The Incredible Lowering of the Medicare Drug Benefit Baseline

Published February 15, 2013

This week, President Obama took credit for the slowdown in health care cost inflation, proclaiming in his State of the Union address that “[a]lready, the Affordable Care Act is helping to slow the growth of health care costs.”

This is a real stretch, to say the least. For starters, as others have noted, the slowdown in health spending predates the enactment of Obamacare–March 2010–by several years. According to the National Health Expenditure accounts, per-capita personal health spending rose 7.2 percent in 2003, but then fell steadily in the following years. By 2008, per-capita spending growth was just 4.0 percent–two years before Obamacare was signed into law. A far more plausible explanation for the slowdown is that it coincided with the spread of consumer-directed health care–spurred on by the liberalization of Health Savings Accounts (HSAs) in the 2003 Medicare prescription drug law. From 2005 to 2012, HSA enrollment rose from 1 million to more than 13.5 million people.

It is also widely understood that the sharp drop in income and wealth that occurred during the 2007 to 2009 recession depressed health spending substantially in those years and the years that followed.

So, no, Obamacare isn’t cutting costs. Indeed, every credible piece of analysis indicates that the law is pushing costs in the wrong direction: up. For employers and individuals, the law is requiring them to pay higher premiums for insurance that is more expansive than what they voluntarily purchase today. Moreover, millions of enrollees in the individual insurance market are facing the prospect of 20 to 30 percent premium increases next year when Obamacare’s insurance rules fully kick into gear.

The talk of the supposed cost-restraining features of Obamacare has also distracted attention away from an actual trend in health spending that is worth noting. Last week, the Congressional Budget Office (CBO) released its annual updated projections for the entire federal budget, including health programs. And, in those projections, CBO dropped the projected ten-year cost for Medicare quite substantially–by $137 billion. The reason? Buried deep in the CBO report there’s this explanation: “the largest downward revision in the current baseline is for spending for Medicare’s Part D (prescription drugs).”

That’s an understatement. Of the $137 billion drop in the Medicare baseline, $104 billion–or 75 percent–was due to the drop in expected Medicare drug benefit spending. This is truly remarkable because CBO had already lowered the drug benefit baseline several times in the preceding years. With this latest revision, CBO’s part D projections bear almost no resemblance to what was expected to occur when the law was enacted in 2003. Consider:

  • Actual Medicare drug spending in 2012 was just $55 billion. In 2007, drug spending was $49 billion. So the average annual growth rate of the program has been just 1.9 percent from 2007 (the first full fiscal year of the program’s operation) to 2012.
  • In 2007, CBO projected 2012 spending to be $89 billion, and the $55 billion of actual spending includes added spending from Obamacare. When that is removed, actual 2012 spending was a full 40 percent below what was projected in 2007.
  • Over the last two years, CBO has dropped the expected cost of the drug benefit over the eight-year period from 2013 to 2020 by nearly $250 billion, or 33 percent.
  • CBO has lowered the Medicare drug benefit baseline in five out of the last six annual revisions.

And this is occurring in a program run entirely through private insurance plans competing with each other for enrollment among Medicare beneficiaries. Naysayers continue to argue that this cost experience has nothing to do with consumer pressure–it’s all supposedly due to the transition from branded drugs to generics. But what’s driving seniors out of branded drugs? It’s the design of the drug benefit being offered by the private plans. Those plans are offering seniors low-premium products with strong incentives for generic substitution, and–surprise, surprise–seniors are readily taking them up on the offer. It turns out that Medicare beneficiaries are just as eager to save on their monthly insurance premiums as everyone else in America. It’s just that this is the first time in the history of Medicare that they have been given the opportunity to cut their expenses by signing up with lower-cost options.

What’s perhaps most remarkable of all about this story is what CBO is projecting for the future. Yes, the agency has lowered its drug benefit baseline again, in response to actual experience. But that doesn’t mean CBO is ready to believe the drug benefit’s design will keep costs under control in the future. Despite repeatedly having to revise downward its estimate of the drug benefit’s costs since enactment in 2003, CBO still believes that–somehow, some way–rapid cost escalation is just around the corner. Over the period 2013 to 2023, CBO’s latest forecasts shows an average annual growth rate for the program of 10.2 percent–a full eight percentage points above its actual performance to date.

The fundamental problem in American health care is that it operates outside the discipline of a functioning marketplace. A notable exception is the Medicare drug benefit. In that program, private plans can garner more market share by offering low-cost options. And seniors who sign up with low-cost plans can reduce their own out-of-pocket expenses. This design has given all sides strong incentives to root out unnecessary spending. The positive results speak for themselves.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center, a visiting fellow at the American Enterprise Institute, and project director of Originally posted at e21 Economic Policies for the 21st Century.