November 11 update. On November 8, California voters chose not to make Proposition 61 a state law, defeating the ballot initiative by a 54-46 margin. This vote, however, is not the end of the drug-pricing debate. A poll taken before the election showed that a strong majority of likely voters support government action on prescription drug prices, either through Medicare Part D negotiations or limits on price increases (though Trump voters were evenly split on the second proposal). A proposal similar to Proposition 61 is still slated for the 2017 election in Ohio.

Though Americans feeling the pressure of rising drug prices may be demanding change, it is unclear when and if the federal government will deliver relief. Rising biotech and pharmaceutical stock prices suggest the market believes the new administration will be lenient on curbing industry profits. Although on the campaign trail both presidential candidates expressed interest in Medicare Part D price negotiations, changing the law would require congressional action, which seems politically unlikely. Moreover, the president-elect has not detailed a plan with respect to prescription-drug pricing; drug pricing does not receive a mention in Donald Trump’s 100-day action plan. We will have to wait and see whether any federal action will come in the lame-duck session or after the government transition.

Original Post. Even in this unconventional election season, California politics has generated little national interest. However, the country should closely follow one of the initiatives on this year’s California ballot because it may have important implications for drug pricing and policy nationwide.

Proposition 61 would direct California state agencies not to pay more for prescription drugs than the U.S. Department of Veterans Affairs (VA), which operates the Veterans Health Administration, pays for the same drugs. This proposal taps directly into the nation’s frustration with prescription drug price increases, including exorbitant price hikes for decades-old drugs such as pyrimethamine (Daraprim) for toxoplasmosis, sold by Turing Pharmaceuticals, and Mylan’s epinephrine autoinjector (EpiPen) for severe allergic reactions. These cases have led to a popular backlash against pricing practices in the pharmaceutical industry. A recent Kaiser Family Foundation survey found more than three-quarters of Americans believe prescription drug prices are unreasonable and a similar proportion supports federal price controls on high-cost drugs for certain illnesses.

In the tradition of California politics, Proposition 61, also called the “California Drug Price Relief Act,” utilizes direct democracy to shape public policy. In order to win over voters, supporters and opponents have already committed over $100 million (with the $87 million in opposition largely coming from drug manufacturers), rivaling the amount spent on 2008’s contentious Proposition 8 campaign related to marriage equality. A recent poll showed that 66 percent of California voters support the measure.

Behind the Proposition 61 Controversy

If passed, Proposition 61 would require the state of California, when purchasing or serving as the “ultimate payer” for a drug, to pay no higher than the price paid by the VA. The relevant state agencies spend about $4 billion on prescription drugs annually. State agencies would need to comply by July 1, 2017. The law would cover 4.4 million Californians, including 3 million Medi-Cal (Medicaid) patients enrolled in fee-for-service health plans, 838,000 state employees, and 294,000 teachers and other employees of the state university systems.

Debate over the ballot measure has been heated. The bill is sponsored by the Los Angeles-based AIDS Health Care Foundation, and supporters of the measure include the California Nurses Association, the American Association of Retired Persons of California, and Senator Bernie Sanders (I-VT). They argue Proposition 61 will force drug companies to lower prices for state purchasers, which will save the state money and increase patient access to life-saving medications. Furthermore, they believe the passage of Proposition 61 could create a cascade effect with other states demanding similar concessions from industry.

Opponents of the proposition note the measure’s provisions cover less than 12 percent of the state’s population and claim that Proposition 61 could raise taxpayer costs. Multiple veterans groups oppose Proposition 61, primarily on the grounds that it could raise drug prices for the VA. They fear the law could disrupt the VA’s ability to extract discounts on the basis of patriotism and national security. Others have raised the specter that some drug manufacturers may simply refuse to contract with the VA if they have to sell to California at the same or a lower price. Even some patient advocates who recognize the problem of rising prices oppose the measure.

Major California newspapers have also come out against the measure. The Los Angeles Times registered its concern about the likely effects because it is unclear how drug manufacturers will respond to the measure. The San Francisco Chronicle stated similar concerns and prefers transparency laws, which would require public disclosure of drug pricing.

The Uncertainty Around Proposition 61

It is unclear what would happen if Proposition 61 passes, and the state’s nonpartisan Legislative Analyst’s Office has concluded the ballot measure’s fiscal effects are highly uncertain. There are three reasons for this uncertainty: the current systems’ complexity and opacity, legal questions regarding implementation, and the range of possible responses by drug manufacturers.

How does Proposition 61 fit within current drug-purchasing arrangements?

The complexity and lack of transparency of both the VA and California’s existing drug-pricing scheme complicate predicting the law’s effects. Both the VA and state Medicaid programs negotiate directly with drug manufacturers, with price ceilings set by federal law. Whereas the VA’s price ceiling is 24 percent off the manufacturer’s average price for a prescription drug, Medicaid pays a discount off the average manufacturer price (23.1 percent for brand-name drugs and 13 percent for generics) or the best price offered on the market, whichever is lower. That best-price calculation excludes the prices charged to certain entities, including the VA. The California Public Employees’ Retirement System (CalPERS) contracts with a pharmacy benefits manager that purchases drugs on behalf of many of its health plans. Other California state agencies typically negotiate through the state’s Department of General Services.

The public does not know how much federal and state governments pay for prescription drugs because purchasing contracts with drug manufacturers are confidential. Critically, many state governments do not know how much the federal government actually pays manufacturers for prescription drugs. Although the VA publishes the prices it pays for many drugs, the published prices may not reflect the actual amount paid by the VA due to rebates that buyers like the VA can negotiate with manufacturers. Similarly, California does not share how much it pays for prescription drugs with the public. Because we do not know whether the state pays more or less than the VA and by how much, the law’s effects are difficult to discern.

Some evidence suggests that the VA tends to pay lower prices for new, brand-name prescription drugs than Medicaid. A 2005 Congressional Budget Office study estimated that on average the VA negotiates prescription drug prices that are 41 percent of list price, as compared with 52 percent of list price for Medicaid. More recent direct comparisons are difficult to find, and inferences across studies are likely to be inaccurate. A 2013 study found the Department of Defense (DOD) paid 32 percent more per unit than the VA, while a 2014 study showed the DOD paid 60 percent more per unit than Medicaid. Combining these studies might suggest the VA actually pays more than Medicaid on average. However, the sets of drugs each of these agencies purchase is different; for example, the VA’s purchases are skewed more towards generics than DOD’s. Comparisons across studies therefore do not capture differences in what agencies pay for the same drug. How other California state agencies stack up is unknown although a new study suggests corrections agencies in many states receive fewer discounts than other government agencies and thus may have potential to benefit more from a reference price.

The VA is able to achieve lower pricing because it has significant discretion in determining which prescription drugs it will cover and which will receive preferred status through its National Drug Formulary. The VA is therefore able to negotiate deep discounts by generating competition among drug companies. Notably, most California departments and programs also have discretion in designing their formulary. Medicaid prescription drug plans, however, are required by law to cover nearly all drugs approved by the Food and Drug Administration. Proposition 61 would essentially allow Medi-Cal to receive the benefits of the VA’s formulary power for the drugs it covers.

The current scheme places some limits on drug makers’ ability to raise prices, but these restrictions do not prevent price gouging in all circumstances. Drug makers selling to the VA and Medicaid are required to give an offsetting discount when the non-Federal average manufacturer price (as opposed to the contract price) of a covered drug increases faster than the rate of inflation. To some extent, this provision would restrain drug companies from raising prices for individuals not covered by the state or VA. However, while multi-year VA contracts cap the price actually paid by the VA to the rate of inflation, single-year VA contracts do not. This provision means drug companies can increase prices for drugs that have VA contracts renewed from year-to-year or when multi-year VA contracts are renegotiated, potentially endangering discounts that the VA has already received. This impact is difficult to estimate without knowing the terms of the VA’s contracts.

Does implementation of Proposition 61 conflict with federal law?

The debate so far has largely focused on the law’s effects on drug prices and access rather than how it would be implemented or enforced. (Though some critics charge the lack of transparency around drug prices makes the statute impossible to implement.) However, there are important federalism and enforcement issues.

If drug manufacturers refuse to sell to California agencies at lower prices, it could create a sticky situation for the state government. Purchasing the drugs at a price above the VA’s would violate state law, while not covering the drugs might violate federal law requiring coverage of most approved drugs. Although Medicaid can be flexible in allowing states to waive requirements, Proposition 61 likely would not provide an adequate basis for a waiver. Officials in a new presidential administration would make the final decision. Proposition 61’s text does include a potential escape route with the clause “insofar as may be permissible under federal law,” but it is unclear what that phrase would mean in this context.

If the state does not comply with Proposition 61’s mandate, supporters’ judicial remedies for enforcement may be limited. Standing doctrine typically requires plaintiffs to show a tangible personal injury to bring a lawsuit, and showing the required specific harm could be challenging. California ballot initiatives such as Proposition 61 now include stock language asserting the stake the proponent—in this case the AIDS Health Care Foundation—has in defending the proposed law from constitutional or statutory challenges to its validity; however, this claim seems irrelevant to enforcement. Moreover, in Hollingsworth v. Perry, the U.S. Supreme Court case that led to the demise of Proposition 8, the majority opinion relied upon the principle that the ballot initiative’s proponents had no role in the enforcement of the law’s ban on gay marriage. Proposition 61 supporters may similarly be precluded from using lawsuits to enforce the law if it passes and the state does not comply.

How will drug manufacturers respond if Proposition 61 passes?

Estimating Proposition 61’s effects is difficult because it is unclear how drug manufacturers will react to the measure. Industry’s opposition seems to suggest the law is a net loss for them. However, many people worry drug companies will find other ways to profit. In one scenario, drug companies might agree to the text of the law and offer VA prices, but raise prices on drugs not on the VA’s formulary. In another scenario, drug companies may raise the prices for the VA. For a historical perspective, when Congress included the VA within Medicaid’s “best price” rule in 1990, drug companies raised prices the next year, and Congress responded by disconnecting pricing for the two programs.

On the one hand, competitive dynamics may prevent drug companies’ from raising prices. When there are competing drugs on the market, buyers have more leverage to extract discounts, especially when they have the power to exclude drugs or place them on a non-preferred tier. Makers of drugs with no therapeutic alternatives typically have leverage to maintain high prices, especially when the buyer feels pressure to cover the drug for clinical or political reasons. Proposition 61 should not disrupt these underlying principles, so the VA may be able to avoid price increases on competing drugs by continuing to negotiate for discounts. On the other hand, to the extent California prices are currently higher than VA prices on these drugs, Proposition 61 would hurt industry profits, so companies with a large portfolio of drugs may raise prices on the many drugs that lack therapeutic alternatives to compensate. Moreover, consolidation in the pharmaceutical industry has resulted in fewer competing companies, reducing the impact of competition to restrain prices.

Public relations concerns may place some limits on drug companies’ actions. Critics have raised the possibility that state agencies will reduce coverage of some drugs, presumably because prices will rise to a prohibitive level or the industry will simply refuse to sell drugs to California. However, loss of coverage due to pharmaceutical companies’ actions has the potential to be a public relations disaster. Finally, to the extent information about price changes is publically available, if drug companies raise prices on drugs sold to the VA, it could inspire additional backlash.

Implications for Drug Pricing Reform

Proposition 61 is an incomplete solution to a complex problem. It does not address the lack of transparency around drug pricing. Even though governments are spending public funds to purchase drugs, data on what we pay is not (but should be) available. It does not create a more competitive environment for drug manufacturers. Finally, it does not address the original Daraprim and EpiPen problems: drug companies’ nearly unfettered ability to raise prices.

Whether or not Proposition 61 passes in November, the problem of high-cost drugs is not going away. Prescription drug prices are a hot campaign issue nationally, and the President who takes office in January will likely feel pressure to take action. Existing initiatives to control industry prices have failed to stall price growth, and new initiatives have struggled to gain traction. A measure that is “almost identical” to Proposition 61 is already slated for the 2017 Ohio ballot.

Given the influence of the pharmaceutical industry and its allies over institutional government bodies, including legislatures and agencies, we may be seeing the emergence of a new battleground: direct democracy. The power of direct democracy is that it captures popular opinion unfiltered by institutional bodies. However, large expenditures on advertising in proposition campaigns suggest that voters may also be subject to interest-group influence. A further complication is that citizen initiatives and referendums on complex topics may be an ineffective way to conduct public policy, and recent votes across the globe have cast doubt on the wisdom of popular governance.

California and Ohio are not the only states that allow citizens to propose new statutes. If popular concern about drug prices does not abate, the next several years could launch ballot measures across the country. These votes might end up taking a variety of routes to tackle the issue. Although this type of experimentation across states is one of the advantages of the American political system, we are entering uncharted territory for policy regarding drug pricing. To correct the shortcomings of Proposition 61, we will need other novel proposals that effectively rein in costs and make trade-offs that are readily apparent to voters. Regardless of the outcome on November 8, Proposition 61 is a first step in determining whether state ballots will effectively channel popular discontent with drug pricing into true reform.