The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) established a prescription drug benefit for Medicare beneficiaries under Part D, which began on January 1, 2006. The MMA establishes that Medicare beneficiaries will receive the prescription drug benefit through private organizations, typically insurers or similar risk-bearing organizations, that sponsor prescription drug plans (PDPs) or Medicare Advantage managed care plans that offer the prescription drug benefit (MA-PDs). One provision of MMA, the "noninterference" clause, expressly forbids the Secretary of Health and Human Services (HHS) from interfering with drug price negotiation between manufacturers and Medicare drug plan sponsors, and from instituting a formulary or price structure for prescription drugs. The Medicare drug plans (or their agents) negotiate prices with the drug manufacturers. The framework created by the law emphasizes competition among the Medicare drug plans to obtain price discounts. The Medicare drug plans have incentive to provide the drug benefit to beneficiaries as efficiently as possible while simultaneously attracting enrollees through low premiums and cost-sharing requirements. The Democratic party included "Affordable Health Care" as one of the "Six for '06" initiatives. As part of this effort, the House passed H.R. 4 on January 12, 2007, a bill that requires the Secretary of HHS to negotiate prescription drug prices for Medicare beneficiaries. As of this writing, the Senate Finance Committee has not reported a prescription drug negotiation bill in the 110 th Congress. This report discusses what it means for the federal government to "negotiate" drug prices under existing public programs, the arguments for and against such activities, and some implications for the pharmaceutical industry, Medicare beneficiaries, and others if similar federal involvement were to occur on behalf of the Medicare Part D program. There are a number of approaches that the federal government could adopt to affect prescription drug prices and expenditures. A few rely primarily on the power of government to dictate an outcome, such as imposing statutory mandates and setting administered prices. Others emphasize more market-oriented approaches, such as soliciting competitive bids from voluntary participants. A reference pricing approach combines elements of both by dictating some aspects of the price but also allowing market forces to work. Some of these methods are currently employed by federal government programs (see below), while others have been adopted by governments in other countries. Many of the methods are used together. Through statutory mandates, the government could set the reimbursement level or the price that the government would pay for each drug, or require that pharmaceutical manufacturers provide a predetermined discount to government purchasers. The federal ceiling price and federal upper limits under the Medicaid program are examples statutorily mandated discounts. (See discussion below.) The government can set the maximum reimbursement rate for drugs by establishing a price ceiling; drug prices could be less than the ceiling, but not more. The federal ceiling price also falls in this category. Under a reference pricing system, drug reimbursement rates are not directly fixed by the government but are tied through a predetermined manner to another measure that may be dynamic. The reference might be an average price for a group or class of drugs, the average price for a payer or group of payers, or the cost of an alternative treatment. Medicaid's federal upper limit prices and the federal supply schedule both use reference pricing. (See discussion below.) The government can also solicit and receive bids through a competitive acquisition program, where interested parties (pharmaceutical manufacturers) submit confidential bids that include the prices the company is willing to provide for its product(s). The government would then select the winning bid(s) and award contracts. Competitive bidding programs, also known as reverse auctions, are already used as the basis for calculating the national average bid amount for the Part D program and for the setting of payment amounts for durable medical equipment (DME) covered under the Medicare program. In describing the DME competitive acquisition program, the Centers for Medicare and Medicaid Services (CMS) states that "competitive bidding provides a way to harness marketplace dynamics to create incentives for suppliers to provide quality items and services in an efficient manner and at reasonable cost." The MMA also included a provision to establish a competitive bidding demonstration for Medicare managed care beginning in 2010. The typical formulation of a bargaining or negotiation process involves a mutual discussion and arrangement of the terms of a transaction or agreement. In contrast to a competitive acquisition process where most of the power rests with the buyer, bargaining and negotiation can be more dynamic for each party. The outcome of the process will depend in part on the relative strength of each party's position; monopolists (as the sole provider) or monopsonists (as the only buyer) will have more bargaining power when facing providers or buyers who are but one of many. A range of activities that might affect prescription drug prices are currently not available to the Secretary because of the noninterference provision. These include activities that would fall under the scope of explicit and implicit authorities provided in the Medicare statute, but that might face legal challenges if currently attempted by the Secretary, on the basis that they could be construed as "interfer[ing] with the negotiations between drug manufacturers and pharmacies and PDP sponsors," "requir[ing] a particular formulary," or "instituting a price structure." A critical criterion for an efficient market is that buyers and sellers be informed decision-makers. When buyers and sellers have widely disparate levels of information about the market and the transactions, the asymmetry could result in market inefficiency or breakdowns. Through the encouragement, sponsorship, and dissemination of research on the safety and comparative effectiveness of drugs, the Secretary may be able to provide more information about the market that could be used by consumers, health plans, and drug manufacturers in their decisions. However, increased transparency may have the unintended consequence of providing negotiators with the opportunity to collude if too much information is revealed about the results of existing price negotiations. Without the noninterference clause, the Secretary may be able to exert influence over the drug price negotiation process through mass communications or through targeted persuasion. Whether the activity involves the spotlight of the "bully pulpit," "jawboning," or highlighted public scrutiny, the effectiveness of these efforts would depend on the persuasive power of the Secretary or public pressure in addition to the merits of the arguments, combined with the ability or inclination of the organization(s) targeted to resist such pressure or to accede to the influence. The federal government has a track record of active involvement in the determination of drug prices through the experience of the Department of Veterans Affairs in obtaining discounts for VA beneficiaries and through the Medicaid program in obtaining rebates from pharmaceutical manufacturers for states. The VA obtains prescription drugs at discount through several mechanisms, including negotiated contracts and statutory discounts. The Veterans Health Care Act of 1992 ( P.L. 102-585 ) requires the Secretary of Veterans Affairs to enter into Master Agreements, under which manufacturers must offer their covered drugs to the Federal Supply Schedule and also report non-Federal Average Manufacturing Prices (AMP) to the Secretary that are used to establish annual federal ceiling prices. In support of this function, the VA also undertakes many other activities typically associated with pharmacy benefit managers (PBMs) in the private sector, including formulary management. The price the VA pays for a drug is the lowest price as determined through one of four methods, less an additional five percent prime vendor discount. The four approaches available to the VA are: (1) the federal ceiling price, (2) the federal supply schedule, (3) the blanket purchasing agreements/performance-based incentive agreements, or (4) the national standardization contracts. Since pharmaceutical manufacturers have an interest in having their products sold to federal purchasers, almost all FDA approved drugs are included in the list of "covered drugs." Therefore, for these drugs, the VA receives at least a 24% discount off the non-federal average manufacturer price. The FCPs amount to maximum pricing canopies that apply to purchases by the Department of Defense (DOD), the Public Health Service (including the Indian Health Service), and the Coast Guard, in addition to Veterans Affairs. FSS prices are the lowest prices that manufacturers charge their most-favored nonfederal customers under comparable terms and conditions. These prices are sometimes below the Federal Ceiling Price but not always. The FSS is maintained by the VA's National Acquisition Center (NAC) and is available to all federal purchasers. Effective January 1, 2007, all FSS drug prices include a 0.25 percent fee to finance VA's National Acquisition Center. Pharmaceutical manufacturers have a strong incentive to have their products included on the FSS because drug manufacturers can participate in the Medicaid program and receive Medicaid reimbursement for their drugs only if the manufacturers sign a Master Agreement and Pharmaceutical Pricing Agreement with the VA. This requires the manufacturers to offer all their covered drugs to the FSS at prices no higher than FCPs. In practice, almost all FDA-approved drugs are included on the FSS. FSS contracts also include a blanket purchasing agreement that allows the VA to negotiate additional discounts. These contracts can be initiated by either the VA or by pharmaceutical manufacturers and produce an additional 5 to 15% off FSS. Typically, the BPAs include performance thresholds that result in discounts if the VA meets and maintains the threshold of use specified in the BPA for the manufacturer's product(s). These contracts typically produce the greatest discounts (from 10 to 60% off FSS) and are negotiated for individual drugs in closed classes on the VA national formulary. The VA is able to obtain favorable prices for these drugs through competitively bid contracts. Most of VA's contracts are for generic drugs. According to the GAO, generic drugs are easier to contract for because these products are already known to be chemically and therapeutically alike, while there is more difficulty in gaining clinical agreement on the therapeutic equivalence of competing brand name drugs. However, VA has successfully negotiated contracts for non-generic drugs in several drug classes using clinical evidence to outline the requirements of the contract.