The Medicare drug price negotiation provision in the 2022 Inflation Reduction Act treats small molecule drugs and biological products differently. For small molecules, drug price negotiations can start seven years after Food and Drug Administration (FDA) approval, with the negotiated price taking effect in year nine after FDA approval. For biological products, negotiations start at 11 years, and the negotiated price can take effect in year 13, after FDA approval. The drug industry has called this difference the “pill penalty,” and it argues that the penalty disincentivizes the development of small molecules as compared to biologics.
The Misunderstanding That Led to the Pill Penalty
The pill penalty has been justified by a fundamental misunderstanding of how the incentive systems for drugs and biologics are structured, as illustrated in a David Mitchell opinion from Stat (https://www.statnews.com/2023/02/17/pharma-industry-flip-flop-ira-small-molecule-versus-biologic-drugs/), where he asserts that biologic exclusivities end at 12 years and small drugs at five. Although this statement is true, it fails to recognize the critical point about exclusivities for this discussion, which is that, among other things, exclusivities delay FDA approval of generic drugs and biosimilars. The critical question is, therefore, when does the FDA approve generic drugs and biosimilars?
For biologics, FDA approval can occur only at the end of the 12-year exclusivity that begins at initial approval. By contrast, for small molecule drugs, FDA approval typically occurs years after the five-year and other exclusivities have ended because of “patent linkage.” Small molecule innovative drug sponsors are required to list certain patents on their drugs at the FDA, and the FDA is not permitted to approve generic versions of the drug until all those patents have expired or been found to be invalid or not infringed by the generic drug (including by excluding a patented use from the generic drug label). That is, FDA approval of generic drugs is linked to the listed patents of the innovator drug they are copying. Patent linkage for small molecule drugs means that the FDA approves small molecule generics on average at about 12.5 years after initial approval—about the length of protection provided by the 12-year exclusivity for biologics coupled with the six-month notice of marketing a biosimilar sponsor must provide to the biologic’s sponsor after biosimilar approval.
There is no patent linkage for biologics: the FDA approves biologics notwithstanding any biologic patents. This was the deal in the Biologics Price Competition and Innovation Act that was first negotiated and passed by the Senate in 2007 and was then included (with some changes) in the 2010 Affordable Care Act: No patent linkage and therefore longer exclusivity for biologics to provide for somewhat comparable FDA approval times for small molecule drugs vs. biologics.
To be sure, there is some variability in FDA approval time for small molecules: Some have patents that expire before 12.5 years and others have patents that can expire after 12.5 years, which is all a function of different drug development times and the rules for drug (and biologic) patent restoration under the Hatch-Waxman Act. But the point is that both innovator small molecule drugs and biologics typically face generic or biosimilar approval about 12.5 years after FDA approval. Yet, under the Inflation Reduction Act, small molecule drugs face negotiated Medicare drug prices in year nine, three or more years before a generic typically can come to market, while biologics face negotiated Medicare drug prices only in the year after the FDA has approved biosimilars. That is, although a drug sponsor may anticipate FDA approval of a generic or biosimilar at about the same time after FDA approval (meaning the time to gain revenue from the drug or biologic is very similar), because of Medicare price negotiation, the small molecule drug may have three–four fewer years of revenue from typical market drug pricing. When considering which drugs to develop or invest in, a drug sponsor and investors must discount anticipated revenue for a small molecule drug because of the possibility of a negotiated Medicare price at year nine. This discount of revenues, caused by the gap between a negotiated drug price and the possibility of generic competition, is the pill penalty, and it disincentivizes the development of small molecule drugs as compared to biologic drugs.
Fixing the pill penalty
In his recent drug pricing Executive Order (EO), President Trump directed Secretary of Health and Human Services Robert F. Kennedy Jr. to work with Congress to “align the treatment of small molecule prescription drugs with that of biological products.” As we have noted [https://www.bhfs.com/insights/alerts-articles/2025/trump-administration-issues-wide-ranging-eo-to-lower-drug-prices], the EO does not specify whether the pill penalty should be fixed by moving biologics to seven and nine years, moving small molecule drugs to 11 and 13 years, or moving both to something in between, like nine and 11 years.
Critical to how Congress chooses to fix the pill penalty is how the Congressional Budget Office (CBO) will score different fixes. CBO will surely score moving to seven and nine years for biologics to save money for Medicare, as price negotiations could begin four years earlier on biologics and reduce prices three years before possible biosimilar entry. Yet this approach would likely undermine the nascent biosimilar market, as it would reduce the prices at which biosimilar competitors could enter the market and so reduce the incentive for biosimilar companies to introduce their products in the U.S. market. Because of this concern, the Democratic-controlled Congress included a mechanism in the IRA to delay the negotiated price for a biologic if a biosimilar were to be coming to market imminently. It seems unlikely that the current Republican-controlled Congress will be less concerned than Democrats about this potential impact on biosimilars. Indeed, the Ensuring Pathways to Innovative Cures (EPIC) Act, introduced by Republican members in both the House (H.R. 1492) and Senate (S. 832) would change small molecule drugs to the current 11- and 13-year periods for biologics.
Yet, moving all drugs to 11 and 13 years will be scored to cost Medicare substantial money, as small molecule drugs with 12-plus years of patent life would be on the market with neither generic competition nor a negotiated price for three or more years. So, whether such a pill penalty fix were to be included in the reconciliation bill that Congress is working on or in some other piece of legislation, it will need to be paired with a significant “pay-for,” a provision that saves approximately what the pill penalty fix will cost. And savings are currency that Congress is seeking for the reconciliation bill’s more central goals, such as tax cuts.
Congress may instead choose to pursue other changes to the IRA’s Medicare drug price negotiation scheme. Options include the Optimizing Research Progress Hope And New (ORPHAN) Cures Act (H.R. 946) and the Maintaining Investments in Innovation (MINI) Act (H.R. 1642). The ORPHAN Cures Act would exclude from price negotiations any drug that is approved only for one or more orphan-designated diseases or conditions and would delay price negotiations by the period of time a drug is such a drug. The MINI Act would move the negotiation time to 11 years only for small molecule drugs that are genetically targeted.
Next steps
We are monitoring developments on these and other issues central to the reconciliation bill and the interests of the pharmaceutical industry and will provide updates when available.
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