January 25, 2007 | WebMemo on Medicare
When Medicare was enacted in 1965, Congress statutorily prohibited government interference in the practice of medicine. That prohibition has largely been ignored in practice, and today Medicare doctors endure a complex and cumbersome administrative pricing system for the more than 7,000 physician services that beneficiaries receive. This system fails to reduce costs, limits access to medical care, threatens patient choice, and ignores value. Imposing this same model on the Medicare prescription drug benefit by instituting government price "negotiation" would lead to similar consequences.
In the Medicare Modernization Act of 2003, Congress stipulated that government would not interfere with private sector price negotiations for drugs. Recently, the House of Representatives passed legislation to overturn this ban on government interference, and the Senate is considering similar action.
The House's action is puzzling in view of the drug cost reductions already achieved through private negotiation. Secretary Michael Leavitt of the Department of Health and Human Services (HHS) has voiced serious doubts that his department could negotiate better prices than providers and consumers in the competitive marketplace. Secretary Leavitt's doubts are well founded. Medicare beneficiaries with common chronic conditions (whose prescription drug use is highest) enrolled in Medicare prescription drug plans (PDPs) are seeing significant savings in their prescription drug costs. Furthermore, the nonpartisan Congressional Budget Office (CBO) doubts that federal price negotiation would lead to reduced spending or significant savings.
Under the House bill, the Secretary of HHS does not have the power to really "negotiate" drug prices in the normal sense because his use of drug formularies would be prohibited. That means that the only viable way for the government to reduce drug spending would be similar to how it controls physician spending today: fix and administer prices.  Given the troubled history of administrative pricing in the Medicare physician payment system, it is stunning that Members of Congress would want to import this process into the Medicare drug benefit program.
The Lessons of Medicare Physician Payment
With the Balanced Budget Act of 1997, Congress introduced the sustainable growth rate mechanism (SGR) that currently governs payment to physicians in the Medicare program. SGR ties annual Medicare physician payment updates to changes in the national gross domestic product (GDP). Administrative pricing has proven to be a flawed system. Specifically, it:
Administrative Pricing in the Drug Benefit Program
If the government administers drug pricing, problems analogous to the mess in the Medicare physician payment system will arise, including:
Private negotiation and competition in the Medicare drug program has thus far achieved significant savings for America's seniors. Recently enacted House legislation (H.R. 4), however, would require the Secretary of HHS to "negotiate" drug prices for Part D Medicare beneficiaries, overturning the prohibition on government interference in private negotiation. Since the Secretary could not use a formulary, under the House bill, the conventional tool for negotiation would be denied to him, and thus a system of administrative pricing or price controls would be his only option left to achieve further cost reduction.
As senators weigh the merits of such an approach, they should keep in mind that the Medicare physician payment system-a combination of administrative pricing and price controls-is a mess. It should serve as a warning. Administrative pricing for more than 7,000 physicians' services has failed to reduce Medicare spending, lacks the proper incentives to promote value, and threatens personal choice and access to quality health care for America's seniors. The maladies of this physician payment system should not be allowed to infect seniors' access to drugs.
John S. O'Shea, M.D., MPA, is Health Policy Fellow in the Center for Health Policy Studies at The Heritage Foundation.
 For a full discussion of Medicare physician payment, see John S. O'Shea, "The Urgent Need to Fix Medicare's Physician Payment System" Heritage Foundation Backgrounder No. 1986, December 5, 2006, at www.heritage.org/Research/HealthCare/bg1986.cfm.
 Mike Leavitt, "Medicare and the Market: Government shouldn't be negotiating prescription prices," The Washington Post, January 11, 2007, p. A-25.
 Centers for Medicare and Medicaid Services, "Medicare Drug Coverage Provides Significant Price Discounts and Savings- Updated Full Report," September 20, 2006, at www.cms.hhs.gov/apps/media/press/release.asp?Counter=1967.
Letter from Donald B. Marron, Acting Director of the Congressional Budget Office, to Rep. John Dingell (D-MI), Chairman of the Committee on Energy and Commerce, U.S. House of Representatives, January 10, 2007, p.1.
 For a discussion of the limits of drug negotiations, see Greg D'Angelo and Robert E. Moffit, Ph.D., "H.R. 4: A Confusing and Contradictory Prescription for Medicare Drugs," Heritage Foundation WebMemo No. 1306, January 12, 2007, at www.heritage.org/Research/HealthCare/wm1306.cfm.
 Donald B. Marron, "Medicare's Physician Payment Rates and the Sustainable Growth Rate," Congressional Budget Office Testimony before the Subcommittee on Health Committee on Energy and Commerce, U.S. House of Representatives, July 25, 2006, p. 3, at www.cbo.gov/ftpdocs/74xx/doc7425/07-25-SGR.pdf.
 American Medical Association, "2006 AMA Member Connect Physician Survey: Physicians' Reactions to the Projected Medicare Payment Cuts," at www.ama-assn.org/ama1/x-ama/upload/mm/468/medicarepaymentmc.pdf (November 20, 2006).