The Senate will soon vote to decide whether Medicare should be
driven by market competition and consumer choice or heavy-handed
government regulation and broad restrictions on market access. The
immediate debate is over striking the noninterference clause that
prohibits the Secretary of Health and Human Services from
interfering with negotiations between drug manufacturers and
private plans in Medicare Part D, but the vote will have farther
reaching consequences. Providing the Secretary broad "negotiation"
authority as envisioned in the Medicare Fair Prescription Drug
Price Act of 2007 (S. 3) will not result in lower prices or program
costs, according to the Congressional Budget Office, unless
the government imposes market access restrictions and other
regulations. Thus, government negotiation would substitute
regulation and access restrictions for market competition and
consumer choice in Medicare.
The Leverage of Private
Medicare Part D is currently structured to leverage the power of
market competition between private plans to lower costs for
beneficiaries as well as taxpayers. This structure also empowers
beneficiaries to choose the coverage that best meets their needs
and preferences. Private plans have the incentive and tools to
negotiate with drug manufacturers and receive price concessions.
Their principal tool is the establishment of formularies, or
preferred drug lists, which cover some drugs and not others and
favor some drugs over others. Drug manufactures provide discounts
to plans in order to be placed on formularies and even grant larger
price concessions to obtain preferred placement, seeking an
increase in market share. Negotiating drug prices is not simply a
matter of bulk purchasing; rather, it is a function of the ability
to move market share toward some drugs and away from others. But
under a structure with competing plan designs, consumers can select
the plan that best suits their needs.
While private plans are successful in negotiating lower prices,
they have a strong incentive to offer broad drug selections to
beneficiaries, who have the freedom to choose drug coverage in a
competitive marketplace. Primarily due to its competitive private
structure, Medicare Part D has exceeded expectations. Beneficiaries
are saving an average of $1,200 a year, and premiums for 2007 are
expected to average $22 a month, more than 40 percent lower than
originally estimated. The Congressional Budget Office (CBO) has
reduced its 10-year estimate of the program's cost by $265
billion. Moreover, surveys consistently demonstrate
that more than 80 percent of beneficiaries are satisfied with the
The Leverage of Government
Although the competition in Medicare Part D is impressive and
the news keeps getting better, some in Congress are eager to
interfere with this private sector model. If government were to
meaningfully interfere with private negotiations between drug
manufacturers and private plans, it would have to be willing and
able to move market share, because bulk purchasing alone is
insufficient to secure price discounts.
As CBO Director Peter Orszag explained after the passage of H.R.
4, the House's price negotiation bill, "Just showing up and saying
'we're from the government and would like a lower price' doesn't
help very much." For the government to move market share, it
would have to impose a government formulary or pricing structure or
some other regulatory regime. Its interference would necessarily
become an exercise of government power to control prices, directly
or indirectly, and exclude from the market any drug offered at a
higher price. In turn, this would result in a one-size-fits-all
Medicare benefit that would preclude competition between private
plans and replace consumer choice with decisions handed down by
CBO Director Orszag has explained that the key factor in
determining whether government negotiations would lead to price
reductions beyond those negotiated by private firms is the leverage
that the Secretary could wield to secure price concessions from
drug manufacturers. But S. 3, like H.R. 4, would strike the
noninterference clause but explicitly prohibit the Secretary from
"requiring a particular formulary or instituting a price structure
for the reimbursement of covered Part D drugs," the very tools that
CBO and other independent experts explain are necessary to obtain
meaningful discounts beyond the current private sector model.
In Orszag's assessment of S.3, he predicts that government
negotiations would have a "negligible effect on federal spending"
because the Secretary would "lack the leverage to negotiate prices
across the broad rang of covered Part D drugs that are more
favorable than those obtained" without the "authority to establish
a formulary or other tools to reduce drug prices." In a separate
correspondence with Congress, he elaborated on this
Negotiation is likely to be effective only if it is accompanied
by some source of pressure on drug manufacturers to secure price
concessions. The authority to establish a formulary, set prices
administratively, or take other regulatory actions against firms
failing to offer price reductions could give the Secretary the
ability to obtain significant discounts in negotiations with drug
manufacturers. In the absence of such authority, the Secretary's
ability to issue credible threats or take other actions in an
effort to obtain significant discounts would be limited.
In the same letter, Orszag speculated that absent this authority
"cost savings might be possible" through use of the bully pulpit if
negotiations were limited to selected drugs. But even so, "the
impact on Medicare's overall drug spending would be limited,"
because the bully pulpit is already in wide use and would work only
in a few instances. Moreover, drug manufactures could easily
make pricing adjustments to offset any potential effects.
Hence, the cost of government interference, in terms of market
uncertainty, would likely far outpace any potential benefits that
may be had through such selective negotiations.
Contrary to the arguments of proponents of government
interference in Medicare drug pricing, the only way for the
government to outperform existing private negotiations and obtain
lower drug prices and greater program savings is to broadly deny or
restrict market access to drugs, for drug manufacturers and
Medicare beneficiaries alike, through the use of a government
formulary, a rigid pricing schedule, or the threat of arbitrary
regulation. The debate about to take place in the Senate is not
about the government's expected failure at attempting to purchase
drugs in bulk; rather, it is the prerequisite to government control
over Medicare drug pricing and, in consequence, the vast majority
of the pharmaceutical market. This is because, for government
"negotiation" to have the necessary impact, government regulations
and access restrictions would need to replace market competition
and consumer choice.
Without leverage over drug manufacturers or advantages over
private plans already conducting negotiations, government
"negotiation" alone would likely fail to deliver any savings. But
the House and Senate's negotiation proposals set a dangerous
precedent. Once government has the ability to interfere with prices
in Medicare, especially if results from government "negotiations"
are not forthcoming, the pressure to expand the government's
authority--its leverage--will grow.
The toothless government "negotiation" proposed in S. 3 merely
lays the groundwork for future government control of
pharmaceuticals in Medicare. In deciding Medicare drug policy,
policymakers should weigh the success of Medicare's structure of
private competition against the real prospect of heavy-handed
government interference. The consequences of Congress's choice will
Greg D'Angelo is Research Assistant
in the Center for Health Policy Studies at The Heritage
Congressional Budget Office, "Congressional
Budget Office Cost Estimate: S. 3 Medicare Prescription Drug Price
Negotiation Act of 2007," April 16, 2007.
Centers for Medicare and Medicaid, "Medicare
Drug Plans Strong and Growing," Press Release, January 30,
Congressional Budget Office, "Detailed
Projections for Medicare, Medicaid, and State Children's Health
Insurance Program," March 2007
Agnes Carey, "HealthBeat," Congressional Quarterly, March
Congressional Budget Office, "Congressional
Budget Office Cost Estimate, S. 3."
Congressional Budget Office, Letter to the
Honorable Ron Wyden, "Re: Issues Regarding Price Negotiation in
Medicare," April 10, 2007.