I wrote in December about how the Congressional Budget Office (CBO) dropped a fiscal bombshell: Based in large part on changes made in Democrats’ 2022 Inflation (Reduction) Act, spending on the Part D Medicare prescription drug benefit would rise as much as $500 billion over a decade above earlier projections.
The Medicare Payment Advisory Commission (MedPAC) recently released its own analysis of the explosion in Part D spending as part of its annual report. And while recent articles of mine have questioned the policy judgment of the commission and its staff, their technical analysis merits some consideration.
What the IRA Did
The IRA included many changes regarding drug pricing in general and the structure of the Part D benefit in particular. On the latter front, the law made several major changes.
First, the IRA restructured the benefit to make insurers, as opposed to the federal government, responsible for the lion’s share of spending if a beneficiary reaches a catastrophic threshold. I noted in 2019 that “the very generous 80 percent federal reinsurance subsidy in the catastrophic phase provides a perverse incentive for insurers to have their beneficiaries reach this benefit level, at which point they can shift most of their costs to the nation’s taxpayers.” Indeed, in 2023 — the last year before the changes went into effect — over 93 percent of subsidy spending on the basic Part D benefit came via reinsurance.
At the same time, the law created a new cap on out-of-pocket spending for beneficiaries. This policy has obvious positive effects, given the unfairness of forcing seniors to pay 5 percent of their prescription drug costs ad infinitum under the prior law. But the law imposed that cap at a much lower amount ($2,000) than the prior threshold for catastrophic spending. And it also provided that, if an enhanced Part D plan lowered seniors’ cost-sharing — for instance, by charging a $25 copayment when the statutorily defined plan would have charged a $50 copay — the higher amount (i.e., $50) would count toward the $2,000 cap.
As a result, beneficiaries spent only about $1,200 to reach the $2,000 out-of-pocket threshold last year. And once beneficiaries reach that threshold, two things happen: Insurers cannot use financial incentives to affect their behavior — say, by charging a higher copayment for a brand-name drug over a generic — and beneficiaries have no incentive not to maintain, or even increase, their consumption.
Insurer Bailouts
Each of these changes — the shift away from reinsurance, capping out-of-pocket spending for beneficiaries, and lowering the threshold for the catastrophic cap substantially — would raise Part D spending individually. Collectively, they also increased uncertainty for insurers trying to understand exactly how the new regime would work.
As a result, the IRA also included a provision specifying that the “basic” (i.e., statutorily defined) benefit could rise by no more than 6 percent in the law’s first few years, with the difference being assumed by federal taxpayers in the form of higher subsidies. But even after including what amounts to an insurer bailout/transition program in the text of the IRA, the Biden administration had to go further and create a second, new (and arguably illegal) demonstration project (i.e., bailout) out of whole cloth in the summer of 2024 because premiums would have skyrocketed without it. And, of course, the announcement landed in seniors’ mailboxes weeks before the 2024 election.
Massive Federal Spending
MedPAC’s analysis shows the effect of these bailouts on federal taxpayers. Whereas the federal government, meaning taxpayers, traditionally paid just under three-quarters (74.5 percent) of Part D expenses, the statutory bailout means that this year Washington will pay 86.8 percent of Part D costs — not counting the effect of the demonstration project, which the Trump administration is thankfully phasing out this year.
In raw dollar terms, the effect is staggering:
In 2025 and 2026, we estimate the … [statutory bailout] increased Medicare’s direct-subsidy costs by about $10.5 billion and $20 billion, respectively. Separately, as noted earlier, under its Part D Premium Stabilization Demonstration, Medicare is estimated to have spent about $6 billion in 2025 and is projected to spend more than $3 billion in 2026.
That amounts to roughly $40 billion in higher spending over the first two years alone. By comparison, CBO at the time of the IRA’s passage in 2022 estimated that the redesign of the Part D benefit would cost “only” about $25 billion over a decade.
The Cost of ‘Free’ Health Care
I noted last December that the explosion in Medicare prescription drug spending, while shocking, should not be considered surprising. Artificially subsidizing something via federal taxpayers will produce more of it. It’s the latest reminder that Democrats’ “affordability” agenda, which consists largely of throwing other people’s money at problems, is proving to be anything but “for” taxpayers.
