Number range CHAPTER

**The Cost of Adding a Prescription Drug Benefit to Medicare**

**Joseph R. Antos, Ph.D.**

**Wilson H. Taylor Scholar**

**in Health Care and Retirement Policy**

Number range CHAPTER**Jagadeesh Gokhale, Ph.D.**

**Visiting Scholar**

**The American Enterprise Institute**

**Testimony Before**

**Subcommittee on Human Rights and Wellness**

**Committee on Government Reform**

**U.S. House of Representatives**

**July 17, 2003**

Mr. Chairman and Members of the Committee: Thank you for inviting me to
appear before you. I am Joseph Antos, the Wilson H. Taylor Scholar in
Health Care and Retirement Policy at the American Enterprise Institute.
I am also adjunct professor in the School of Public Health at the
University of North Carolina at Chapel Hill. I have previously served as
the assistant director for health and human resources at the
Congressional Budget Office (CBO), and earlier held several research and
management positions in the Health Care Financing Administration, the
precursor to the Centers for Medicare and Medicaid Services (CMS).
Number range CHAPTERThe coauthor of this testimony is Jagadeesh Gokhale,
visiting scholar at the American Enterprise Institute and an expert in
fiscal policy. Dr. Gokhale developed the estimates of Medicare's
long-term fiscal imbalance that I will describe later. The views I
present today are my own and those of my coauthor, and do not represent
the position of the institutions with which we are associated.

The Medicare program faces unprecedented challenges. Medicare's benefit
structure is outmoded and inadequate, failing to cover outpatient
prescription drugs or to provide adequate financial protection for
millions of enrollees. Physicians, hospitals, and other providers have
developed new and better ways to diagnose, treat, and cure
diseases---causing Medicare spending per enrollee to grow rapidly. The
impending retirement of 78 million baby-boomers, beginning in just 8
years, will rapidly escalate demands on Medicare's finances.

These challenges cannot be avoided. Steps must be taken to improve and
strengthen Medicare so that it can meet the changing needs of seniors
and the disabled, now and in the future. That means the passage of a
prescription drug benefit and prudent reforms that will encourage
competition among health plans, give beneficiaries realistic choices,
and begin to slow the overall growth of Medicare costs. Adding a drug
benefit alone would sharply increase the cost of Medicare to future
taxpayers and jeopardize the financial viability of the program.

My testimony today will examine the likely cost of a Medicare
prescription drug benefit over the next ten years and in the decades to
come. I will make three points:

1.  Actual program spending for Medicare prescription drugs through 2013
    will probably exceed the \$400 billion currently projected by the
    CBO.

2.  Spending for prescription drugs could be constrained, but there are
    risks in that approach. A more comprehensive strategy is needed to
    limit taxpayer cost while assuring that beneficiaries receive
    appropriate services.

3.  The long-term cost of the new drug benefit is astronomical and will
    largely fall on our children and grandchildren.

**The Drug Benefit Will Cost More**

Proposals for a Medicare prescription drug benefit under H.R. 1 in the
House and S. 1 in the Senate would increase federal outlays by just over
\$400 billion through 2013, according to the CBO. That estimate could
greatly understate actual outlays under a Medicare drug benefit for two
reasons. First, CBO had to make numerous assumptions about how the
complex policies proposed in the two bills would actually work. The
resulting estimate is highly uncertain, and there is nothing in the
legislation that would hold spending to \$400 billion. Second, the CBO
estimate cannot account for future legislation that could substantially
increase program outlays.

The House and Senate bills posed an unusually difficult challenge to
CBO. Each proposal is a major departure from the way Medicare has
operated in the past, making it very difficult to arrive at an accurate
estimate. Since many of the features of the new benefit are unique, the
empirical evidence used to develop the cost estimate is more limited
than usual. If the new drug plans are less effective in containing costs
the CBO has assumed or if more employers drop retiree drug coverage than
expected, federal spending could be substantially greater than currently
estimated. Numerous other factors could drive federal outlays above
estimated levels, including changes in physician prescribing behavior,
unexpected increases in demand for prescription drugs by patients, and
changes in the pricing and marketing of drugs by manufacturers.

Actual outlays are likely to be driven well above the \$400 billion
level by changes in law that the CBO cannot consider in its estimates.
Even before a drug benefit can be enacted, the campaign to expand its
generosity has begun. Senator Kennedy has gone on record that the Senate
bill represents a mere down payment on adequate drug coverage.

One indication of the cost of possible expansions is the proposal by
House Democrats that offers very generous coverage for prescription
drugs. That proposal would increase outlays by \$1 trillion in total
over the next 10 years. If future policymakers fill in some of the
significant gaps in coverage under H.R. 1, the \$400 billion drug
benefit that is enacted this year could conceivably cost double that
amount by 2013.

The history of Medicare cost estimating does not leave one sanguine
about the accuracy of CBO's estimate. Actual spending has usually come
in much higher than initial projections, reflecting changes that could
not be anticipated in the behavior of patients and providers, changes in
the practice of medicine, and changes in legislation. For example, in
1965 the actuaries estimated that Hospital Insurance under Medicare
would cost about \$9 billion by 1990. Actual spending was about \$67
billion in that year.

History will almost certainly repeat itself. Congress is considering
what appears to be a \$400 billion benefit, but the real cost is likely
to be much higher.

**Medicare Drug Spending Could Be Held to \$400 Billion**

House Speaker Dennis Hastert (R-Ill.) has promised that the final
Medicare bill will have a cost-containment provision to prevent
prescription drug spending from skyrocketing. Unless considerable
flexibility and consumer choice are built into the Medicare program,
spending control measures could have unintended consequences. If poorly
designed spending limits caused beneficiaries to shift from prescription
drugs to other, less restricted forms of treatment, that could raise
overall program costs and lower health outcomes.

One approach would cap total spending for prescription drugs in each
year. Spending in excess of the cap in one year could be "recouped" the
following year by reducing the federal prescription drug subsidy. Plans
would pass that reduction to beneficiaries by raising premiums or
reducing the benefit (through increased cost-sharing requirements and
tighter drug formularies). Stuart Butler of the Heritage Foundation
suggests that cost sharing could be automatically increased for middle-
and upper-income beneficiaries, while protecting from cost increases
those with low incomes.[^1]

This general approach could be effective in reining in the government's
prescription drug costs. But the exclusive focus on prescription drugs
overlooks the broader fiscal problem facing Medicare. Even without a new
drug benefit, Medicare spending is rising at an unsustainably high rate.
The Medicare program has been growing substantially faster than the
economy since 1965. The baby boomers, who begin to turn age 65 in eight
years, will place an unprecedented new demand on Medicare.

Moreover, by singling out the new drug benefit for spending controls, we
run the risk of biasing treatment decisions, which could frustrate
attempts to slow Medicare spending without harming patient welfare.
Rather than trying to control the costs of individual health services,
as Medicare has tried unsuccessfully over the past three decades, we
should integrate prescription drugs with all other benefits. Our proper
concern should be on the overall growth in health spending.
Micromanaging the cost of individual services has proven to be both
ineffective and inefficient.

The traditional Medicare program is an uncapped entitlement to payment
for health care providers. The payment incentives foster ever-expanding
spending growth for services that, at the margin, are not worth what
they cost. A new approach, modeled after the premium support system of
the Federal Employees Health Benefits Program (FEHBP), is needed if we
are to control costs sensibly. By offering beneficiaries real choice
among health plans, we can promote competition that over time can slow
the growth of spending and improve the value of what we purchase.

H.R. 1 would introduce a new approach to competition that places the
traditional Medicare program and the private plans on a more even
footing. Beginning in 2010 in selected market areas, all plans
(including traditional Medicare) would bid against the same benchmark.
Beneficiaries would pay lower premiums if they select plans with
below-average costs. Those choosing traditional Medicare might face
higher or lower premiums, depending on whether the traditional program
is more effective in containing cost. Although it could be improved,
this provision represents a very significant step toward premium support
and fair competition among all the health plans in Medicare.

**Huge Long-Term Cost Will Be Borne By Younger Generations**

Although the political debate has focused on the \$400 billion cost to
taxpayers over the next 10 years, that ignores the fact that the
Medicare drug benefit will cost hundreds of billions more after 2013.
Both the House and Senate bills make a permanent commitment to a new
subsidy, but neither bill explicitly mentions how that subsidy will be
paid for. Instead, the proposals rely on transfers from general
funds---in other words, increasing the federal budget deficit.

Congress should have a better idea of the cost before it enacts the
permanent new drug entitlement. Federal outlays for Medicare
prescription drugs will increase sharply as the baby boomers retire and
enroll in the benefit. Since the program does not terminate, additional
federal costs will be incurred for the indefinite future.

The government's unfunded obligation for the new drug benefit proposed
in S. 1 is between \$7 [trillion]{.underline} and \$12
[trillion]{.underline} measured in today's dollars. Those figures are
based on CBO's estimate of the Senate bill. The lower estimate assumes
that the per-beneficiary growth in drug spending slows sharply starting
in 2014. The higher estimate, which is more realistic, assumes that the
dramatic slowdown in spending growth does not begin until 2041.

The \$7 trillion to \$12 trillion figure is the [increased]{.underline}
unfunded liability resulting from the new benefit. That is on top of
Medicare's existing shortfall, some \$30 trillion in today's dollars. By
comparison, Social Security is a model of fiscal prudence, with unfunded
obligations of about \$7 trillion.

Those figures do not reflect any program savings that might accrue
because of other reforms. The Senate bill does not include any
incentives for broader competition that would yield future cost savings.
As mentioned earlier, the House bill does include such incentives, and
the potential savings could be quite significant over time. Although we
could not make a direct estimate of the impact of H.R. 1\'s reform
provisions, the administration's original proposal provides some basis
for speculation. The latter proposal, which included strong incentives
for competition, would generate about \$6 trillion in unfunded
obligations. That cuts the long-term cost of the drug benefit in half.

Although the proposals do not address financing, ultimately someone will
have to pay the bill. Congress will no doubt try to reduce overall
Medicare spending in future budget deals, once the size of the financial
commitment becomes known. It may force wider-ranging cuts, putting
housing, education, transportation, and other services at risk. Or
Congress could raise taxes to prevent the burgeoning deficits from
damaging economic growth. Tax hikes appear to be the most probable
outcome, simply because once the baby boomers retire, they will
constitute a potent political force seeking to preserve and expand their
entitlement to Medicare benefits.

One possible funding approach is a new permanent tax on wages sufficient
to pay for the benefit. Suppose such a tax was imposed starting in 2004.
Today's seniors would pay little additional tax under that approach,
since they are already out of the labor force. After taxes, the average
person over the age of 56 would gain nearly \$10,000 in drug benefits
measured in today's dollars. Baby boomers would shoulder some of the
cost, but they would still come out ahead. Measured in today's dollars,
the average boomer would gain \$21,000 in new benefits, and would pay
about \$18,000 in new taxes.

The big losers are 150 million Generation-Xers and others born after
1964. They would receive about \$23,000 in benefits per person, but each
would have to pay about \$30,000 in new taxes over their lifetimes
(measured in today's dollars). Children, who obviously do not get a
vote, would pay the most.

Congress is unlikely to consider ways to pay for the new Medicare
outlays until there is a fiscal crisis brought on by rising budget
deficits. The longer Congress waits to pay its bills, the more those
costs will be shifted from older generations to younger ones. Delaying
the tax increase to 2014, for example, reduces the tax burden of boomers
by about \$11,000 per person. Their children and grandchildren would
have to pay even higher taxes as a result.

If we fail to take the first steps toward real reform, we run the risk
of upsetting the social compact that has sustained Medicare since 1965.
The beneficiary population will rise sharply as the boomers reach age
65, outstripping growth in the number of workers paying their bills.
Younger generations will eventually find that the massive shift of
resources from them to their elders has become unbearable, and political
support for the status quo will vanish to the detriment of everyone. The
unraveling of Medicare could be avoided, but only if we begin to face
the inescapable facts about the program's future.

**Conclusion**

The Medicare prescription drug benefit advancing through Congress will
cost much more, and do less good, than many legislators realize. Federal
outlays will almost certainly grow faster over the next decade than
current estimates indicate, and the added liability that will be
incurred over the long term is enormous. That money is not well spent,
as the proposals displace the good coverage that many Medicare
beneficiaries already have and extend generous subsidies even to the
wealthy. For all of that spending, Congress will hear plenty of
complaints over the coming years that the benefit is not good enough.

Medicare clearly needs to be modernized, and prescription drugs are an
essential part of that modernization. Medicare remains firmly rooted in
the insurance market of 1965. The four-year debate over a prescription
drug benefit is proof that the program as currently structured is not
responsive to the changing needs of consumers or the changing face of
medicine, and does little to foster cost-effective health care. Simply
adding a new benefit would not resolve Medicare's fundamental problems
that drive spending levels skyward.

Reforms that go beyond prescription drugs are needed if the program is
to survive the financial pressures created by the baby boomers, who will
double Medicare enrollment by 2030. The policy objective should be to
moderate the growth in health costs without also cutting the value of
what we buy. The FEHBP, which has served federal employees and retirees
well for 40 years, presents a practical model to achieve that objective
in Medicare. Congress has an opportunity in the current legislation to
adopt elements of an FEHBP-style reform and improve upon them. This
might be the last, best chance that Medicare will have to prepare for a
demanding and difficult future.

[^1]:  ^?^Stuart Butler, "The Crucial Elements of an Acceptable Medicare
    Bill," The Heritage Foundation, WebMemo #311 (July 10, 2003).