CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

DECEMBER 2004

Medicaid’s

Reimbursements

to Pharmacies

for

Prescription

Drugs

CBO

The Congress of the United States O Congressional Budget Office

CBO

Medicaid’s Reimbursements to 

Pharmacies for Prescription Drugs

December 2004

A

PAPER
Note

Numbers in the text and tables may not add up to totals because of rounding.
Preface

Between fiscal years 1997 and 2002, Medicaid’s expenditures on prescription drugs in 

the fee-for-service part of the program increased from $10.2 billion to $23.4 billion. About 

one-quarter of those amounts went to wholesalers and pharmacies to compensate them for 

distributing and dispensing the drugs. 

Prepared at the request of the House Committee on Energy and Commerce, this paper examines recent trends in that “markup”—or the difference between the total amount that state 

Medicaid agencies paid to pharmacies and the amount that pharmacies and wholesalers paid 

to purchase the drugs from manufacturers. In keeping with the Congressional Budget Office’s 

(CBO’s) mandate to provide objective, impartial analysis, the paper makes no recommendations.

Todd Anderson, Anna Cook, and Judy Wagner of CBO’s Health and Human Resources Division wrote the paper under the supervision of Steve Lieberman, Bruce Vavrichek, and James 

Baumgardner. (Steve Lieberman and Judy Wagner have since left CBO.) Perry Beider made 

helpful suggestions on early drafts, and Samuel Kina provided research assistance. Richard 

Frank of Harvard University provided a valuable review. (The assistance of an external 

reviewer implies no responsibility for the final product, which rests solely with CBO.)

John Skeen edited the paper, and Leah Mazade proofread it. Judith Cromwell produced drafts 

of the manuscript. Maureen Costantino formatted the document for publication, Lenny 

Skutnik produced the printed copies, and Annette Kalicki formatted the electronic versions 

for CBO’s Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

December 2004

Summary and Introduction 1

Measuring Markups 3

Factors Contributing to Rising Markups 3

Markups on Generic and Brand-Name Drugs 4

Markups by Type of Brand-Name or Generic Drug 5

The Relative Contribution of Generic and Brand

Name Drugs to Rising Markups 8

Medicaid’s Reimbursement Policies That May Have

Contributed to 

Increasing Markups 8

Recent Changes in States’ Policies for Reimbursing

Pharmacies 11

Data and Methods 13

CONTENTS
vi MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

Tables

1. Summary of Medicaid’s Average Reimbursements, Wholesalers’ and

Pharmacies’ Acquisition Costs, and Markups for Prescription Drugs, 

1997 and 2002 2

2. Medicaid’s Reimbursements, Wholesalers’ and Pharmacies’ Acquisition

Costs, and Markups for Brand-Name and Generic Drugs,

1997 to 2002 4

3. Distribution of Medicaid Prescriptions, by Drug Type, 1997, 2000,

and 2002 6

4. Medicaid’s Reimbursements, Wholesalers’ and Pharmacies’ Acquisition

Costs, and Markups, by Type of Brand-Name or Generic Drug,

1997, 2000, and 2002 7

5. Distribution of Increasing Markups Among Types of Brand-Name and

Generic Drugs, 1997 to 2002 9

6. Average Markups in States With and Without a Maximum Allowable

Cost List, 1997 to 2002 12

7. Distribution of Average Markup Levels Among States, 1997, 2000,

and 2002 12

Figures

1. Markups per Prescription and Margins Under Medicaid, 1995 to 2002 3

2. Average Annual Change in Reimbursements, Acquisition Costs, and

Markups for Brand-Name Drugs Under Medicaid 5
Medicaid’s Reimbursements to Pharmacies

for Prescription Drugs

Summary and Introduction

In recent years, the Medicaid program has experienced a 

rapid increase in spending for prescription drugs. Between fiscal years 1997 and 2002, Medicaid’s expenditures on them in the fee-for-service part of the program 

increased at an average annual rate of 18 percent, growing 

from $10.2 billion to $23.4 billion.1 Consequently, policymakers at both the federal and state levels are considering ways to moderate that growth. Some states have already taken action by adopting lists of preferred drugs (to 

encourage beneficiaries to use less expensive drugs) or increasing the rebates that drug manufacturers pay to Medicaid.

One important component of Medicaid’s spending on 

prescription drugs is the amount that the program pays 

for wholesalers and retail pharmacies to distribute and 

dispense the drugs to beneficiaries. On the basis of data 

from the Centers for Medicare and Medicaid Services 

(CMS), the Congressional Budget Office (CBO) estimates that the amount paid for distributing and dispensing those drugs accounts for approximately 23 percent of 

Medicaid’s reimbursement to pharmacies. That percentage is roughly in line with the industry average for the entire outpatient pharmaceutical sector.2 However, Medicaid’s payments for those services have increased markedly 

in recent years, adding significantly to the overall cost of 

the program.

For each prescription that a pharmacy fills under the program, Medicaid pays the pharmacy an amount meant to 

cover both the cost of acquiring the drug from the manufacturer and the cost of distributing and dispensing it. 

That “markup” that Medicaid pays is defined in this paper as the dollar difference between the total amount that 

Medicaid pays the pharmacy for each prescription and 

the amount that the pharmacy or wholesaler pays the 

manufacturer for the drug.3 Between 1997 and 2002, by 

CBO’s estimates, the average markup increased by nearly 

60 percent—rising from $8.70 to $13.80 per prescription, or by about 9.7 percent per year (see Table 1).4

Those are national estimates; the experiences of individual states and individual pharmacies can differ greatly 

from them.

Much of the increase in the average markup was attribuable to the use of relatively new generic drugs. For generic 

drugs that came on the market between 1997 and 2002, 

Medicaid reimbursed pharmacies an average of about $46 

per prescription in 2002, of which only about $14 went 

for the purchase of the drug itself. Pharmacies and wholesalers retained the remainder, or markup, of about $32 

per prescription.

1. Those expenditures are net of rebates that prescription drug manufacturers pay to Medicaid on drugs purchased by the program. In 

2002, for example (the most recent year for which data were available when CBO began its review), Medicaid received $5.9 billion 

in rebates from manufacturers, reducing Medicaid’s drug expenditures from $29.3 billion to $23.4 billion. Both the federal government and the states pay for the drug benefit, with the federal share 

averaging 57 percent nationwide.

2. The National Association of Chain Drug Stores estimates that of 

the average retail prescription cost of $53.10 in 2002, the wholesaler received 3 percent, and the pharmacy, 21 percent. See 

www.nacds.org/wmspage.cfm?parm1=507 (figures obtained on 

May 9, 2003). 

3. Pharmacies can sometimes collect a small copayment from the 

Medicaid beneficiary (usually $1 to $3). Those copayments are 

not included in this analysis.

4. Those estimates represent averages based on data for 40 states and 

the District of Columbia (see the appendix).
2 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

Table 1.

Summary of Medicaid’s Average Reimbursements, Wholesalers’ and Pharmacies’ 

Acquisition Costs, and Markups for Prescription Drugs, 1997 and 2002

(Dollars per prescription)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services (CMS).

Note: * = not estimated, because most such drugs were not available in 1997.

a. To estimate acquisition costs, CBO used the average price that manufacturers earned on sales of outpatient drugs to wholesalers and 

pharmacies, as reported to CMS under Medicaid’s rebate program (see the appendix).

That markup significantly exceeded the average markup 

that Medicaid paid for older generic drugs in 2002 ($10 

per prescription) as well as for brand-name drugs ($14 

per prescription). Although the Medicaid program saved 

money overall from the substitution of newer generic 

drugs for brand-name drugs, spending was not reduced 

to nearly the extent it might have been if the markups on 

newer generic drugs had more closely approximated those 

on the other classes of drugs.

One of the main factors behind high markups for some 

types of drugs was Medicaid’s reimbursement system. 

That system relies on the published list prices of drugs 

(which are largely set by manufacturers) to determine 

pharmacies’ reimbursements, instead of using the actual 

cost of the drugs to the pharmacies. States reimburse 

pharmacies using formulas that are typically based on the 

average wholesale price (AWP) of a drug, which (like the 

sticker price on a car) is a published list price that few 

purchasers actually pay. For example, a state might reimburse a pharmacy 85 percent to 90 percent of the average 

wholesale price of a drug plus a fixed dollar amount of $3 

to $5 (as a dispensing fee) to cover the pharmacy’s other 

costs. By relying on list prices, Medicaid’s reimbursement 

formulas lead to large markups on drugs that have large 

differences between their list price and the price that the 

pharmacy actually pays. Within that system, then, the use 

of new generic and new brand-name drugs, for which 

that price spread tends to be larger, contributed to the recent increase in average markups.

Especially in the case of a newer generic drug, manufacturers have an incentive to set a high list price but to 

make the drug available to pharmacies at a significantly 

lower price. A relatively high markup on a generic drug 

gives a pharmacist an incentive to substitute that drug for 

another generic or brand-name drug. When a new generic drug becomes available, manufacturers can compete 

for the pharmacy’s business partly by setting a high list 

price and a low actual price for the pharmacy. Over time, 

manufacturers continue to compete on the prices they 

charge pharmacies, but eventually their incentive to 

maintain high list prices diminishes for most generic 

drugs, in part because Medicaid’s reimbursement rates to 

pharmacies for those drugs usually become subject to federal upper limits (FULs) that are based on the lowestpriced versions available.

State Medicaid programs have not shifted to using actual 

rather than list prices of drugs in part because those actual 

prices are not readily available to them. (For this analysis, 

CBO estimated actual prices on the basis of data reported 

by manufacturers directly to the Centers for Medicare 

and Medicaid Services as part of Medicaid’s rebate program.) Nonetheless, many states have recently taken actions to reduce Medicaid’s reimbursement rates to pharMedicaid’s

Reimbursements

to Pharmacies Acquisition Costsa Markups

1997 2002 1997 2002 1997 2002

All Drugs 37.00 60.90 28.30 47.10 8.70 13.80

Generic Drugs

Newer * 45.70 * 13.60 * 32.10

Older 11.90 14.20 4.30 4.40 7.60 9.90

Brand-Name Drugs 61.90 97.30 52.20 83.40 9.80 13.80
MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS 3

macies. Those actions have included setting state-specific 

upper limits on the reimbursement for drugs available in 

both generic and brand-name versions (limits that are frequently lower than the federal upper limits) and lowering 

the estimated acquisition costs used as a basis for the reimbursement for brand-name drugs. Perhaps partly as a 

result of those state actions, the average annual growth 

rate in markups slowed from 11 percent over the 1997-

2000 period to 8 percent over the 2000-2002 period.

Measuring Markups

In addition to dollar terms, the difference between the 

amount that Medicaid pays pharmacies for prescription 

drugs and the amount that manufacturers charge pharmacies for the drugs can be expressed in percentage terms 

as a margin (or gross margin)—that is, the difference between what Medicaid pays a pharmacy and the cost of acquiring the drug from the manufacturer, divided by 

Medicaid’s payment. 

The two measures—the markup and the margin—yield 

very different pictures. For example, the percentage margin retained by pharmacies and wholesalers has been 

about the same in recent years for both newer and older 

generic drugs, but because Medicaid’s reimbursements 

for newer generic drugs have been higher, the dollar 

markup on them has been more than three times that on 

older generic drugs.

Because pharmacies’ cost of filling a prescription is largely 

unrelated to the cost of acquiring its ingredients or the 

size of the prescription, the dollar markup is a better indicator of the size or adequacy of Medicaid’s reimbursements to pharmacies than is the percentage margin. The 

time a pharmacist spends filling a prescription is generally 

unrelated to the drug’s cost and is only marginally greater 

for larger prescriptions than for smaller ones. Moreover, 

the shelf space required to store a $5 pill is no different 

from that required for a $1 pill. If ingredient costs increase, pharmacies’ cost of invested capital tied up in inventories will increase, as drugs are held on the shelves 

and pharmacies are waiting for payment from Medicaid. 

By CBO’s estimates, however, on a per-prescription basis, those costs account for only a small share of the increase in markups over the period.5

Figure 1.

Markups per Prescription and Margins 

Under Medicaid, 1995 to 2002

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services.

Note: The real (inflation-adjusted) markup is calculated using the 

chain-weighted gross national product price index.

Factors Contributing to Rising

Markups

After rising slowly between 1995 and 1997, the average 

dollar markup for all Medicaid prescriptions increased 

between 1997 and 2002, as described, by 59 percent, rising from $8.70 to $13.80, or about 9.7 percent annually 

(see Figure 1). In comparison, pharmacists’ wages—a key 

component of dispensing costs—increased by 5.3 percent 

5. Over the 1997-2002 period, the average acquisition cost per prescription increased by 66 percent, from $28.30 to $47.10. Assuming a cost of capital for pharmacies of 8 percent per year and an 

average shelf life of two months would put the associated rise in 

capital costs at about 25 cents per prescription. Adding in the cost 

of waiting for a final payment from Medicaid would probably no 

more than double that amount. Sales taxes (another type of cost 

that could increase with the price of a prescription) currently are 

imposed by only one state (Illinois, at 1 percent). See an analysis 

by the Federation of Tax Administrators at www.taxadmin.org/

fta/rate/sales.html. 

1995 1996 1997 1998 1999 2000 2001 2002

0

2

4

6

8

10

12

14

0

4

8

12

16

20

24

28

32

Nominal Markup

(Left scale)

Real Markup

(Left scale)

Margin

(Right scale)

Dollars Percent
4 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

Table 2.

Medicaid’s Reimbursements, Wholesalers’ and Pharmacies’ Acquisition Costs, 

and Markups for Brand-Name and Generic Drugs, 1997 to 2002

(Dollars per prescription)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services.

per year during that same period, and the overall inflation 

rate was less than 2 percent per year.6 If the rate of increase of markups had matched the rate of increase of 

pharmacists’ wages for that period, the markups under 

Medicaid would have cost about $1 billion less in 2002 

than they actually did.7

Overall, the largest single factor contributing to the rapid 

increase in markups was the use of newer generic drugs, 

with their high markups. Another factor was the use of 

newer single-source brand-name drugs, which had somewhat higher average markups than did older brand-name 

drugs. 

Markups on Generic and Brand-Name Drugs

Even as they produce savings for the Medicaid program 

as a whole, generic drugs are an important source of pharmacies’ revenue from markups. Although generic drugs 

account for close to half of all prescriptions dispensed in 

the fee-for-service portion of Medicaid, because of their 

lower cost they account for only 14 percent to 16 percent 

of the program’s reimbursements to pharmacies. Yet 

since the average markup on generic drugs is close to that 

on brand-name drugs, reimbursements for generic drugs 

provided an estimated 47 percent of total revenue from 

markups on Medicaid drugs in 2002.

In recent years, the average dollar markup on generic 

drugs has grown closer to that on brand-name drugs. In 

1997, the average markup on generic drugs was about $2 

less than that on a brand-name drugs—at $7.70 compared with $9.80 (see Table 2). But by 2002, the average 

markup on brand-name drugs had increased by 41 percent, while that on generic drugs had increased by 79 percent. Thus, by 2002 the average markup on generic drugs 

was about the same as that on brand-name drugs—at 

$13.80.

The growth in both acquisition costs and Medicaid’s reimbursements for brand-name drugs has slowed in recent 

years, falling from over 12 percent annually during the 

1995-1997 period to less than 8 percent between 2000 

and 2002 (see Figure 2). At the same time, the growth 

rate of markups on brand-name drugs has increased. 

During the 2000-2002 period, all three measures grew at 

roughly the same rate—and the growth rate in markups 

was at its highest level.

While the relationship between acquisition costs and 

Medicaid’s reimbursements has been stable for brandname drugs, it has been more variable for generic drugs. 

Throughout the 1997-2002 period, the acquisition costs 

for brand-name drugs averaged about 85 percent of Medicaid’s reimbursements. For generic drugs, the acquisition 

 Brand-Name Generic Brand-Name Generic

All Drugs Drugs All Drugs Drugs

1997 37.00 61.90 12.00 28.30 52.20 4.30 8.70 9.80 7.70

1998 41.80 69.30 13.20 32.20 58.80 4.50 9.70 10.50 8.80

1999 47.20 76.80 14.10 36.60 65.50 4.20 10.60 11.30 9.90

2000 53.30 83.30 16.10 41.30 71.30 4.20 12.00 11.90 12.00

2001 57.40 89.60 18.30 44.80 77.00 5.70 12.60 12.60 12.60

2002 60.90 97.30 19.90 47.10 83.40 6.00 13.80 13.80 13.80

Acquisition Costs Markups

Medicaid's Reimbursements

All Drugs

to Pharmacies

Brand-Name Generic

Drugs

6. Inflation is calculated using the chain-weighted gross national 

product price index.

7. The estimated changes in markups presented here do not measure 

changes in pharmacies’ profits from Medicaid-related sales. While 

CBO has data on the cost of the ingredients used in filling Medicaid prescriptions, it has few comparable data on the level of, or 

changes in, the cost of distributing drugs and operating the pharmacies that serve Medicaid patients.
MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS 5

Figure 2.

Average Annual Change in Reimbursements, Acquisition Costs, and Markups 

for Brand-Name Drugs Under Medicaid

(Percentage change)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services.

costs averaged 36 percent of reimbursements in 1997, fell 

to 26 percent in 2000, and then climbed back up to 30 

percent in 2002. In fact, for generic drugs, the average reimbursement continued to rise even as the average acquisition cost changed little: between 1997 and 2000, the 

average acquisition cost per prescription fell slightly 

(from $4.30 to $4.20), while the average reimbursement 

increased by about $4, from $12.00 to $16.10.

Markups by Type of Brand-Name or Generic Drug

A more detailed analysis of markups shows that new generic drugs and new brand-name drugs had predominant 

roles in the increase in markups from 1997 to 2002. For 

this analysis, CBO placed drugs into three groups—single-source brand-name drugs (brand-name drugs that 

had no generic substitutes, in the same dosage form and 

strength, on the market), multiple-source brand-name 

drugs (brand-name drugs that had generic competitors), 

and generic drugs—and then accounted for the “newness” of the drugs and any change in their status (for example, from being a single-source brand-name drug to 

becoming a multiple-source brand-name drug).

Single-source brand-name drugs were designated as

follows:

B Continuing single-source drugs—single-source brandname drugs that were introduced by the first quarter 

of 1997 and remained single-source throughout the 

1997-2002 period;

B New single-source drugs introduced by 2000—singlesource brand-name drugs that were introduced between the second quarter of 1997 and the end of 

2000; and

B New single-source drugs introduced by 2002—singlesource brand-name drugs that were introduced between the beginning of 2001 and the end of 2002.

Multiple-source brand-name drugs, as follows:

B Continuing multiple-source drugs—brand-name 

drugs that already faced competition from generic 

drugs by the first quarter of 1997;

B New multiple-source drugs introduced by 2000—

brand-name drugs that were single-source drugs in the 

first quarter of 1997 but that faced competition from 

generic drugs by the end of 2000; and

B New multiple-source drugs introduced by 2002—

brand-name drugs that were single-source drugs from 

1997 through the end of 2000 but that faced competition from generic drugs by 2002.

And generic drugs, as follows:

B Continuing generic drugs—generic drugs that were 

introduced by the first quarter of 1997; 

B New generic drugs introduced by 2000—generic 

drugs that were introduced between the second quarter of 1997 and the end of 2000; and

B New generic drugs introduced by 2002—generic 

drugs that were introduced between the beginning of 

2001 and the end of 2002.

1995 to 1997 1997 to 2000 2000 to 2002

0

2

4

6

8

10

12

14

16

Reimbursements Acquisition Costs Markups
6 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

Table 3.

Distribution of Medicaid Prescriptions, by Drug Type, 1997, 2000, and 2002

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services (CMS).

Note: n.a. = not applicable.

a. Brand-name drugs for which CBO lacked sufficient data to determine whether they were single-source or multiple-source drugs.

b. Drugs that were classified in CMS's data as brand-name in one year and generic in a different year.

Medicaid’s Reimbursements by Drug Type. Singlesource brand-name drugs accounted for 75 percent to 77 

percent of Medicaid’s reimbursements in 1997, 2000, 

and 2002. Generic drugs accounted for 14 percent to 16 

percent, and multiple-source brand-name drugs constituted the remainder.

In terms of the number of Medicaid prescriptions dispensed, in 2002, generic drugs introduced in 2001 or 

later constituted 3.7 percent of the total, and those introduced over the four-year period from 1997 through 2000 

accounted for only slightly more, at 4.7 percent of the total (see Table 3). The market share of affected brandname drugs fell quickly after generic drugs entered the 

market. Brand-name drugs that were single-source drugs 

at the beginning of 1997 but that faced competition from 

generic drugs by the end of 2000 constituted almost 10 

percent of the market in 1997 but only about 1 percent 

by 2002. Similarly, brand-name drugs that became available as generic drugs as well in 2001 and 2002 saw their 

market share decline from 10 percent in 2000 to about 4 

percent in 2002.

Markups by Drug Type. Among the markups for the 

groups of drugs considered here, those for new generic 

drugs stand out. Generic drugs first marketed between 

1997 and 2000 had an average markup of $35.20 in 

2000 (see Table 4)—which was about two-and-one-half 

times their average acquisition cost of $13.60. Between 

2000 and 2002, that markup fell somewhat, to $29.20. 

Thus, markups on those new generic drugs in 2002 reDrug Type 1997 2000 2002

50.0 55.4 53.0

Single-source Single-source Single-source 21.5 26.8 25.8

n.a. Single-source Single-source 0.1 8.7 14.1

n.a. n.a. Single-source 0 0 3.7

Multiple-source Multiple-source Multiple-source 5.5 3.0 2.4

Single-source Multiple-source Multiple-source 9.6 3.8 1.1

Single-source Single-source Multiple-source 8.2 10.0 3.9

2.1 0.7 0.5

conflicting classificationb 3.1 2.4 1.5

50.0 44.6 47.0

Multiple-source Multiple-source Multiple-source 49.8 42.0 38.5

n.a. Multiple-source Multiple-source 0.2 2.7 4.7

n.a. n.a. Multiple-source 0 0 3.7 ____ ____ ____

100.0 100.0 100.0

Multiple-source Multiple-source Multiple-source 5.5 6.8 7.4

Single-source Single-source Single-source 39.2 45.5 43.7

n.a. n.a. n.a. 5.2 3.1 1.9

Unclassified because of lack of dataa

All Brand-Name Drugs

1997 2000 2002

Alternative Breakouts

Continuing single-source

New single-source introduced by 2000

New single-source introduced by 2002

Continuing multiple-source

New multiple-source by 2000

New multiple-source by 2002

All Generic Drugs

Unclassified because of 

Single-source brand-name

Unclassified (for either reason)

Percentage of Medicaid

Status of Drug by Year Prescriptions Dispensed

Continuing generic drugs

New generic drugs introduced by 2000

New generic drugs introduced by 2002

Multiple-source brand-name

Total, All Drugs
MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS 7

Table 4.

Medicaid’s Reimbursements, Wholesalers’ and Pharmacies’ Acquisition Costs, 

and Markups, by Type of Brand-Name or Generic Drug, 1997, 2000, and 2002

(Dollars per prescription)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services (CMS).

Note: n.a. = not applicable.

a. Brand-name drugs for which CBO lacked sufficient data to determine whether they were single-source or multiple-source drugs and drugs 

that were classified in CMS’s data as brand-name in one year and generic in a different year.

mained high even though most had been on the market 

for at least three years. Generic drugs first marketed in 

2001 and 2002 also had a high markup, of $35.80, in 

2002.

The ratio of acquisition cost to reimbursement per prescription was roughly the same for new generic drugs and 

older generic drugs in 2002, at about 30 percent. Therefore, their percentage margins were similar, at roughly 70 

percent. But because newer generic drugs were much 

more expensive (the average reimbursement on the newest ones was nearly $50 in 2002), that constant percentage led to particularly high dollar markups for them.

Single-source brand-name drugs introduced between 

1997 and 2000 had markups that exceeded those of continuing single-source drugs by $1.30 in 2000 ($12.90 

versus $11.60). Markups for those new single-source 

drugs continued to rise, reaching $15.00 by 2002. Singlesource drugs introduced between 2001 and 2002 also had 

markups that were almost $1 more than those on continuing single-source drugs in 2002 ($13.60 compared 

with $12.70). 

The ratio of acquisition cost to reimbursement was 

roughly the same for newer single-source drugs as it was 

for older single-source drugs (between 87 percent and 88 

percent). But because the new single-source drugs were 

more expensive on average (at over $110 per prescription 

Percentage

Change

in Markups, 

1997 2000 2002 1997 2000 2002 1997 2000 2002 1997-2002

61.90 83.30 97.30 52.20 71.30 83.40 9.80 11.90 13.80 40.8

79.40 91.70 98.20 68.90 80.10 85.50 10.50 11.60 12.70 21.0

 introduced by 2000 n.a. 102.40 113.20 n.a. 89.40 98.20 n.a. 12.90 15.00 n.a.

 introduced by 2002 n.a. n.a. 110.70 n.a. n.a. 97.20 n.a. n.a. 13.60 n.a.

28.40 30.30 29.40 20.60 18.80 17.80 7.80 11.40 11.60 48.7

 by 2000 59.00 65.10 64.30 49.70 52.70 48.90 9.30 12.40 15.40 65.6

by 2002 63.20 77.00 83.30 53.30 65.90 67.40 9.90 11.10 15.90 60.6

28.60 50.00 71.70 19.00 35.20 52.80 9.60 14.80 18.90 96.9

12.00 16.10 19.90 4.30 4.20 6.00 7.70 12.00 13.80 79.2

11.90 14.00 14.20 4.30 3.50 4.40 7.60 10.50 9.90 30.3

introduced by 2000 n.a. 48.80 42.50 n.a. 13.60 13.30 n.a. 35.20 29.20 n.a.

introduced by 2002 n.a. n.a. 49.80 n.a. n.a. 13.90 n.a. n.a. 35.80 n.a.

Average 37.00 53.30 60.90 28.30 41.30 47.10 8.70 12.00 13.80 58.6

New single-source

Continuing generic drugs

Medicaid's Reimbursement

to Pharmacies Acquisition Costs Markups

Unclassifieda

New generic drugs 

New generic drugs 

Drug Type

All Brand-Name Drugs

All Generic Drugs

Continuing multiple-source

New multiple-source

New multiple-source 

Continuing single-source

New single-source
8 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

in 2002), their average dollar markups were higher than 

those for older single-source brand-name drugs.

Besides newer generic drugs, those with the highest markups in 2002 were new multiple-source drugs—that is, 

brand-name drugs that were newly available from multiple sources in that they first faced competition from generic drugs during the 1997-2002 period. Typically, such 

drugs were brand-name drugs that lost patent protection. 

Markups for new multiple-source drugs were over $15.00 

in 2002, and the percentage change in markups from 

1997 to 2002 was relatively high, at over 60 percent.

The lowest markups in 2002 were on older generic 

drugs—that is, those introduced prior to 1997—at 

$9.90, followed by those for older multiple-source brandname drugs at $11.60 and then older single-source drugs 

at $12.70. While markups on older generic drugs grew 

faster than inflation between 1997 and 2000, those 

markups actually declined between 2000 and 2002 as the 

average acquisition cost for those drugs rose more quickly 

than Medicaid’s average reimbursement for them did.

The Relative Contribution of Generic and BrandName Drugs to Rising Markups 

Of the total increase in average markups of $5.10 between 1997 and 2002, just over one-half was attributable 

to generic drugs and one-third to brand-name drugs (see 

Table 5). (The remainder of the increase came largely 

from shifts in utilization between 1997 and 2002 that 

were not fully captured in CBO’s analysis.)8

 Although 

new generic drugs constituted only 8.4 percent of the 

prescriptions dispensed in 2002, they accounted for 37 

percent of the increase in average markups since 1997.9

Conversely, while older generic drugs accounted for 

nearly 40 percent of the prescriptions dispensed in 2002, 

their relative contribution to increasing markups was less 

than half as large—at 17 percent.

Single-source drugs introduced after the first quarter of 

1997 accounted for 18 percent of the prescriptions dispensed in 2002 and 15 percent of the total increase in 

markups between 1997 and 2002.10 Older single-source 

brand-name drugs constituted about one-fourth of the 

prescriptions dispensed in 2002, yet they accounted for 

only 11 percent of the total increase in markups between 

1997 and 2002.

Medicaid’s Reimbursement Policies 

That May Have Contributed to 

Increasing Markups

Following federal guidelines, states typically reimburse 

pharmacies for a prescription on the basis of an estimate 

of the cost of acquiring the drug from the manufacturer 

plus a dispensing fee—both of which vary among the 

states.11 Costs for brand-name drugs that have no generic 

substitutes (or single-source drugs) are typically reimbursed at a rate equal to the average wholesale price minus roughly 10 percent to 15 percent plus a dispensing 

fee of $3 to $5.12 The AWP is a published list price that 

is based on information provided by the manufacturers. 

Like the sticker price on a car, it is a price that few purchasers actually pay.

For many multiple-source drugs, which include generic 

drugs and their brand-name counterparts, the reimbursement formula is more complicated. For such drugs that 

are sold by at least two or three different manufacturers, 

state Medicaid reimbursements are subject to a federal 

upper limit of 150 percent of the lowest-priced therapeutically and biologically equivalent drug (which is usually a 

generic drug). CMS sets that limit on the basis of its

8. In order to attribute the change in markups over time to different 

types of drugs, CBO assigned a weight to each type based on its 

share of total Medicaid prescriptions in a single year, 2002. Consequently, part of the effect on markups of shifts in utilization 

between 1997 and 2002 is not captured by the fractions presented 

here (but appears in “other factors” in Table 5).

9. The contribution of new generic drugs to the total increase in 

markups is calculated by multiplying their share of prescriptions 

in 2002 by the difference between their markups in 2002 and 

those of their brand-name counterparts (new multiple-source 

drugs) in 1997.

10. The contribution of new brand-name drugs to the total increase 

in markups is calculated by multiplying their share of prescriptions in 2002 by the difference between their markups in 2002 

and those of single-source brand-name drugs in 1997.

11. In addition, Medicaid’s payments cannot exceed pharmacies’ 

“usual and customary charges” (42 C.F.R. 447.331).

12. Some states use the published wholesale acquisition cost, which is 

another type of published price that more closely approximates 

pharmacies’ acquisition costs but is less widely available. Typically, states using the wholesale cost add on (rather than subtract) 

a percentage to approximate pharmacies’ acquisition costs. See 

National Pharmaceutical Council, Pharmaceutical Benefits Under 

State Medical Assistance Programs (Reston, Va.: National Pharmaceutical Council, Inc., 2003), p. 4-41.
MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS 9

Table 5.

Distribution of Increasing Markups Among Types of Brand-Name and Generic 

Drugs, 1997 to 2002

(Dollars per prescription)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services (CMS).

Note: n.a. = not applicable.

a. Because new single-source drugs were not available in 1997, the change in markup is calculated relative to the average markup (of 

$10.50) on continuing single-source drugs in 1997.

b. Because new generic drugs were not available in 1997, the change in markup is calculated relative to the average markup (of $9.60) for 

their brand-name counterparts in 1997.

c. Brand-name drugs for which CBO lacked sufficient data to determine whether they were single-source or multiple-source drugs and drugs 

that were classified in CMS’s data as brand-name in one year and generic in a different year.

d. In order to attribute the change in markups over time to different types of drugs, CBO assigned a weight to each type based on its share 

of total Medicaid prescriptions in a single year, 2002. Consequently, part of the effect on markups of shifts in utilization between 1997 

and 2002 is not captured for the particular types of drugs but is included as an overall figure here.

analysis of list prices.13 If, in the aggregate, a state’s Medicaid reimbursement for multiple-source drugs exceeds 

the federal upper limit, the state does not receive federal 

matching funds on the excess amount. One recent study 

found that generic drugs with a FUL accounted for 65 

percent of the total sales of generic drugs nationwide in 

2001.14

States also have the latitude to set an upper bound on a 

reimbursement, referred to as the maximum allowable 

cost (MAC), that is different from the FUL, as well as to 

set a MAC for a multiple-source drug that does not yet 

have a federal limit. Because of that flexibility and a desire 

to contain Medicaid costs, some states have MAC programs that include more drugs than are on the federal list, 

and some states are also more aggressive in setting price 

limits (by setting maximum allowable costs that are lower

Drug Type

Continuing Single-Source Brand-Name 10.50 12.70 2.20 25.8 0.57 11.1

New Single-Source Brand-Name n.a. 14.70 4.20 a 17.9 0.75 14.7

Continuing Multiple-Source Brand-Name 7.80 11.60 3.80 2.4 0.09 1.8

New Multiple-Source Brand-Name 9.60 15.80 6.20 5.0 0.31 6.1

Continuing Generic Drugs 7.60 9.90 2.30 38.5 0.89 17.4

New Generic Drugs n.a. 32.10 22.50 b 8.4 1.90 37.2

Unclassifiedc 9.60 18.90 9.30 1.9 0.18 3.5

Other Factorsd 0.42 8.2

All Drugs 8.70 13.80 5.10 100.0 5.10 100.0

1997

Markups

2002 Increase 

Share of

Total Increase

in Markup

(Percent)

Contribution

to Increase

in Markup,

1997 to 2002

Share of Medicaid

Prescriptions 

Dispensed in 2002

(Percent)

13. See www.cms.hhs.gov/medicaid/drugs/drug10.asp. If there is only 

one manufacturer of a generic drug and the Food and Drug 

Administration (FDA) has classified it as therapeutically equivalent (with an A rating) to the brand-name product, then CMS 

may establish a FUL for that drug. If there are multiple generic 

versions, then FDA must have classified at least two of the versions as equivalent in order for CMS to establish a FUL.

14. Richard G. Abramson and others, “Generic Drug Cost Containment in Medicaid: Lessons from Five State MAC [maximum 

allowable cost] Programs,” Health Care Financing Review, vol. 25, 

no. 3 (Spring 2004), pp. 25-34.
10 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

than the federal upper limits).15 By 2003, about 40 states 

had a MAC program in place.16

Under Medicaid’s system for paying for drugs, reimbursement for new generic drugs may be based on their 

list price if an upper limit has not yet been set by CMS or 

the state. Only a handful of states have set a separate reimbursement formula for generic drugs that are not yet 

subject to a federal upper limit.17 The remaining states 

provide reimbursement for such generic drugs by using 

the same reimbursement formula as for brand-name 

drugs (usually the AWP minus 10 percent to 15 percent 

plus a dispensing fee).

On the one hand, a relatively high markup on new generic drugs gives pharmacists an incentive to substitute 

them for brand-name drugs, even before an upper limit 

has been placed on Medicaid’s reimbursement that could 

make the brand-name drug unprofitable to dispense.18

Such substitution of new generic drugs for their brandname counterparts helps to reduce Medicaid spending. 

On the other hand, whether markups that are over three 

times those of brand-name drugs are necessary to accomplish that outcome is unclear.

Manufacturers may have an incentive to increase the gap 

between their list prices and the prices that they charge 

pharmacies when they compete for pharmacies’ business. 

That situation occurs for generic drugs because pharmacies frequently have the choice of acquiring what is essentially the same drug from several manufacturers.19 Pharmacists have an incentive to stock the generic drug with 

the lowest acquisition cost relative to its list price. The incentive for a manufacturer of a generic drug to maintain a 

high list price may be greatest before the FUL pricing formula takes effect because once it does, the list price becomes irrelevant to reimbursement under Medicaid unless that price is the lowest available.20 However, the 

incentive to compete for pharmacies’ business by selling 

the drug at a low price remains.

Manufacturers of multiple-source brand-name drugs may 

also have a similar incentive to increase the gap between 

the list prices and acquisition costs. Once the patent for a 

drug expires (and before the FUL is in effect), increasing 

that gap would help to make the brand-name drug more 

profitable for pharmacies to dispense relative to its generic competitors. Indeed, the data that CBO analyzed 

show that average markups tended to be higher for 

multiple-source brand-name drugs that had recently lost 

patent protection than for older single-source brandname drugs.21 Although markups were relatively high for 

brand-name drugs that had recently faced competition 

from generic drugs compared with those for other brandname drugs, however, they were not nearly as high as 

those for new generic drugs.

Recent research has also shown that the percentage difference between list prices and acquisition costs generally is 

much larger for generic drugs than for brand-name drugs. 

And, perhaps more important, the relationship between 

list prices and acquisition costs is much more variable for 

generic drugs. The larger percentage gap for generic drugs 

enables the markups on them to be comparable with 

those on brand-name drugs on average and thus provides 

an incentive for pharmacies to dispense generic drugs. 

However, the more variable relationship between list 

prices and acquisition costs for generic drugs means that 

states may not be able to accurately estimate the size of 

the markups on those drugs. States do not have access to 

the average prices that manufacturers report to CMS (and 

that are used in this paper) and therefore may find assess15. Ibid.

16. National Pharmaceutical Council, Pharmaceutical Benefits (2003). 

17. For example, Illinois reimburses such generic drugs at the AWP 

minus 20 percent.

18. In most states, the substitution of generic drugs is encouraged 

through an upper limit on reimbursements that applies to both 

the brand-name and generic versions. When the upper limit is in 

effect, pharmacists will usually lose money by dispensing the 

brand-name drug. There is sometimes a delay before CMS establishes a federal upper limit. Of 200 top-selling multiple-source 

drugs in 2001, 90 did not have a federal upper limit, although 

they met the established criteria. See Department of Health and 

Human Services, Office of Inspector General, Omission of Drugs 

from the Federal Upper Limit List in 2001, OEI-03-02-00670 

(February 2004).

19. Provided all generic drugs have received an A rating from FDA on 

their therapeutic equivalence to the brand-name drug, patients 

and physicians are generally indifferent about the manufacturer of 

the generic drugs.

20. The incentive to set a high list price is also affected by how pharmacies are reimbursed by payers other than Medicaid.

21. For example, in 2002, the markup on new multiple-source brandname drugs exceeded $15 while that on continuing single-source 

drugs averaged about $13 (see Table 4).
MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS 11

ing the appropriateness of reimbursement rates for generic drugs difficult.

According to a September 2002 report by the Office of 

Inspector General within the Department of Health and 

Human Services (HHS), the acquisition costs of brandname drugs with no generic substitutes averaged 17 percent below the AWP, with relatively little variation 

around that level.22 For multiple-source brand-name 

drugs not yet subject to a FUL, the difference was somewhat greater, with acquisition costs 24 percent below the 

AWP. For generic drugs not yet subject to a FUL, acquisition costs averaged 54 percent below the AWP. And for 

multiple-source drugs subject to a FUL (brand-name and 

generic drugs combined), acquisition costs averaged 72 

percent below the AWP.23 Consequently, HHS’s Inspector General recommended that CMS work with states to 

reexamine their reimbursement formulas, particularly for 

multiple-source drugs.

Recent Changes in States’ Policies for 

Reimbursing Pharmacies

Although markups increased over the 1997-2000 period, 

states’ Medicaid reimbursement formulas themselves remained relatively unchanged. More recently, however, 

many states have taken actions to reduce their reimbursement rates, which probably helped slow down the average 

annual growth rate in markups, from 11 percent between 

1997 and 2000 to 8 percent between 2000 and 2002.

According to a study by HHS’s Office of Inspector General, 17 of 43 states responding to a 2003 survey had recently reduced their Medicaid reimbursement formulas 

for prescription drugs.24 In addition, drawing on the National Pharmaceutical Council’s semiannual surveys of 

states’ Medicaid reimbursement policies, CBO found 

that more than 10 states had lowered the estimated acquisition cost that they used as a basis to reimburse pharmacies for brand-name drugs between 2000 and 2002.25 By 

2003, about 40 states had a MAC list in place. Also, five 

states had begun to set separate reimbursement formulas 

for generic drugs that were not subject to a FUL or on a 

state MAC list.26 Changes to dispensing fees were generally more modest: nationally, only 10 states significantly 

changed their dispensing fees—five of those states slightly 

lowered their fees, and five states slightly raised them.27

By 2002, 31 of the 41 states examined in CBO’s analysis 

had taken steps to hold down reimbursements for multiple-source drugs by adopting a MAC list. States that have 

adopted such a list tend to have lower average markups 

than states that have not. For states with a MAC list in effect by 2002, the average markup was $13.30—roughly 

$2 less than the average of $15.50 among states without 

that list (see Table 6). The growth rate in markups over 

the 2000-2002 period was also much lower in states that 

had adopted a MAC list—at 6.2 percent, compared with 

10.9 percent for the other states. Perhaps states that had a 

list in place were more active than other states in monitoring reimbursement rates overall, so the differences 

22. For over 90 percent of brand-name drugs dispensed to Medicaid 

patients in 1999, pharmacies’ acquisition prices were between 82 

percent and 84 percent of the AWP. See Department of Health 

and Human Services, Office of Inspector General, Medicaid Pharmacy: Additional Analyses of the Actual Acquisition Cost of Prescription Drug Products, A-06-02-00041 (September 12, 2002), p. 5.

23. About 600 of the 5,575 products examined had acquisition costs 

that ranged from 15 percent to 20 percent below the list price. 

Those were probably the brand-name multiple-source drugs 

within the group of drugs subject to a FUL.

24. Department of Health and Human Services, Office of Inspector 

General, State Strategies to Contain Medicaid Drug Costs, OEI-05-

02-00680 (October 2003).

25. National Pharmaceutical Council, Pharmaceutical Benefits (2000 

and 2002).

26. The states were Arkansas, Colorado, Illinois, Indiana, and Kansas. 

The formulas varied for generic drugs, from the AWP minus 20 

percent to the AWP minus 35 percent. See National Pharmaceutical Council, Pharmaceutical Benefits (2003).

27. See National Pharmaceutical Council, Pharmaceutical Benefits

(2000 and 2002).
12 MEDICAID’S REIMBURSEMENTS TO PHARMACIES FOR PRESCRIPTION DRUGS

Table 6.

Average Markups in States With and Without a Maximum Allowable Cost List, 

1997 to 2002

(Dollars per prescription)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services.

Notes: MAC = maximum allowable cost.

The designation of states with and without a MAC list comes from National Pharmaceutical Council, Pharmaceutical Benefits Under 

State Medical Assistance Programs (Reston, Va.: National Pharmaceutical Council, Inc., 2002).

Table 7.

Distribution of Average Markup Levels Among States, 1997, 2000, and 2002

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid Services.

cannot be attributed to MAC policies alone. Still, the differences suggest that state MAC lists have contributed to 

lower markups.

Given the variation that now exists in reimbursement formulas among states, the level of markups also varies considerably. In 1997, the weighted average markup in 41 

states was $8.70, and markups ranged between $7.00 and 

$10.00 for 78 percent of those states (see Table 7). By 

2002, the weighted average markup was $13.80 and the 

range spanned from $11.00 to $17.00 for 83 percent of 

those states.

1997 1998 1999 2000 2001 2002

States With a MAC List in 2002 8.50 9.50 10.40 11.80 12.30 13.30 9.4 6.2

States Without a MAC List in 2002 9.30 10.30 11.20 12.60 13.50 15.50 10.8 10.9

1997 to 2002 2000 to 2002

Average Markups in Markups (Percent)

Average Annual Growth Rate

Markup Intervals

(Dollars)

5.00 to 5.99 2 4.9 1 2.4

6.00 to 6.99 3 7.3 1 2.4

7.00 to 7.99 8 19.5 2 4.9

8.00 to 8.99 14 34.1 1 2.4

9.00 to 9.99 10 24.4 5 12.2

10.00 to 10.99 3 7.3 9 22.0 2 4.9

11.00 to 11.99 9 22.0 8 19.5

12.00 to 12.99 1 2.4 7 17.1 8 19.5

13.00 to 13.99 7 17.1 5 12.2

14.00 to 14.99 7 17.1

15.00 to 15.99 2 4.9 2 4.9

16.00 to 16.99 4 9.8

Over 17.00 2 4.9 __ ____

Total 41 100.0 41 100.0 41 100.0

2002

Percentage of

States

1997 2000

Number of

States

Percentage of

States

Number of

States

Number of

States

Percentage of

States
Data and Methods

To estimate pharmacies’ revenues from dispensing 

drugs to Medicaid patients, the Congressional Budget 

Office’s (CBO’s) analysis relies on quarterly data published by the Centers for Medicare and Medicaid Services 

(CMS). The data cover prescriptions and units (for example, tablets) dispensed to Medicaid recipients and reimbursements to pharmacies by state Medicaid agencies 

from 1995 to 2002 for each drug covered by Medicaid. 

CMS receives those data from the states, and reporting 

lapses occur. Data were unavailable for some states in 

some quarters. CBO’s analysis included data reported by 

40 states and the District of Columbia when those data 

were available in at least three quarters of four benchmark 

years: 1995, 1997, 2000, and 2002.1

To estimate the cost of acquiring drugs, CBO used the 

per-unit average manufacturer price (AMP) reported to 

CMS by manufacturers as part of the Medicaid rebate 

program. The AMP is the average price at which the 

manufacturer sells a unit in the retail class of trade, including sales to wholesalers, who distribute to pharmacies; direct sales to pharmacies; and sales to mail-order 

pharmacies. Because rebates from manufacturers to Medicaid are calculated on the basis of the AMP, their value 

could be scrutinized by government auditors. Retail pharmacies that buy through wholesalers may pay more than 

the AMP, but the wholesale markup constitutes a very 

small proportion (estimated at about 3 percent by the 

National Association of Chain Drug Stores) of the total 

retail price.

Medicaid’s drug purchases in a fee-for-service setting, to 

which this analysis applies, accounted for about 14 percent of total nationwide outpatient drug expenditures, 

net of rebates, in 2002.2 CBO’s analysis excluded drugs 

that were sold over the counter and was limited to oral 

solid dosage forms (that is, tablets and capsules), which 

accounted for about 73 percent of prescriptions filled and 

77 percent of reimbursements by Medicaid agencies in 

the fee-for-service sector of the program in 2002.3 After 

CBO further limited the analysis to 41 states, the reimbursements covered in this paper accounted for 58 percent to 66 percent of total Medicaid reimbursements over 

the 1997-2002 period.

1. Reimbursement data were drawn from CMS’s Web site on June 

27, 2002; see www.hcfa.gov/medicaid/drugs/drug5.htm.

2. CMS estimated that total outpatient drug spending, net of manufacturers’ discounts and rebates, was $162 billion in 2002; see 

www.cms.hhs.gov/statistics/nhe/historical/t2.asp. Medicaid’s feefor-service spending came to $23.4 billion in 2002—constituting 

14.4 percent of the outpatient market. Some states reimburse 

HMOs (health maintenance organizations) on a capitated basis to 

cover drug expenditures for Medicaid beneficiaries; others “carve 

out” the drug benefit so that it remains in the fee-for-service system (and states continue to collect the rebates from manufacturers). CBO’s analysis does not apply to Medicaid’s drug spending 

that falls outside Medicaid’s fee-for-service reimbursement system.

3. CBO used the number of units of the drug dispensed per prescription in combination with the average manufacturer price per unit 

(reported under Medicaid’s rebate program) to estimate the acquisition cost of the drugs dispensed. Because the unit variable (number of units) is more reliable for drugs that come in tablets and 

capsules, CBO limited its analysis to drugs in those forms.