Critical Condition

Surprise! Waxman Is Wrong!

Dog Bites Man. Baby Cries.Water Flows Downhill. And Henry Waxman is a hard statist. The august NY Times reports today that Waxman “is on a crusade to save Medicare billions of dollars.” And just how will Waxman do that? Easy: He’ll take from the evil (John McCain’s adjective, not mine) drug producers, who have received a purported “windfall” from the new Medicare Part D program for subsidized drugs for Medicare beneficiaries.

Precisely how has Big Phrma done that? Well, there are about 6 or 7 million people eligible for both Medicaid and Medicare — “dual eligibles” in Beltwayspeak — and they were shifted from Medicaid to Medicare Part D for their drug needs when Part D was implemented. (This made the governors very happy, as some of their Medicaid costs were shifted to the feds; so much for the argument that bureaucracies can be expected to put patients’ interests first.) Medicaid “negotiates” (imposes) prices directly with the pharmaceutical firms, while price negotiations under Part D are conducted between the drug producers and the private-sector “pharmacy benefit managers” negotiating on behalf of their customers, the Part D beneficiaries. Accordingly, there is a strong case to be made that Medicaid to some extent is obtaining a free ride on the R&D investments of the drug producers, while the Part D prices are more likely to be efficient in terms of balancing lower prices for current patients with the need for prices consistent with the need of future patients for the R&D of new and improved medicines.

Not renowned for subtle thinking, Waxman simply believes that Part D should get the same prices as Medicaid, and thus that the higher prices now observed for Part D are a “windfall.” This is incorrect even apart from the issue of short-term and longer-term efficiency just noted. Most drugs are characterized by enormous R&D and fixed (“sunk”) costs, and very small production costs. Under such conditions, perhaps surprisingly, it is efficient to charge different prices to different groups of consumers, so that resources can be allocated most productively; those with higher demands pay higher prices. As a crude generalization, those with higher incomes (or wealth) have higher demands.

Which brings us back to Medicaid and Part D. The dual eligibles are older and far less likely to suffer from mental illnesses than those eligible for Medicaid alone. Accordingly, they are likely to have higher incomes, and higher prices for drugs under Part D than under Medicaid are almost certainly efficient. 

So: There is no “windfall.” Can someone explain this to Waxman? Would he understand? Would he care? Sadly, those questions answer themselves.

Benjamin Zycher is a senior fellow at the Pacific Research Institute.