Medicare Drug Legislation
The State Fiscal Crisis
Child Tax Credit
While many low-income seniors will benefit from
the new Medicare drug benefit, several million will be left worse off. Why?
Seniors whose incomes are low enough to qualify them for Medicaid currently receive drug coverage through Medicaid. Under the new legislation, they will receive drug coverage through Medicare instead. Normally, if a benefit is covered by Medicare and Medicaid alike, people who are eligible for both programs receive the benefit through Medicare and also receive any additional assistance that Medicaid may provide, such as a lower co-payment for the covered services. However, the new legislation takes the unprecedented step of eliminating this “wrap around” Medicaid coverage for the Medicare drug benefit. As a result:
Medicaid-eligible seniors with incomes above the poverty line — currently $8,980 for an individual — will be charged higher co-payments. Currently, they receive drugs through Medicaid free of charge or pay nominal charges; in many states, they pay no more than $2 per month per prescription (and generally less than that). Under Medicare, they will pay $5 per brand-name prescription per month and $2 per generic-drug prescription. For seriously ill people who have a large number of medications, this could pose problems. (Nursing home residents will be exempt from co-payments.)
Of particular concern, the $5 and $2 co-payment charges for seniors with incomes above the poverty line will be raised each year at the same rate that drug costs increase. The Congressional Budget Office projects these costs will increase at least 10 percent per year. These low-income seniors, however, generally live on fixed incomes such as small Social Security checks that rise with the general inflation rate, or only 2 percent to 3 percent per year. Thus, drugs will take up an ever-increasing share of these seniors’ limited incomes.
Many Medicaid-eligible seniors may lose coverage for certain drugs altogether. Unlike Medicaid, which covers nearly all drugs, Medicare will cover only those drugs that the private insurance companies administering the benefit decide to cover. These companies are required to cover only two drugs in each “therapeutic class” and may have a financial incentive not to cover drugs that are particularly costly. As a result, many low-income elderly and disabled people may lose coverage for various drugs that doctors have prescribed and they now receive through Medicaid.
Medicare Agreement Would Make Substantial Numbers of Seniors and People with Disabilities Worse Off than Under Current Law...
How effective is the legislation likely to be in containing Medicare drug costs?
The legislation could have used Medicare’s enormous purchasing power to negotiate significantly lower prices for drugs (as, for example, the Department of Veterans Affairs and the Medicaid program do). Instead, the bill prohibits the federal government from playing this role. The bill also contains only a weak provision aimed at making generic drugs more widely available, and it effectively continues the current ban on the reimportation of drugs.
As a result, the federal government will pay more for drugs than would have been the case under more soundly designed legislation. In addition, since the bill itself covers less than one-fourth of seniors’ drug expenses, its failure to contain drug costs effectively also will directly affect millions of seniors and people with disabilities.
The Troubling Medicare Legislation.
What are some of the major coverage limitations of the new Medicare drug benefit?
Beneficiaries will be responsible for paying the first $250 in drug costs. Medicare will then pay 75 percent of the next $2,000 in costs. At that point ($2,250 in total costs), there is a gap in coverage: Medicare covers no additional drug costs until total costs reach $5,100, at which point Medicare begins paying 95 percent of all remaining costs. Put another way, Medicare does not begin paying 95 percent of drug costs until the beneficiary has already paid $3,600 out-of-pocket.*
The legislation also prohibits those enrolled in the Medicare drug benefit from purchasing “Medigap” coverage to fill this large coverage gap or to cover any other drug costs that the Medicare drug benefit does not cover.
Finally, as noted in question 1 above, the private plans that administer the drug benefit will be allowed to limit the prescription drugs they cover. These private plans will not be required to cover more than two drugs per “therapeutic class.” If your doctor prescribes a drug that the private plan does not cover, you must do without the drug or pay the full cost yourself. (Moreover, if you do pay the full cost of such drugs yourself, the amounts you pay do not count toward the $5,100 threshold that your drug costs must reach before coverage for 95 percent of remaining drug costs kicks in.)
* This $3,600 represents the initial $250 deductible, plus 25
percent of drug costs between $250 and $2,250, plus all costs between $2,250 and
The AARP Ads and the New Medicare Prescription Drug Law.
Will the legislation help contain the growth of Medicare costs by promoting competition between private insurers and traditional fee-for-service Medicare, as supporters claim?
The provisions of the legislation related to private insurers appear designed not so much to contain Medicare costs as to promote a goal of beginning to shift Medicare to private managed care organizations.
Currently, Medicare beneficiaries can elect to receive their benefits from
private managed care plans (primarily HMOs) rather than through traditional
fee-for-service. The federal government already pays these plans more than it
costs them to cover their Medicare clients. It does so both because the Medicare
statute requires larger payments to private managed care plans in some
geographic areas and because the Medicare beneficiaries who choose private plans
tend to be younger and healthier, and thus less costly to cover, than other
The new legislation will exacerbate these excessive payments. It provides an
additional $14 billion in federal subsidies to private managed care plans. With
these added subsidies, private plans will be reimbursed at rates that are about
25 percent higher than traditional Medicare pays to provide the same services to
the same types of beneficiaries.
These added subsidies will further tilt an already-unlevel playing field between
traditional Medicare and private plans, enabling the latter to make the array of
benefits they offer more attractive than what traditional fee-for-service
provides. As noted in question 3, for example, there is a gap in the standard
Medicare drug benefit after the first $2,250 in drug costs. Private plans will
be able to use their federal subsidies to create a more generous drug benefit
that closes part of this coverage gap.
As a result, many people who would otherwise want to remain in traditional
Medicare and retain their choice of physicians are likely to switch to private
plans to obtain these more-adequate benefits. Over time, this could pose a
significant threat to the survival of traditional fee-for-service Medicare.
In short, while the idea of introducing more competition into Medicare through
the expanded use of private plans has been promoted as a “reform” that can
restrain rising Medicare costs, the reality is that the legislation increases
Medicare costs by overpaying private plans in order to induce more beneficiaries
to enroll in them.
The Troubling Medicare Legislation.
(a) The legislation makes tax-free medical savings accounts, which now exist
only in a limited demonstration project, universally available. What are the
implications of these accounts for federal tax policy and for the federal
These accounts, called Health Savings Accounts, represent an unprecedented
and highly lucrative type of tax shelter. Not only are deposits to the accounts
tax deductible, but earnings compound on a tax-free basis and withdrawals are
tax free if used for medical costs. In contrast, all existing tax-advantaged
savings or retirement accounts provide a tax break when funds are deposited or
when they are withdrawn, but not both.
If a precedent of providing both “front end” and “back end” tax breaks is
established, the political pressure to do the same for other types of savings
and retirement accounts could become irresistible. A proliferation of tax-free
accounts of this type could send federal deficits to much higher levels.
Health Savings Accounts in Final Medicare Conference Agreement Pose Threats Both to Long-Term Fiscal Policy and to the Employer-Based Health Insurance System.
(b) Which income group will benefit the most from the tax advantages provided by
the new accounts?
High-income households will be the greatest beneficiaries of Health Savings
Accounts. High-income households will be more likely than lower-income
households to be able to afford to contribute to these accounts in the first
place. Furthermore, they will receive much larger tax breaks from the accounts
because they are in higher tax brackets.
For example, someone who pays taxes at the top income tax rate of 35 percent
gets an immediate tax break of about 35 cents for each dollar he or she places
in such an account. Someone who pays taxes at a 10 or 15 percent tax rate gets
an immediate tax break of only 10 or 15 cents on each dollar invested.
Similarly, high-income households will gain much more than lower-income
households from the fact that earnings in the accounts are never taxed and funds
can be withdrawn tax free.
It also should be noted that unlike IRAs, Health Savings Accounts have no upper
income limit on who may make tax-deductible contributions to the accounts.
(c) What are the implications of the new Health Savings Accounts for
employer-sponsored health coverage?
The Health Savings Accounts are likely to make comprehensive
employer-sponsored coverage much more costly by making the “pool” of workers in
these plans more expensive to cover.
The accounts will only be available to people who have high-deductible health
insurance policies ($1,000 for an individual, $2,000 for a family). Persons with
traditional, employer-sponsored comprehensive health coverage will have to give
up that coverage in order to obtain the substantial tax advantages the accounts
Healthy, affluent workers will have a strong incentive to opt out of
comprehensive health plans in favor of the new accounts: they will receive a
large tax break, and they will not be much affected by switching to a
high-deductible policy since they generally use fewer health services. If large
numbers of such workers opt out of comprehensive plans, the pool of people left
in comprehensive plans will become older and sicker, on average — and thus more
expensive to insure.
That would cause premiums for comprehensive insurance to rise significantly,
which in turn would drive still more of the healthier workers out of the
comprehensive plans, causing further premium increases.
According to studies conducted in the mid-1990s by RAND, the Urban Institute,
and the American Academy of Actuaries, premiums for comprehensive,
employer-based coverage could more than double if this type of savings account
becomes widespread. The number of Americans who are uninsured or underinsured
would likely increase as more employers and employees alike dropped out of
comprehensive coverage because they could no longer afford it.
Health Savings Accounts in Final Medicare Conference Agreement Pose Threats Both to Long-Term Fiscal Policy and to the Employer-Based Health Insurance System.
Also see the Center's Issue in Depth Series on
Key Issues in Medicare Prescription Drug Legislation.
why did the federal program for the long-term unemployed expire?
The Temporary Extended
Unemployment Compensation (TEUC) program, which provides additional weeks of
unemployment benefits to workers who run out of regular, state-funded
unemployment benefits before they can find a job, began phasing out on December 21, 2003 and ended altogether at the close of March, 2004.
TEUC was created as part of the
March 2002 economic stimulus legislation. (Congress has created a temporary
program like TEUC in every recent recession.) The program was subsequently
extended twice before it began phasing out in December.
In February 2004, majorities in
both the House and the Senate voted to resume federal unemployment benefits.
However, Republican leaders in Congress have prevented legislation from moving
forward. The White House has not taken a public position on whether federal
benefits should be resumed.
The Mechanics and Immediate Implications of the December 21
Cut-off in the Temporary Extended Unemployment Compensation Program.
How is the
expiration of the program affecting unemployed workers?
Workers who exhaust their regular state unemployment benefits after December 20
receive no TEUC benefits. About 1.15 million people fell into this category as
of the end of March. Some 30,000 of these workers qualified for additional aid
under the federal/state Extended Benefits program; the remaining 1.12 million
workers received no additional federal aid.
More Than One Million Of The Unemployed Have Now Been Denied Aid Due To End Of
labor-market conditions justify restarting the program?
The total number of jobs in the
economy has grown in recent months, which indicates that the labor market has
started to improve. However, job growth has been extraordinarily slow in this
recovery, and there are still 2.4 million fewer jobs in the economy than there
were before the start of the downturn.
Moreover, record numbers of workers are exhausting their regular, state-funded
unemployment benefits and not receiving federal unemployment assistance.
It also is worth noting that
Congress extended the temporary federal unemployment benefits program
established during the last downturn (in the early 1990s) several times. That
program was not allowed to phase out until employment had risen for 22 of the
previous 23 months and exceeded pre-recession levels.
Need Hits Record Level For the Unemployed.
it cost to restart the TEUC program?
The TEUC program costs a little less than $1 billion per month. The
Federal Unemployment Insurance Trust Fund, which finances the program, currently
contains about $15 billion. Thus, TEUC could be extended for several
months without endangering the trust fund. It should be noted that one of
the purposes of the trust fund is to provide federal unemployment assistance
during periods of labor market weakness.
State "Reed Act" Funds Are Not A Viable Or Desirable Substitute For Federal
wouldn’t extending the program encourage people not to look for work?
It has been argued that
unemployment benefits discourage jobless workers from seeking employment, since
they can rely on their unemployment check instead of a paycheck. However,
unemployment checks replace only 38 percent of a worker’s former earnings on
average, and the average weekly unemployment check is only $258. (Both of these
figures vary widely from state to state and from worker to worker.)
Further, unemployment benefits are unlikely to act as a significant work
disincentive when the labor market is weak, as it continues to be.
Recent unemployment data bolster
these conclusions. If the existence of the TEUC program had been the main
reason the unemployed were not finding jobs, the number of workers exhausting
their regular unemployment benefits should not have been exceptionally large in
January and February 2004, since TEUC was no longer open to these workers. In
fact, a record number of workers ran out of regular unemployment benefits in
January and February.
Than One Million Of The Unemployed Have Now Been Denied Aid Due To End Of
Also see the Center's Special Report Series on
- How big were state budget deficits this year?
States closed an estimated $78 billion in budget deficits in fiscal year 2004,
which began July 1 in most states. This came on top of large deficits that were
addressed in fiscal years 2002 and 2003. The National Conference of State
Legislatures estimates that over the last three years, states have had to close
a cumulative budget gap approaching $200 billion.
Moreover, some 21 states already have identified shortfalls for fiscal year 2005
totaling about $40 billion to $41 billion. The total could rise to $50 billion
or more as more states issue estimates over the coming weeks and months.
Projected State Budget Deficits
for Fiscal Year 2005 Continue to Threaten Public Services.
- What kinds of tax increases are states enacting in response to the fiscal crisis?
About two-thirds of the revenue raised through tax increases has come through hikes in regressive taxes such as sales and excise taxes, which consume a larger share of the income of poorer households than wealthier ones. (Income taxes, in contrast, are progressive, meaning that they consumer a larger share of the income of wealthier households than poorer ones.) Since the beginning of the fiscal crisis in 2001, states have raised sales taxes by close to $5 billion and excise taxes (for items such as cigarettes, gasoline, and alcohol) by a similar amount, compared to $2.9 billion in new personal income taxes and $3.1 billion in corporate taxes and related business taxes.
Many Governors Are Proposing Tax Increases and Other Revenue Measures.
- How do the tax increases states enacted this year compare with the tax cuts they enacted during the 1990s?
The tax cuts states enacted in the mid- and late 1990s now cost states about $40 billion per year. The tax increases enacted for fiscal years 2003 and 2004 fall well short of that amount, totaling about $18.4 billion. They also fall well short of closing states' budget gaps.
State Tax Cuts of the 1990s, the Current Revenue Crisis, and Implications for Social Services.
- How are recent changes in federal taxes affecting state revenues?
Because of the linkages between state and federal tax codes, cuts in federal taxes often reduce state revenues. For example, the phaseout of the federal estate tax in the 2001 tax legislation had the potential to cost states up to $23 billion in revenue between 2003 and 2007.
Similarly, the tax cut President Bush signed in May 2003 could reduce state revenue by some $3 billion over the next two state fiscal years and by $16 billion or more over the next ten years if its provisions are extended through that period. Most of this revenue loss stems from tax breaks for companies that purchase new equipment. See Federal Tax Changes Likely to Cost States Billions of Dollars in Coming Years.
In many cases, states can protect themselves against the loss of revenue from a federal tax cut by "decoupling" the relevant part of their tax code from the federal code, and a number of states have done so. For example, 19 states (including the District of Columbia) are decoupled from the effects of the estate tax phaseout; this has saved about a third of the potential $23 billion revenue loss from the phaseout of the federal tax.
Why States Should Act Now to Preserve Their Estate and Inheritance Taxes.
Also see the Center's three Special Report Series on the state fiscal crisis:
- What is the background of the controversy over the Child Tax Credit?
The tax cut enacted in 2001 expanded, over a period of several years, two pieces of the Child Tax Credit: one primarily for middle-income families, the other for low-income families. When the Administration proposed a new package of tax cuts in early 2003, it called for accelerating the increase for middle-income families but not the increase for low-income families. (The Administration's package as a whole would speed up most of the major 2001 tax cuts for middle- and especially higher-income families, but neither of the 2001 tax cuts aimed at low-income working families.) The Senate included in its tax bill a provision that would have accelerated the child credit increase for low-income families, but this provision was dropped in conference negotiations and thus wasn't part of the tax bill President Bush signed May 28.
- What group of people would have benefited from the low-income Child Tax Credit provision that was dropped from the final bill? Is this the same group of people who pay federal income taxes yet won't receive any tax cut at all from the legislation?
The low-income child credit provision, which would accelerate the increase in the child tax credit contained in the 2001 tax-cut law, would have benefited 6.5 million families (containing 11.9 million children) with incomes between roughly $10,000 and $25,000. The recent tax legislation accelerated the increase in the child credit for families with higher incomes, but not for these 6.5 million low-income working families.
The group of people who pay federal income taxes yet will receive no tax cut from the legislation is entirely separate. There are 8.1 million such people, most of whom are low-income single individuals and moderate-income single parents whose children are over age 16.
The reason there is no overlap between the 6.5 million low-income working families who would have benefited from the child credit provision and the 8.1 million taxpayers who will receive no tax cut is that the low-income child credit provision applies only to families who owe no federal income tax.
How the New Tax Law Alters the Child Tax Credit and How Low-Income Families Are Affected, and
Tax Cut Law Leaves Out 8 Million Filers Who Pay Taxes.
- Could the low-income child credit provision have been included in the final tax bill without exceeding Congress's $350 billion limit for the legislation?
The $3.5 billion cost of the provision amounts to one percent of the official $350 billion cost of the bill as a whole. Any one of several possible minor changes could have been made in the bill to make room for the provision:
- The bill's cut in capital gains and dividend taxes could have been made slightly smaller. (The child credit provision equals only 2.3 percent of the official cost of the capital gains/dividend tax cut.)
- The reduction in the top income tax rate could have been implemented more slowly so that filers with incomes of $1 million or more received a tax cut in 2003 of $88,000, rather than the $93,500 they will receive under the final bill.
- The Senate version of the tax bill contained $25 billion in provisions to reduce abusive corporate tax shelters. All of these provisions were dropped from the final bill; retaining a small number of them would have yielded enough revenue to pay for the low-income child credit provision.
Was There Enough Room in the Tax Bill for the Low-Income Child Provision?
Updated April 6, 2004