Federal policymakers have employed inflation rebates to lower drug prices, requiring drug companies to pay rebates when list prices increase faster than inflation. Currently, these rebates apply to various market segments but not to units of drugs sold to patients with commercial insurance. This gap presents an opportunity for state policymakers to implement their own inflation rebate requirements, ensuring compliance with the Commerce Clause of the Constitution and federal restrictions on revenue from health care providers.
Inflation rebate requirements are a tool to combat high prescription drug prices. Federal law mandates that drug manufacturers pay inflation-based rebates to state Medicaid agencies and provide larger discounts under the 340B program when drug prices increase faster than inflation. In 2022, Congress extended this rebate to Medicare for single-source drugs without generic competition, costing over $100 per year per patient. Initially, the expansion aimed to include drugs sold to commercially insured patients, but it was removed due to budget reconciliation rules. Consequently, drug manufacturers must make additional payments in Medicare, Medicaid, and 340B for price increases exceeding inflation, but they can retain extra price increases for commercially insured patients not served by 340B providers.
States can fill this gap by imposing their own inflation rebate requirements for drugs sold to commercially insured patients. A straightforward policy would limit rebates to brand-name drugs costing over $100, avoiding concerns about low-cost generic drugs exacerbating shortages. This policy would raise revenue and deter price increases, with the effectiveness increasing as more commercial sales are subject to rebates.
Constitutional and Federal Statutory Constraints
However, states must consider constitutional and federal statutory constraints. The dormant Commerce Clause limits state regulation of interstate commerce, and courts have struck down laws that burden interstate commerce impermissibly. Recent Supreme Court decisions have reiterated that state laws regulating out-of-state prices can be problematic. States often use national data sources like Wholesale Acquisition Cost (WAC), Average Manufacturer Price (AMP), or Average Sales Price (ASP) to determine drug prices, but relying on these metrics has led to dormant Commerce Clause challenges. Pharmaceutical companies argue that state penalties based on national pricing metrics impermissibly regulate out-of-state economic conduct.
To avoid these challenges, states should base inflation rebates on state-specific metrics, such as data from All-Payer Claims Databases (APCDs). Nearly half of states have APCDs, which provide in-state commercial transaction data. These databases can illustrate ingredient costs and dispensing fees for outpatient drugs and separately identify payment associated with physician-administered drugs. States can use APCD data to establish inflation rebates based on changes in ingredient costs and count the units of drugs paid by commercial insurance subject to rebates. If APCD data are incomplete, states can use other claims data sources, such as state employee health plans or vendor-provided data.
Pharmaceutical companies may argue that even state-specific rebates violate the dormant Commerce Clause by affecting out-of-state transactions. However, the Supreme Court’s recent rejection of a per se prohibition on state laws’ practical effects on out-of-state economic activity weakens these arguments. States must also ensure their inflation rebates comply with Supreme Court rules on tax imposition, focusing on in-state economic activity and ensuring fair apportionment.
State Tax Imposition and Federal Medicaid Program Restrictions
The dormant Commerce Clause also limits state tax imposition. The Supreme Court’s four-part test examines whether a tax has a substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state. Congress has regulated state corporate income taxes, and large pharmaceutical manufacturers are generally subject to these taxes but may pay little or nothing.
States must also consider federal Medicaid program restrictions on health care-related taxes. Prior to the 1990s, there were no federal limits on state receipt of revenue from providers. However, Congress enacted legislation limiting provider taxes and donations, requiring them to be broad-based and not include hold harmless provisions. The Centers for Medicare and Medicaid Services (CMS) promulgated regulations defining impermissible indirect hold harmless provisions. In 2006, Congress codified the guarantee test into statutory law, and in 2025, further limited state use of provider taxes.
To design an inflation rebate that does not violate federal law, states should ensure the rebate is broad-based and does not include a hold harmless provision. The guarantee test assesses whether a tax produces revenues exceeding a certain percentage of the taxpayer’s net patient revenue and whether taxpayers receive enhanced Medicaid payments offsetting their tax burden. State Medicaid programs generally do not make payments to pharmaceutical manufacturers, making it unlikely that an inflation rebate would violate the guarantee test.
Conclusion
In summary, states have options to implement inflation rebate requirements that comply with constitutional and federal statutory constraints. By focusing on in-state economic activity and avoiding impermissible provider taxes, states can fill the gap left by federal policy and lower drug prices for commercially insured patients.
