Commentary––

Prescription Drugs, Medicare, And Conventional Wisdom

By Raymond J. Keating

Conventional wisdom tells us that since health care has changed so dramatically since Medicare was set up in 1965, then Medicare must change as well. Specifically, the assertion is that prescription drugs played less of a role in treating patients some 40 years ago, so therefore Medicare must be adjusted and expanded to cover prescription drugs today.

Both political parties have accepted this as the basis for pushing ahead with the Medicare prescription drug debate. But has anybody checked to see if the conventional wisdom is actually true? Interestingly, the numbers on personal health care spending seem to tell a different story.

According to data from the US Department of Health and Human Services, in 1960, spending on prescription drugs accounted for 11.5 percent of total personal health care expenditures, which was actually higher than in 2000 (most recent data), when prescription drug spending accounted for 10.8 percent. In between, the prescription drug share of personal health care spending had declined to 8.7 percent by 1970, 5.6 percent in 1980, and up slightly to 6.6 percent in 1990.

Why the general decline from 1960 to 1990, and then the big jump up by 2000? Spending was accelerating at much faster rates in other health care areas. The reason for this was that the third-party-payer share of expenditures in these other areas of health care skyrocketed while private out-of-pocket payments fell. When third party payments rise and out-of-pocket spending drops, utilization increases, and both the providers and consumers have few incentives to be concerned about costs. Hence, costs rise more rapidly than otherwise would be the case.

In terms of funding for hospital expenditures, in 1960, out-of-pocket payments registered 20.8 percent, private insurance covered 35.8 percent, and government 42.2 percent. By 2000, while the private insurance share declined slightly to 32.5 percent, out-of-pocket payments plummeted to 3.2 percent, while government’s share jumped to 59 percent.

As for nursing home spending, 77.9 percent came from out-of-pocket payments, 0 percent from private insurance, and 15.7 percent from the government in 1960. The shift was dramatic by 2000, as out-of-pocket dropped to 27 percent, private insurance inched up to 8.1 percent, and government leaped to 60.6 percent.

Meanwhile, funding for physician services shifted as well. In 1960, out-of-pocket payments accounted for 61.6 percent of spending, private insurance covered 29.8 percent, and government only 7.2 percent. By 2000, out-of-pocket funding was down to 11.6 percent, private insurance had climbed to 47.7 percent, and government was up to 33.2 percent.

In terms of total personal health care spending (including on prescription drugs), out-of-pocket payments accounted for 55.2 percent, with private insurance and government each registering 21.4 percent in 1960. As of 2000, out-of-pocket payments were down to 17.2 percent, private insurance was at 34.6 percent, and government had more than doubled to 43.3 percent.

But what about the prescription drug trend? Interestingly, in 1960, out-of-pocket payments financed 96 percent of spending on prescription drugs, with private insurance coming in at 1.3 percent and government at 2.7 percent. While the subsequent trend was away from out-of-pocket dollars, as late as 1990, out-of-pocket funding still covered a substantial share –– 59.1 percent –– of prescription drug spending, with private insurance registering 24.4 percent and government 16 percent.

The change from 1990 to 2000 in terms of how prescription drugs were paid for, though, was breathtaking. In just ten years, out-of pocket payments fell by almost half to 32 percent. Private insurance coverage almost doubled to 46.2 percent, while government increased to 21.8 percent. With such a dramatic rise in third-party payments, it was completely predictable that costs would rise, and prescription drug spending as a share of total personal health care expenditures almost doubled.

If politicians succeed in their efforts to have government pick up a bigger part of the tab, costs will increase even more rapidly. Taxpayers will take the first big hit –– both individuals and businesses –– and then government will turn to rationing and price controls.

Price controls sound nice to some people, but their effects are quite dangerous. Quite simply, price controls mean that pharmaceutical companies have reduced incentives and resources to undertake the very costly and risky endeavors of researching and developing new and improved drugs. That, of course, translates into fewer illnesses treated and fewer lives saved.

Before passing any legislation to deal with prescription drug coverage, our elected officials need to get the facts straight and understand economic reality. This is far too important for government to be dealing with the issue in a careless, uninformed manner. It literally is a matter of life and death.

(Raymond J. Keating serves as chief economist for the Small Business Survival Committee.)