Part of President Barack Obama’s deficit reduction plan is to allow Medicare to “negotiate” prescription drug prices. This sounds sensible, except that government never “negotiates” anything. It sets prices and then tells sellers to take it or leave it.
The president’s plan is misguided, would lead to shortages and other market distortions, and would wind up undermining the most successful and cost-effective entitlement program the federal government runs–the Medicare prescription drug benefit, also known as Part D.
The first principle in health care and economics should be: first, do no harm. The president’s plan will cost taxpayers more in the long run and undermine seniors’ choices.
The prescription drug benefit was controversial when it first passed in 2003. Many worried about creating an expensive new entitlement program where taxpayers once again would find themselves on the losing end of runaway costs.
Instead, Part D has shown that it is successful and could even be a model for overall Medicare reform. It gives seniors a choice of prescription drug plans offering different cost and benefit structures, it relies on choice and private competition to keep costs under control, and it is coming in far below expected costs.
Part D works because it relies on the power of the market, not top-down central planning. Rather than a massive government-run insurance mega-program, Part D offers set subsidies toward the purchase of private prescription drug plans, which then compete for seniors’ business. These private plans have different costs, work different ways, and cover different drugs. The competition creates more choices for seniors with plans constantly forced to balance costs with providing the broadest coverage possible.
Part D is now expected to cost taxpayers about 46% less than originally estimated for the period of 2004 to 2013. This is unprecedented in the history of entitlements. Premium costs for seniors are 43% lower than expected. In recent polls, 84% of enrollees say they are satisfied with their coverage, and 95% say their plans work well. Enrollment in Part D has grown steadily, from 11.6 million in 2005 to 27.6 million last year.
Private insurance companies offering prescription drug coverage typically negotiate with drug manufacturers and pharmacies to obtain lower prices. They can get bulk discounts, and through setting their drug lists to favor one medication over its competitors, they can obtain further price concessions from the favored manufacturer. All parties are attentive to the bottom line, and seniors can pick which drug plan they prefer.
This program is working. So what’s the problem? The president said in April he has a different plan. He wants to use Medicare to try to lower the federal budget deficit and “limit excessive payments for prescription drugs by leveraging Medicare’s purchasing power.” What he means by that, unfortunately, is that he wants to impose mandatory Part D “rebates” on pharmaceutical companies similar to those in the Medicaid program.
Rebates are a fancy term for kickbacks to the government–a bribe that must be paid for companies to participate in the program. Because seniors are the biggest consumers of prescription drugs, it would be hard for companies to say no. But we would all play a high price for this misguided policy.
Medicaid follows a rigid formula: If a manufacturer wants its drug available through Medicaid, it must offer a rebate of at least 23.1% off average wholesale prices for brand-name drugs and 13% for generics. If the company offers a bigger discount to any one of its other customers, it must match that price for Medicaid. According to the Congressional Budget Office, one consequence is that to make up for the revenue lost on Medicaid patients, drug manufacturers have to charge everyone else more.
That only works when there is someone else to shift costs to. But now, President Obama wants to multiply the damage that Medicaid rebates already cause by extending them to Medicare as well. Through Part D, Medicare pays for drugs on a vast scale. There’s no way companies will be able to cost-shift their way out of this big squeeze on their revenues.
There is a huge difference between a mix of private insurance companies negotiating with drug manufacturers and a massive government program that simply rules on prices by decree, ordering all drug manufacturers to offer a specific, steep discount. The first system allows the market to do its work. The second is a command-and-control exercise in central economic planning and price controls.
In the short run, the president’s plan will cut investment in research and development. In the longer term, the diminished incentive for success will have companies thinking hard about whether it’s worth it to invest $1.2 billion to bring a new drug to market when the government may set prices below their costs of development and production.
Is a promising Alzheimer’s treatment going to be worth developing if Medicare will be dictating a lower return? The CBO already has determined that mandatory rebates reduce the incentive for pharmaceutical companies to develop drugs for seniors. Without market feedback, the cost of the program to taxpayers will likely move higher, not lower.
A loss in medical innovation and in access to cutting-edge treatment is something no one wants. Yet that is where Obama’s plan would lead us. We should stick with the competition and consumer choice that are working in Part D and not switch to government price controls that have failed for centuries.
Posted on Forbes.com, June 29, 2011.