a tool lawmakers love and free-market advocates loathe.
The IRA created a maximum fair price (MFP) for a list of drugs paid for by Medicare. Each year, it will add more drugs to that list. MFP works as a threat to drug companies. If they are not willing to sell to the government at the set price, the government will impose a confiscatory excise tax that no company could possibly afford to pay.
“It is important to note that the excise tax is 95 percent of the manufacturer’s sales prices, which includes the tax,” Holtz-Eakin wrote. “When the tax is expressed as a percentage of the revenue the manufacturer receives from the sale, the effective rate is 1,900 percent. This means, for example, that the manufacturer would pay $190 in taxes on a sale that yields $10, for a total retail price of $200.”
You don’t have to be an award-winning economist to know a company will not last under these conditions.
No company can make money paying $190 in taxes on a product that sells for $10, so in the first year of the program, all manufacturers knuckled under and accepted Medicare’s offer. Expect to see that trend continue if the IRA remains in place.
That is not the most effective way to reduce prices. Just as opening a Target next door to a Walmart drives down prices in both stores, more competition drives down prices in the drug industry.
“A clear majority of patients’ drug savings was acquired through negotiations between manufacturers’ rebates — offered to secure better placement on insurers’ formularies — compared to the lesser savings extracted from the IRA’s drug pricing provisions,” Holtz-Eakin found. Markets always work.
What did not work was the politicians’ attempts to buy power. The Congress that passed the Inflation Reduction Act was almost immediately voted out of office. Voters have since ousted the president who signed the law and installed Republican leadership.
Today’s lawmakers should give the voters what they want. They should repeal the entire IRA, including the ill-considered price controls. Instead, they should focus efforts on reducing the size and scope of government and on using the power of markets to lower prices.
Prices are too high, and consumers are already nervous about the future. They sense that inflation may be on its way back. Republican lawmakers can do something about that. They should repeal the IRA right now.
