The Prescription Drug Bill: Many Steps Backward

Henry J. Aaron
Henry J. Aaron The Bruce and Virginia MacLaury Chair, Senior Fellow Emeritus - Economic Studies

November 21, 2003

Moderate Democratic members of Congress may be strongly tempted to vote for the Medicare prescription drug proposal crafted by the conference committee that reconciled the versions passed by the House and Senate in June. For one thing, they have long sought to extend Medicare’s coverage to prescription drugs, which are an increasingly important component of modern health care but whose cost can impose heavy burdens on low- and moderate-income beneficiaries. Furthermore, it is quite tempting to grab the $400 billion that a conservative president has put on the table this year for such a benefit, as it may be snatched away as lawmakers focus on mounting deficits. And the political risk from opposing passage is real: “Democrats killed the prescription drug benefit,” Republican opponents will charge. Then there’s the notion that even a seriously flawed bill, as this one certainly is, can be fixed later.

Even worse, the conference committee bill could single out Medicare for unfair benefit cuts or payroll tax increases in the future. Currently, Medicare hospital benefits (part A) are covered by a dedicated payroll tax. Revenues from this tax now exceed costs and, together with the excess collections from past years (which are deposited in the Hospital Insurance trust fund), are sufficient to cover benefits through 2026. Under current law, three-fourths of the cost of Medicare’s Supplemental Medical Insurance (SMI or part B), which covers doctors bills, durable medical equipment, and certain other expenses, are paid from general revenues and the balance by beneficiary premiums.

This financing mechanism has served the program well since its enactment thirty-eight years ago. Nonetheless, the conference committee bill would declare the whole Medicare program to be in financial crisis any time general revenues were projected to finance more than 45 percent of the total cost of the program (including the costs of the new drug benefit) for two of the next seven years. This crisis could be entirely artificial. It could by declared, even the Hospital Insurance Trust fund was still in surplus. It could be declared even part B costs are running below forecasts. Thus, even if Medicare was working as well as or better than Congress intended, the president would be required to prepare plans to cut Medicare benefits or raise payroll taxes and Congress would have to vote on those plans. No such requirement would apply to the rest of the budget where massive deficits exist and, under plausible assumptions, will grow.

The conference bill would also introduce so-called premium support system in large parts of the country. This is an approach that Robert Reischauer and I described and christened seven years ago. Under premium support, Medicare beneficiaries would receive a sum based on the average premium charged by competitive private plans for a standard package of benefits. They could apply that sum to buy traditional Medicare or any private plan. If they elected a particularly costly plan, they would have to pay the extra charges. If they chose an inexpensive plan, they could keep some or all of the savings. A danger in such a plan, which we emphasized, is the risk that private insurers could use their power to design and market their plans selectively to attract relatively healthy customers. To the extent that they successfully engaged in such “risk selection” and that its effects can not be offset by the rudimentary mechanisms available to adjust the government’s contribution for the differential risk of plan participants, a premium support structure could leave traditional Medicare with the high cost elderly and disabled. Premiums for traditional Medicare would escalate, possibly resulting in a so-called death spiral, in which the extra premiums charged by traditional Medicare became unaffordable.

There are various ways to reduce the likelihood of such an outcome, such as requiring private companies to offer only a few standard plans and creating an independent and disinterested agency vested with responsibility for disseminating information about various plans to Medicare beneficiaries and for handling enrollment. Unfortunately, the conference committee proposal provides no such safeguards, rendering the committee proposal too risky to adopt.

Passage of the conference bill would also add more than $500 billion (including interest costs from increased national debt) to the projected federal budget deficits during the next decade. Even without this added spending, cumulative deficits over the next ten years may well exceed $4 trillion. Troubling though these projections are, the fiscal outlook in the succeeding decade, when pension and health costs for retiring baby-boomers begin to escalate and the drug benefit’s costs will double, is much worse. Making a potentially lethal long-term problem significantly worse is too great a cost even to advance so important a goal as protecting Medicare beneficiaries from rising drug costs. Doing so through a poorly designed plan that leaves other equally important Medicare flaws unattended and that threatens to undermine Medicare itself would be a Faustian bargain.

This is not the last chance for a prescription drug benefit. Most members of Congress will be frantic to pass a better prescription drug bill before next year’s election. But they should do so within a framework that is better designed than this year’s monstrosity and simultaneously begins to close, not widen, an already dangerous, long-term fiscal gap.