The Office of Fair Trading says that the NHS is paying hundreds of millions of pounds too much for branded drugs.
The competition watchdog said that the Department of Health - which buys £7bn of branded medicines a year - is not getting the best prices for drugs.
It is recommending an overhaul of the Pharmaceutical Price Regulation Scheme (PPRS) that is used to set prices.
But pharmaceutical firm representatives insisted that the NHS got a good deal.
Incentives
The big problem is that the prices paid to drug companies does not reflect the value of those drugs to patients
John Fingleton
OFT chief executive
The OFT's study, carried out since 2005, identified several drugs where it said prices were "significantly out of line with patient benefits".
Treatments for blood pressure and cholesterol were among those identified.
The watchdog added that some treatments which are prescribed in large volumes are up to ten times more costly than other drugs offering similar benefits.
Value-based pricing would give companies stronger incentives to invest in drugs for those medical conditions where there is greatest need, the report said.
"The big problem is that the prices paid to drug companies does not reflect the value of those drugs to patients," OFT chief executive John Fingleton told BBC Radio 4's Today programme.
"We would like to see incentives for investment directed much more towards complaints for which there are no current drug treatments."
In many cases, other countries view the NHS prices as the maximum - and they use them as a basis for negotiating a discount
Robert Peston
BBC Business Editor
Read Robert Peston's blog
Initial opposition to the proposals from drug companies should be expected, he added, "because they make quite a bit of money on one or two drugs which are close substitutes for existing drugs".
"But over time this is a very good scheme for investment," he said.
'Blazing row'
The report is likely to be welcomed by the Treasury, which is looking to make savings on the NHS.
BBC business editor Robert Peston said the pharmaceutical industry was likely to argue that continued success depends on being properly rewarded for very expensive and risky scientific research.
It sounds to me as if they have exposed the taxpayer being ripped off
Mike Penning MP
Commons Health Committee member
"However there is likely to be a blazing row with the major drug companies, who frequently complain that the NHS does not spend enough on their products," he said.
Mr Peston added that while the Department of Health did not have to accept the OFT's recommendations, it was highly unlikely to reject them, given that hundreds of millions of pounds of public money were at stake.
Conservative MP Mike Penning, a member of the Commons Health Committee, said he was concerned about how much money the NHS was being charged.
As a country we pay less per head for medicine than most major European countries
Dr Richard Barker
Association of British Pharmaceutical Industry
"This report explains a lot about where the money is going. We are not talking about a few pounds," he said.
"Hundreds of millions are being spent when they don't need to be spent, and it sounds to me as if they have exposed the taxpayer being ripped off."
'Feel valued'
However, the director-general of the Association of British Pharmaceutical Industry, Dr Richard Barker, said that this was untrue.
"As a country we pay less per head for medicine than most major European countries," he told the BBC.
"We've seen the drug bill actually fall since last renegotiation of the pricing scheme, so the NHS is not overpaying for medicines."
He added that that global drug firms needed to feel valued in the UK. "We have to do everything we can to keep research and development here," Dr Barker said.
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Michael Summers from the Patients' Association said the achievements of the drug companies should not be forgotten.
Drug companies invest heavily in order to produce new drugs for the benefit of patients, he said.
"If too much money is being paid to the pharmaceutical industry, then the NHS should renegotiate the regulation which they have in relation to setting the cap.
We recognise the importance of the pharmaceutical industry to healthcare
Department of Health
"But we are fortunate that so many of the drug companies are producing fantastic drugs which overall benefit patients to a very large extent."
'Encourage research'
The PPRS sets a cap on the profits that each drug company can earn on its annual sales of branded medicines to the NHS.
It is a voluntary scheme negotiated every five years between the Department of Health and the Association of the British Pharmaceutical Industry.
The price paid by the NHS for drugs is used as a benchmark by health services in other countries, but they frequently insist on paying less than the NHS pays.
A statement from the Department of Health, which will now consider the report, said: "It is important that we have fair prices which give value for money to the taxpayer."
"However, we recognise the importance of the pharmaceutical industry to healthcare and the development of medical advances and it is in all of our interests to encourage research and reward innovation."
First published on bbc website|