In a recent posting Richard Frank and Jack Hoadley argue in support of a proposal that would introduce Medicaid-style rebates into Medicare’s Part D drug program for the low-income subsidy population.  The evidence argues against such a policy.

At the outset, however, it is important to note that we agree on the basic goal: a Part D program that displays effective cost containment in a very tight federal budgetary environment.  The good news is that the existing program is quite successful in this regard. Since 2007 per capita costs in Part D have grown at a compound annual rate of 1.8 percent, while costs in Part A and B have grown at 3.6 percent and 3.7 percent, respectively. The program’s negotiated rebates between large purchasers and drug manufacturers, and the ability for consumers to compare plan prices and benefits, have resulted in lower than expected Part D spending overall.  (In contrast, note that from 1990 to 2005, average annual drug cost growth in the Medicaid program was about 13.1 percent per year.)

What would the proposed policy do to improve on this record?  Impose a rebate of $137 billion over the next 10 years (according to the Congressional Budget Office).  On its face, imposing a Medicaid-style rebate to the low-income subsidy Part D population may sound appealing.  Of course, just like the Medicaid rebate program, the Part D rebate proposal isn’t a market-driven negotiation between businesses seeking to serve a common market — it’s a government fiat.

CBO scoring and Congressional budgeting treats rebates as part of the spending side of the budget (rebates lower spending).  However, from an analytic point of view, the economics of rebates are the same as the economics of taxes.  Rebates, like taxes, are mandatory payments from pharmaceutical firms to the government.  Proponents want to argue that they would not only generate nearly $137 billion in savings to the federal government over 10 years, but that the extension of this burden would have an insignificant impact on Part D premiums, or on the rest of the prescription drug marketplace.

One could certainly debate the net merits of such an imposition, or the details about how its burden would ultimately be manifested to beneficiaries and Part D premium costs. But it’s a lot harder to argue that a $137 billion transfer from an industry to the U.S. Treasury results in a non-existent, or at least very minimal, cost-shift.

Rebates would impact 56 percent of Part D drug spending to the tune of $137 billion and almost certainly produce a corresponding impact in one or more of the following ways:

  • Higher Part D premiums
  • Higher-cost drug coverage outside of Medicare Part D
  • Lower quality/diversity of Part D plan formularies
  • Lower incentive to provide Part D plan “perks”
  • Lower investment in R&D for drugs that will be subject to the rebate

The magnitude of each of these effects is a fair subject for policy debate; there is a lot of room for reasonable discussion about exactly how the market will be distorted as a result.  But it is at odds with the economics of public finance to suggest they can be imposed without consequence.

If $137 billion in mandated costs are imposed, somebody will bear that burden.  In previous research with Michael Ramlet, we presented some illustrative computations of the magnitude of where these costs might be shifted. It would be overconfidence to take these estimates at face value.  But it would be equally mistaken to impose this burden on a Medicare population that already has a functioning drug program with effective cost controls.