Politicians and Donuts

An article in today's Washington Post discusses the "donut hole" in the Medicare prescription drug benefit:

The program was designed to give all participants a certain level of insurance and to protect elderly and disabled recipients with chronic or catastrophic illnesses from huge prescription expenses. To afford those two goals, Part D's designers built in an annual period during which individuals have to pay for medicines themselves.

Under a standard plan this first year, Medicare handles 75 percent of drug costs after a deductible until the bill reaches $2,250. It does not kick in again until those costs total $5,100. After that, prescriptions are almost completely paid for. The very poor can get special subsidies.

Why does the program have this odd structure? In a word, politics.

The part of the program that is defensible is the coverage for catastrophic expenditures. A program limited to this goal does not necessarily generate more benefits than costs, but an intelligent case for such an intervention exists.  The argument is that private markets undersupply insurance due to adverse selection problems.

A prescription drug program that covered only catastrophic expenditures, however, would not provide benefits to most elderly.  So the politicans designing the system, who wanted to please their constituencies, included coverage for everyone up to the "donut" level.

This component makes no economic sense.   Remember that the poor already had prescription drug coverage through Medicaid, the health insurance program for the poor.  So coverage for Medicare recipients is a transfer to the middle class, not the poor.  And reimbursing Medicare recipients for low to moderate expenditures is not fixing a market failure in insurance markets.  Insurance is valuable for large, unpredictable events not regular, moderate expenses.

So the Medicare prescription drug benefit is expensive mainly for political rather than economic reasons.  And the program illustrates perfectly why laissez-faire can be better than intervention, even when a case for intervention exists.  Actual government interventions often bear little resemblance to any policy that has a reasonable justification.

Comments

[Mark C. Foley]

A quick note: As most news stories and Dr. Miron's pithy comment state, the donut hole is defined as the level from $2250 to $5100 ("until the bill reaches $2,250" .. note "bill" is generic ... whose bill?!). However, I believe it would be more correct to say that the donut hole starts at $2250 TOTAL BILL, counting both that paid out of the customer's pocket AND by the customer's insurance plan. In other words, it is *not* correct to infer that a senior pays $5100 - $2250. They pay $5100 - OOP, where OOP < $2250 and OOP = their personal out-of-pocket.