On the Incidence of the Subsidy from the Prescription Drug Benefit

Social Security Online has a summary of the “New Medicare Part D Subsidy”, which begins with:

The Medicare Modernization Act (MMA) established a new voluntary Part D Prescription Drug Program effective January 1, 2006. While the overall responsibility for development and administration of this new program resides with CMS, the statute also requires SSA to take applications and determine eligibility for a new subsidy program. This subsidy will reduce out of pocket costs paid by those Part D enrollees who have limited income (below 150% of the poverty line applicable to the size of the family involved) and resources (up to $10,000 in assets for an individual or $20,000 for a married couple) by providing reduced monthly premiums and other cost-sharing assistance.

Indeed, President Bush is going around the national telling seniors that there is some free lunch as the government is subsidizing their health care even as President Bush is telling the rest of us that he is cutting our (current) taxes. OK, the reality is that this subsidy is increasing our already massive deferred tax liabilities.

Economists often describe tax incidence in terms of who ultimately pays the tax. Similarly, one could ask how much of the incidence of this subsidy accrues to patients versus the suppliers of pharmaceutical products. Dean Baker suggests we read the article by Milt Freudenheim:

The pharmaceutical industry is beginning to reap a windfall from a surprisingly lucrative niche market: drugs for poor people. And analysts expect the benefits to show up in many of the quarterly financial results that drug makers will begin posting this week. The windfall, which by some estimates could be $2 billion or more this year, is a result of the transfer of millions of low-income people into the new Medicare Part D drug program that went into effect in January. Under that program, as it turns out, the prices paid by insurers, and eventually the taxpayer, for the medications given to those transferred are likely to be higher than what was paid under the federal-state Medicaid programs for the poor … It is too early to calculate the full effect of the shift of the former Medicaid patients now covered by Part D. But analysts expect it to generate hundreds of millions of additional dollars this year for the drug companies, which have long chafed under the pricing restraints of the state programs. Drugs tend to be cheaper under the Medicaid programs because the states are the buyers and by law they receive the lowest available prices for drugs. But in creating the federal Part D program, Congress – in what critics saw as a sop to the drug industry – barred the government from having a negotiating role. Instead, prices are worked out between drug makers and the dozens of large and small Part D drug plans run by commercial insurers. Since Part D went into effect, the pharmaceutical industry has raised the wholesale prices of its brand-name drugs an average of 3.6 percent. Although the actual amount spent depends on what each insurer negotiates, in many cases the drugs for those 6.5 million people who used to receive their medicines through Medicaid will cost more now. Initially, the added costs will be paid by the insurers administering the new Medicare drug program. But when it comes time for the insurers to settle accounts with the government, the costs of the 6.5 million drugs for the transferees will end up being passed along to federal taxpayers, according to analysts and health care economists. The windfall for the drug makers was made possible by a provision of the 2003 Medicare law that exempts Part D drugs from “best price” rebates that the drug makers have been required to give to the state Medicaid programs since 1991. Those rebates are meant to make sure that state Medicaid agencies pay no more than the best prices drug companies offer to any big commercial insurer.

One of the complaints of fiscal conservatives was that Medicare Part D was too expensive. Perhaps part of the problem lies in how its pricing was established so as to increase the incidence of the subsidy that would go to the pharmaceutical companies.