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A regulation that

that result from imposing this $6.3 billion

ers have been required as a condition of

hidden tax on the private sector. We treat this

Medicaid coverage to provide rebates of at

is apparently ben-

cost shift as the equivalent of an excise tax

least 15.1 percent (or their "best" price offered

eficial on a small

since such costs effectively raise the pharma-

to any other purchaser, whichever is lower) to

scale might

ceutical industry's cost of doing business and

state Medicaid programs for outpatient drugs.

would have the same theoretical impact as an

Another condition, imposed in 1992, requires

become quite

excise tax, including lower output. The MEB

manufacturers to list their brand name drugs

costly on a larger

was, therefore, employed for output taxes

on the Federal Supply Schedule, thereby

(such as excise or sales taxes), which is 20.9

extending these Medicaid discounts to other

scale.

percent.35 Thus the further cost of imposing

major federal purchasers of pharmaceuticals,

including the Department of Veterans Affairs

this $6.3 billion hidden tax on the pharma-

and the Department of Defense. However, a

ceutical industry is roughly $1.3 billion. The

careful study of the impact of the Medicaid

different MEB figures applied to the benefits

Drug Rebate Program found that these

realized by the public sector and the costs

"most-favored-nation" provisions had no

borne by the private sector produces the

detectable effect on the rate of inflation for

entire $2.0 billion net benefit of these phar-

prescription drugs, implying that any savings

maceutical price regulations. These regula-

enjoyed by Medicaid and other public payers

tions, then, produce a net benefit that is whol-

effectively was being shifted to other payers,

ly due to the reduced level of economic ineffi-

leaving average prices unaffected.33 Thus, for

ciency that results from the reallocation of a

small tax burden--not a reduction in average

the most part, any benefits enjoyed by the

prices for pharmaceuticals.

public sector apparently are offset by equiva-

Moreover, it is important to recognize

lent increases in costs in the private sector.

that the federal rebates are relatively small in

However, these regulations are expected to

the overall scheme of things; $6.3 billion in

result in a net benefit to society solely due to

public savings for Medicaid, VA, and DOD

the efficiency gains--or more precisely, the

combined is less than 4 percent of the $162.4

reduced efficiency losses--that result from

billion spent on pharmaceuticals in 2002.36

financing a small share of overall pharmaceu-

tical consumption through hidden taxes on

At such small volumes, these discounts are

industry rather than income taxes. These effi-

roughly equivalent to the limited number of

ciency gains should disappear were the scope

deeply discounted seats available on an air-

of these regulations to widen.

line. Were all seats subject to such a discount,

As suggested above, the $6.3 billion bene-

the plane could not fly, as its average revenue

fit to the public sector also imposes a $6.3 bil-

would not exceed the costs of getting the

lion cost on the private sector. Yet because the

plane to its destination. In the same fashion,

gross public savings are $6.3 billion annually,

cross-national comparisons suggest that if

society saves the marginal cost of collecting

the entire U.S. market was to enjoy compara-

that $6.3 billion in taxes. Those would-be

ble discounts, that might result in a pre-

marginal costs are estimated to be 52.5 per-

dictable decline in research, development,

and innovation.37 Thus a regulation that is

cent of revenues collected. This includes

administrative costs (0.5 percent), taxpayer

apparently beneficial on a small scale might

compliance costs (12.0 percent), and the MEB

become quite costly on a larger scale.

of the input taxes (e.g., income taxes) that

likely would finance this would-be expendi-

Quality-Related Facilities Regulations

ture (40.0 percent).34 Thus the further benefit

Quality related includes hospital accredita-

tion and licensure, which includes Medicare

of not having to collect the $6.3 billion in

conditions of participation (COPs, which have

taxes is roughly $3.3 billion. However, when

many purposes, but quality is arguably the

estimating the costs of these regulations, we

central one) and state accreditation and licen-

likewise must account for the efficiency losses

9