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What if drugs were priced based on their effectiveness?

In August, the FDA approved a drug called Repatha that lowers cholesterol. This drug is a true innovation that may benefit millions of Americans, but it comes with a steep price tag of $14,100 a year — double its price in Europe. And according to the FDA, Repatha's impact on heart attacks and stroke is still being studied.

Then there's Farydak, a new blood cancer drug, which the FDA approved against the initial recommendation of its independent experts. According to the FDA, Farydak slows the progression of the disease by only five months, and it comes with severe side effects. The cost? Nearly $10,000 a month.

Prices for drugs like these are part of an alarming trend; last year, the cost of prescription drugs increased 13.6 percent for a family of four that has health insurance from an employer, according to the Milliman Medical Index. This spike is fueling a rise in health-care spending and premiums for both private insurance and Medicare. Rising drug costs are straining state and federal budgets and the pocketbooks of middle-class families. Worse, they're making drugs unaffordable for the patients who need them.

Prescription drugs
Steve Cole | E+ | Getty Images

It would be one thing if these exorbitant prices were needed to encourage innovation, as the drug industry argues. But the industry spends only 18 percent of its revenues on research and development—less than what most of the big companies spend on marketing. The drug industry has higher profit margins than almost any other industry, and more than double the average margin for S&P 500 companies.

When many drugs offer little or no benefit, how should they be priced? What about drugs that offer significant benefit, but may still be overpriced? The basic problem is that our system does not pay for success, and therefore does not encourage true innovation.

The first step to solving the problem is to evaluate new drugs for their effectiveness compared to existing treatments. Drugs would be categorized by whether they offer no benefit, minor benefit, or significant benefit. A nongovernmental institute, such as the Institute for Clinical and Economic Review, would conduct such studies.

The second step is for the institute to recommend ranges of price increases for each of the categories. For example, if a drug offers no added benefit, its recommended price would be equal to the price of its existing competitor. But if a drug offers significant added benefit, its recommended price increase range would be significant percentage increases over the price of the existing drug.

These guidelines would be voluntary. But if a drug company demands a price that exceeds the recommended range, it would be required to submit a public justification for the price. And if the price exceeds the recommended range by more than 20 percent, the institute would deem it to be unreasonable. In this case, the drug's patent exclusivity would be shortened.

In addition, if the drug's patent resulted from federally-funded research, the government would license the patent to competitors — unleashing market competition. This incentive is authorized under a little-known and never-invoked provision of law known as the Bayh-Dole Act. Currently, the incentive would apply to more than 9 percent of all new drugs and nearly one quarter of drugs that receive priority review, including many cancer drugs. Since taxpayers paid for the development of these drugs, they shouldn't also have to pay unreasonable prices.

These simple reforms would lower drugs costs across the board and ensure that prices reflect the benefits to patients. Because prices paid by private insurance are linked to prices paid by public programs, these reforms would lower prices in both sectors—a holistic approach. And they would bring much-needed transparency and encourage true innovation by rewarding value.

Even though paying for success is common sense, the drug lobby has always had an iron grip on Congress. But the past is not prologue. Polls show that the American public is now demanding action at unprecedented levels. And what can't continue won't; drug prices have become so high that they're simply unsustainable.

Most importantly, much of this approach can be accomplished without congressional action. The evaluation of drugs, and pricing guidelines, can and should be implemented independently of government. And a critical incentive for drug companies to charge reasonable prices is authorized under existing law.

All that is needed is leadership — exercising the power of the bully pulpit — and the will to challenge the status quo. The drug lobby will seek to protect its monopoly prices and economic rents — extracting vast amounts of wealth. It's time for the American people to get a better deal.

Commentary by Topher Spiro, the vice president for Health Policy at the Center for American Progress. Follow him on Twitter @TopherSpiro.