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 Medicare Prescription Drugs
 Medical Necessity Meets Fiscal Insanity
by Joseph Antos and Jagadeesh Gokhale
 Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at the American Enterprise Institute. Jagadeesh Gokhale is a senior fellow at the Cato Institute. An earlier version of this analysis was presented in testimonybefore the House Subcommittee on Human Rights and Wellness, July 17, 2003.
No. 91
Medicare is facing severe financial strainsthat threaten its future viability. On a per capita basis, Medicare spending is increasing at twicethe rate of the gross domestic product, and,according to Medicare’s chief actuary, the pro-gram is facing a breathtaking funding shortfallof $62 trillion—nearly six times larger than themuch-discussed shortfall in Social Security. Thenewly enacted Medicare prescription drug bene-fit could cost more than $700 billion over thenext 10 years and will only add to the program’sfinancial woes.That new drug law would provide a sizable netbenefit to retirees and older workers withoutexisting coverage, even if Congress immediately funded it through higher Medicare payroll taxes.Workers born before 1965—baby boomers andcurrent retirees—would receive a net gain of about$20,000 per capita. Younger workers and allfuture generations, however, would suffer netlosses of between $2,500 and $4,000 per capita.Furthermore, failure to include meaningfulMedicare reforms in the drug program may causesteeper cost escalations, diluting its benefits.Congress should revisit the Medicare pre-scription drug program and insist on significantmarket-based reforms, not merely an ever-expanding array of benefits.
February 9, 2005
 
February 9, 2005
 Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at the American Enterprise Institute. Jagadeesh Gokhale is a senior fellow at the Cato Institute. An earlier version of this analysis was presented in testimonybefore the House Subcommittee on Human Rights and Wellness, July 17, 2003.
Executive Summary
Cato Institute•1000 Massachusetts Avenue, N.W.• Washington, D.C. 20001•(202) 842-0200
 
Introduction
Even more than Social Security, theMedicare program is in deep trouble, facingdemographic and financial pressures thatthreaten the future viability of the program.The demand for health care benefits will risesteeply as the retiree population balloons andretirement life spans grow longer. An explosionof the population of those eligible for Medicarecoverage—78 million baby boomers—will com-mence this decade.Health care providers—physicians, hospi-tals, and others—have developed better diag-nostic and treatment methods for many dis-eases. Technological development will likely continue in the future, adding to our arsenalof effective treatments. However, new treat-ments are likely to be expensive because of high development costs. Therefore, undercurrent Medicare reimbursement rules,spending per Medicare enrollee will also con-tinue to grow rapidly, adding to spendinggrowth due to purely demographic changes.That implies growing pressure on the fed-eral budget to find dollars to continue feedingthe Medicare beast. Medicare expenditureswere 0.7 percent of gross domestic product in1970 and grew to 2.6 percent in 2003, reflect-ing rapid increases in the factors affecting thegrowth of health care costs. That trend is like-ly to continue at an accelerated pace. To meetthe rising demand for more and better quality health care and yet slow the pressure generat-ed by Medicare on the budget, Medicarereforms need to be considered and imple-mented—the sooner the better.Simply spending money does not necessar-ily lead to better health care. Despite the explo-sive growth in Medicare spending, the pro-gram still does not provide complete coverageof seniors’ health care needs. Responding toone of Medicare’s inadequacies, Congresspassed the Medicare Modernization Act in2003 to add prescription drug coverage. Thedrug coverage attempts to restructure Medi-care benefits in the face of changing healthcare needs of seniors and the disabled—who,in the future, are more likely to rely on pre-scription drugs than on traditional medicaltreatments and procedures.The drug coverage, however, adds to thefinancial challenge facing Medicare. In their2004 report, the Boards of Trustees of theFederal Hospital and Medical Insurance TrustFunds estimated that the drug benefit’s totalcost is about $16.6 trillion in present valueterms.
1
That comes on top of the already mas-sive financial shortfall in Medicare, some$45.0 trillion even without the new benefit.
2
By enacting the drug benefit, Congress hasincreased the financial burden of Medicare by more than a third. In 2006, when the fullphase-in of prescription drug coverage is com-pleted, Medicare’s projected expenditures willimmediately jump to 3.4 percent of GDP.Such rapid growth in Medicare costs isunsustainable, even for the largest economy in the world. We need prudent reforms thatwill encourage competition among healthplans, give beneficiaries realistic choices, andbegin to slow the overall growth of Medicarespending. Adding a drug benefit alone with-out thorough reforms sharply increases thecost of Medicare to future taxpayers and jeop-ardizes the financial viability of the program.In this paper, we examine the likely cost of a Medicare prescription drug benefit over thenext 10 years and in the decades to come. Wemake three points:
•
 Actual program cost for Medicare pre-scription drugs through 2015 will prob-ably exceed the $720 billion that hasbeen estimated as the cost of the benefitunder current law.
•
Constraints could be placed on spend-ing for prescription drugs, but thatapproach would likely limit the avail-ability of new and beneficial drugs. Amore comprehensive strategy is neededto limit taxpayer cost while ensuringthat beneficiaries receive appropriateservices.
•
The long-term cost of the new drug ben-efit is astronomical, and most of it willlikely fall on our children and grand-
2
The demandfor health carebenefits will risesteeply asthe retireepopulationballoons andretirement lifespans grow longer.
 
children. We provide estimates of how large those costs would be for the aver-age person under official economicassumptions and demographic projec-tions.
The Drug Benefit Will CostMore Than We Were Told
In November 2003, the CongressionalBudget Office estimated that the federal costof the Medicare drug benefit amounts to$409 billion through 2013.
3
Many observers,including us, thought that estimate couldgreatly understate actual outlays under a Medicare drug benefit. First, the new pro-gram has many novel features, requiring theCBO to make numerous assumptions abouthow the complex policies proposed in thetwo bills would actually work. The resultingestimate is highly uncertain, and there isnothing in the legislation that would holdspending to $400 billion. Second, the CBOestimate cannot account for future legisla-tion that could substantially increase pro-gram outlays (see Appendix).Estimates from the Centers for Medicareand Medicaid Services are much higher thanthose from the CBO. The president’s fiscalyear 2005 budget, released in February 2004,indicated that the MMA would cost federaltaxpayers $534 billion through 2013.
4
Thefollowing month, the Medicare trustees clar-ified that report. Medicare Part D (the drugsubsidy program) would require general rev-enue infusions of $690 billion over the nextdecade.
5
In September 2004 the president’sbudget office increased the spending esti-mate by another $42 billion, bringing thetotal (federal and state) cost to $732 billionthrough 2014. Thus, within one year of pas-sage, the estimated cost of drug coveragegrew by 86 percent.
6
The latest budget for fis-cal year 2006 escalates the spending on pre-scription drug coverage to $1.2 trillion—anincrease of $470 billion, simply from movingthe budget window ahead by 1 year! Now the10-year net cost through 2015 is estimated at$720 billion.
7
This indicates the hazard of making a long-term policy on the basis of a short-term evaluation of its cost.Clearly, the new drug subsidy law poses anunusually difficult challenge in making costestimates. It is a major departure from theway Medicare has operated in the past. Many of the features of the new benefit are unique,and the empirical evidence used to developthe cost estimate is more limited than usual.Even the $720 billion estimate may severe-ly underpredict the actual net cost of the pro-gram. The new drug plan may be less effectiveat containing costs than is assumed in mak-ing the estimates; more employers thanexpected may drop retiree drug coverageunder their plans; newer drugs may be moreexpensive than assumed; more retirees may enroll in the drug program than assumed;enrollees may demand more drug treatmentsthan assumed; physicians may begin prescrib-ing more drugs to seniors than assumed; con-solidation in the pharmaceutical industry may lead to less competition, greater monop-oly power, and higher drug prices. In all of those cases, federal spending would come insubstantially larger than estimated. Actual outlays may also be driven wellabove current estimates by future legislativechanges that cannot be included in officialcost projections.
8
When the full drug subsidy becomes effective in 2006, many seniors willfind that the benefit does not cover a sub-stantial portion of their drug costs. They arelikely to continue pressing for a more gener-ous subsidy—and policymakers are likely toaccommodate such demands. Sen. EdwardKennedy (D-MA) is already on record thatthe current drug subsidy represents a meredown payment on adequate drug coveragefor seniors.
9
Some Democrats in Congress have pro-posed a more generous program that wouldincrease outlays by $1 trillion in total over thenext decade. If policymakers fill some of thesignificant gaps in coverage in the currentsubsidy over the next few years, the drug ben-efit enacted in 2003 could conceivably costtwice its latest cost estimate of $720 billion.
3
Within one yearof passage, theestimated cost of drug coveragegrew by 86percent.
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