Policy Analysis No. 556

Avoiding Medicare’s Pharmaceutical Trap

Executive Summary

The Medicare drug benefit will soon set a dangerous trap. In January 2006 the federal government is scheduled to start purchasing prescription drugs for more than 40 million seniors and disabled Americans through that new addition to the Medicare program. The enormous tax burden that will be required to fund the drug benefit will put constant pressure on politicians to limit spending. Some observers argue that the federal government should dictate the prices it pays for drugs. Though cloaked in the rhetoric of “negotiated prices,” such proposals in fact amount to price controls. Unless the new benefit is delayed or repealed, it will set the stage for Congress to enact price controls on pharmaceuticals.

Economic theory and empirical evidence show that price controls cause enormous harm. Existing federal price controls have already cost Americans an estimated 140 million life-years. Applying such controls to Medicare purchasing would eliminate approximately 40 percent of all future pharmaceutical research and development and cost another 277 million life-years.

Rather than attempt to fix drug prices, Congress should reform Medicare by converting it to a program that provides premium support for the purchase of private insurance policies offering a broad array of options, including prescription drug coverage. Washington also should pressure other nations to lift their price controls, encourage patients to be more careful drug purchasers, and reduce unnecessary regulatory costs by reforming the federal Food and Drug Administration.

In the meantime, Congress should contain the spread of pharmaceutical price controls by delaying or repealing the Medicare drug benefit before it takes effect.

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Doug Bandow is a senior fellow at the Cato Institute.