Congressional Budget Office
Director's Blog

Four years ago, Medicare began providing outpatient prescription drug benefits for senior citizens and people with disabilities. Known as Part D, the program uses private plans to provide coverage for prescription drugs to enrollees. Those plans negotiate payment rates with pharmacies and rebates from drug manufacturers while competing for enrollees. Such competition provides incentives for plans to control their costs; one important way in which plans seek to control costs is by encouraging the use of generic drugs. A CBO study released today assesses how successful plans have been in encouraging the use of generic drugs and the potential for savings from the additional use of such drugs.

In 2007, total payments to plans and pharmacies from the Part D program and its enrollees were about $60 billion. The total number of prescriptions filled was about 1 billion, of which 65 percent were filled with generic drugs, 5 percent were filled with multiple-source brand-name drugs (brand-name drugs that are also available in generic versions), and 30 percent were filled with single-source brand-name drugs (brand-name drugs for which no chemically equivalent generic versions are available). Even though a majority of prescriptions were filled with generic drugs, their lower prices meant that those prescriptions accounted for only 25 percent of total prescription drug costs.

Potential Savings from Generic Substitution. To control their costs, plans encourage enrollees to switch from brand-name drugs to their less expensive generic equivalents, a practice known as generic substitution. CBO estimates that:

• Dispensing generic drugs rather than their brand-name counterparts reduced total prescription drug costs in 2007 by about $33 billion, meaning that total payments to plans and pharmacies from the Part D program and its enrollees would have been about $93 billion—or 55 percent higher—if no generics had been available.
• The potential for additional savings from increased generic substitution is comparatively small, totaling less than $1 billion.

Potential Savings from Therapeutic Substitution. In one form of a practice known as therapeutic substitution, plans can also encourage enrollees to switch from a brand-name drug to the generic form of a different drug that is in the same therapeutic class (that is, a drug designed to treat the same medical condition). To assess the potential for such savings, CBO examined seven therapeutic classes identified by the Medicare program as providing opportunities for such substitution. CBO finds that:

• If all of the single-source brand-name prescriptions in those seven classes had been switched to generic drugs from the same class, prescription drug costs would have been reduced by $4 billion in 2007.
• Savings from therapeutic substitution to generic drugs could have been much higher than $4 billion to the extent that other classes of drugs also would have presented options for substitution. The seven classes that CBO evaluated represented only about 15 percent of the cost of single-source brand-name drugs under Part D. However, the potential savings could have been lower than $4 billion because in many cases it would have been medically inappropriate to switch to a generic form of a therapeutically similar drug.

Policymakers would face several challenges in developing tools to achieve any additional savings from the expanded use of generic drugs—particularly in the case of therapeutic substitution. About half of Part D spending is on behalf of enrollees who have lower incomes and thus qualify for additional subsidies. Policies that used financial incentives to steer enrollees toward certain drugs might not be effective for that population because Medicare pays nearly all of their costs.

This study was prepared by Julie Somers of CBO’s Microeconomic Studies Division.
 

As awareness of global climate change has expanded over past decades, Congresses and Administrations have committed several billion dollars annually to studying climate change and reducing emissions of greenhouse gases, most notably carbon dioxide. Most of that spending is done by the Department of Energy (DOE) and by the National Aeronautics and Space Administration, although a dozen other federal agencies also participate. The effort has included funding science and technology, creating tax preferences, and assisting other countries in their attempts to curtail greenhouse-gas emissions. In a study released this afternoon, CBO examines the government’s commitment of resources to those purposes. The study presents information on current spending and analyzes recent patterns and trends in spending.

From 1998 through 2009, appropriations for agencies’ work related to climate change totaled about $99 billion (in 2009 dollars); more than a third of that sum—$35.7 billion by CBO’s estimation—was provided in the American Recovery and Reinvestment Act of 2009 (see the figure below). During that period, the nation’s commitment to climate-related technology development increased significantly, as has the forgone revenue attributable to tax preferences. Funding for climate science and international assistance, by contrast, stayed roughly constant.

Federal Climate Change Funding, by Category

(Budget authority in billions of 2009 dollars)

Growth in reported funding for climate programs occurred in three ways over the past decade. First, funding increased for some programs whose basic mission was maintained throughout the period. Second, as different Administrations reconsidered what constituted a climate change program, some programs, most notably those in DOE for the development of nuclear power, were included in the tabulation without a change in mission. Third, the focus of some programs has shifted to emphasize climate change. DOE’s program for research and development (R&D) on energy supplied from fossil fuels, for example, evolved from research on converting coal into liquid fuels to finding ways to cut emissions from coal-fired power plants.

There are several rationales for these federal activities. A leading argument in favor of federal support for climate science and technology R&D holds that because private developers of scientific and technical innovations do not capture all of the benefits from their discoveries and inventions, private investment is lower than would be justified by the magnitude of its benefit to society. A different rationale arises from the fact that the prices for fossil fuels and for carbon emission do not fully reflect environmental and social costs. Some activities in the climate change budget can be viewed as compensating for the lower energy prices. Although some or all of the conceptual justifications could apply to many types of policies, they do not indicate that any particular federal program should be undertaken.

CBO assessed the effect of technology programs for R&D, technology demonstration, energy efficiency, infrastructure investment, and tax preferences—areas in which there has been a significant recent commitment of resources. Previous analyses have shown that some programs in the climate change budget, although not all, have provided economic benefits to society that exceed the federal government’s investment.

This study was prepared by Philip Webre of CBO’s Microeconomic Studies Division.

Pharmaceutical companies’ efforts to promote prescription drugs have attracted the attention of policymakers because such activities may affect the rate at which different drugs are prescribed and consumed, the total amount spent on health care, and, ultimately, health outcomes. Yesterday CBO released a brief highlighting trends in promotional spending for prescription drugs and market characteristics that influence promotional strategies. CBO examined data on promotional strategies from 1989 to 2008 for drugs in the classes of medication that include most outpatient drugs that were produced in tablets or capsules and were among the top-selling drugs in 2003. Of the more than 2,000 drugs in CBO’s data set, 700 to 800 have some promotional spending reported in any given year.

The way that pharmaceutical manufacturers promote prescription drugs has changed significantly in the past decade. Until the late 1990s, pharmaceutical manufacturers confined their marketing efforts largely to physicians and other health care providers. In the late 1990s, the Food and Drug Administration changed its advertising guidelines and drugmakers began marketing directly to consumers—a practice known as direct-to-consumer (DTC) advertising. Since then, the manufacturers of many prescription drugs have increased their purchases of air time on television and of advertising space in newspapers and magazines.

Recognizing that both consumers and physicians take part in the decision to purchase a drug, pharmaceutical manufacturers spent at least $20.5 billion on promotional activities aimed at those groups in 2008. For a practice called detailing, which involves sales representatives meeting with physicians, nurse practitioners, and physicians’ assistants, pharmaceutical companies spent $12 billion, accounting for more than half of that promotional spending. Companies spent another $3.4 billion sponsoring professional meetings and events and about $0.4 billion placing advertisements in professional journals. Pharmaceutical manufacturers spent the rest of their promotional budgets, $4.7 billion in 2008, on DTC advertising. To place those figures in context, in 2008, promotional expenditures equaled 10.8 percent of the U.S. sales reported by the Pharmaceutical Research and Manufacturers of America, in line with most years since the early 1990s, during which time that share has remained between 10 percent and 12 percent.

Though pharmaceutical manufacturers use DTC advertising for only a small set of drugs, they spend heavily on DTC advertising for those drugs. Among the drugs in CBO’s dataset, the 10 with the highest DTC expenditures in 2008 accounted for 30 percent of expenditures for DTC advertising industry-wide. That concentration is nearly twice what was observed for detailing, where the drugs with the highest expenditures totaled 16 percent of the industry’s detailing expenditures. Drugs promoted using DTC advertising are, on average, newer to the market than drugs promoted through detailing, but the difference in the average expenditures for DTC advertising and detailing seems largely a result of the distribution of the two types of spending.

According to CBO’s analysis, when pharmaceutical manufacturers promoted drugs to consumers, they also spent more, on average, promoting those drugs to physicians. For those drugs in CBO’s dataset with reported spending on DTC advertising, their manufacturers spent an average of $40.5 million per drug in 2008 on promotional activities directed to physicians—14 times the average amount they spent when promoting drugs exclusively to physicians. That difference may indicate that manufacturers use promotional activities directed to physicians and DTC advertising to reinforce each other.

A pharmaceutical manufacturer’s decision to use DTC advertising or other types of marketing tools depends on the potential size of the market for a given prescription drug, the current competition in that market, and the amount of time that has elapsed since the drug received FDA approval. If a drug has both a large potential market and is approved to treat chronic or long-term conditions, its manufacturer may be even more likely to embrace DTC advertising. DTC advertising is less common for drugs (such as antibiotics) that address acute conditions (such as an infection)—perhaps because individuals are more likely to seek care for an acute condition without being prompted by an advertisement or because such drugs are typically prescribed only for a short time. Further, the data analyzed by CBO show that average spending per drug on DTC advertising declines as the number of competitors in the same class increases.

This issue brief was prepared by Sheila Campbell of CBO’s Microeconomic Studies Division.

In 2005, the National Flood Insurance Program (NFIP), administered by the Federal Emergency Management Agency (FEMA), experienced an unprecedented volume of claims resulting from hurricanes Katrina, Rita, and Wilma. Total payments on those claims were greater than the total for all of the program’s previous years combined and led the NFIP to borrow about $17 billion from the Treasury. The 2005 losses highlighted a number of factual and policy questions—discussed in a CBO paper released today—about the NFIP’s financial health, including the actuarial soundness of the premium rates charged on policies that are not explicitly subsidized and the cost of paying claims for properties that have suffered multiple flood losses.

As of July 31, 2009, the NFIP had 5.6 million policies, with a total insured value of $1.2 trillion and total premiums of $3.1 billion. For most of those policies, about 80 percent, FEMA charges “full-risk” premium rates, which it considers to be actuarially sound (that is, sufficient to cover the expected value of flood claims and administrative costs). About 20 percent of the premium rates are explicitly subsidized under current law; those explicit subsidies give the NFIP a built-in actuarial deficit of about $1.3 billion per year, by CBO’s estimate. Those policies mainly cover older structures in areas at high risk of flooding.

Are FEMA’s full-risk premium rates actuarially sound?

Historically, the NFIP’s full-risk premiums have been too low to cover the flood claims and administrative costs of the policies insured at those rates. Between 1978 and 2004, premiums for such policies totaled $10.2 billion in nominal dollars, while claims and expenses totaled $10.7 billion. The result was a loss of $0.5 billion over that period on policies with full-risk rates. Taking into account the large losses of 2005, income was about half of costs over the 1978-2006 period—total premiums were $12.6 billion while claims and expenses were $24.2 billion.

Previous experience does not necessarily imply that current premium rates are too low, however, because rates have risen over time and because the frequency of future catastrophic years like 2005 is highly uncertain. In part because of that uncertainty, CBO does not have enough information about the current distribution of flood risks to calculate whether the present full-risk premiums are actuarially adequate.

Further, analyzing the methods that FEMA uses to set the full-risk rates also does not provide definitive answers. Some aspects of those methods tend to contribute to an actuarial surplus—the primary one being the additional 10 percent that FEMA includes in the rates in high-risk areas (20 percent in high-risk coastal areas) as a safety margin for uncertainty. Other aspects of the agency’s rate-setting methods tend to contribute to an actuarial deficit. FEMA is not reviewing its flood maps every five years as required by law, and some older maps do not reflect significant changes in local conditions, such as coastal erosion, which can increase the probability of flooding. In addition, evidence suggests that climate change has increased the risk of flooding from rivers and perhaps also from coastal storms, making FEMA’s models of flood frequencies out of date. Those issues may warrant attention regardless of the overall adequacy of the program’s full-risk rates.

To what extent are the NFIP’s losses attributable to properties that have experienced multiple floods?

Currently insured repetitive-loss properties (RLPs)—defined by FEMA as those that have been the subject of at least two flood-claims payments of more than $1,000 apiece in any 10-year period—account for 2 percent of current policies and 3 percent of current premiums but about 12 percent of total claims since 1978. Including formerly insured RLPs, such properties accounted for almost one-quarter of claims payments since 1978. About 23,000 RLPs nationwide have been the subject of at least four claims payments while insured, and 10,000 of those have prompted six or more payments. FEMA’s approach to reducing the cost of repetitive-loss properties focuses more on measures to mitigate the worst flood risks—such as elevating, relocating, flood-proofing, or demolishing properties—than on charging higher premiums for flood insurance. More than half of the policies covering RLPs in high-risk areas have subsidized rates.

This paper was prepared by Perry Beider of CBO’s Microeconomic Studies Division.

The public and private sectors in the United States together spend over $500 billion a year on infrastructure projects, including highways and airports, water and energy utilities, dams, waste disposal sites and other environmental facilities, schools, and hospitals. The federal government makes a significant contribution to that investment through its direct expenditures and the subsidies it provides indirectly through the tax system, which are sometimes referred to as tax expenditures. Today CBO and the Joint Committee on Taxation (JCT) released a study on the importance of tax preferences, the types of tax-preferred bonds used in financing infrastructure, and the economic efficiency of such bonds.

That study concludes that the amount that the federal government forgoes through tax-exempt bond financing is greater than the associated reduction in borrowing costs for state and local governments. Some analysts have estimated the magnitude of that differential and conclude that several billion dollars each year may simply accrue to bondholders in higher income-tax brackets without providing any cost savings to borrowers.

The Importance of Tax Preferences in Financing Infrastructure

Most federal tax expenditures for infrastructure are the result of tax preferences granted for bonds that state and local governments issue to finance capital spending on infrastructure. Those tax preferences reduce borrowing costs. The amount of tax-preferred debt issued to finance new infrastructure projects undertaken by the public and private sectors totaled $1.7 trillion from 1991 to 2007. About three-quarters of those bond proceeds, or roughly $1.3 trillion, was for capital spending on infrastructure by states and localities, and the remainder was used to fund private capital investment for projects that serve a public purpose, such as schools and hospitals. That $1.3 trillion amounted to over one-half of the $2.3 trillion in capital spending on infrastructure by state and local governments (that is, net of federal grants and loan subsidies).

Tax preferences for debt are attractive to states and localities because they generally allow those governments to exercise broad discretion over the types of projects they finance and the amount of debt they issue. But unlike direct expenditures, tax expenditures—including tax preferences for state and local bonds—are not subject to the annual appropriation process that determines federal outlays for infrastructure and other discretionary programs. As a result, the cost of tax subsidies for infrastructure is not readily apparent, making the design of cost-effective tax preferences all the more important. For fiscal years 2008 to 2012, federal revenues forgone through the tax-exemot bond financing of infrastructure—both for new investments and for the financing of existing debt—are estimated to exceed $26 billion annually.

The Types of Tax-Preferred Bonds and Their Characteristics

The Internal Revenue Code provides for three forms of tax-preferred state and local bonds:

• Tax-exempt bonds pay interest to the bondholder that is not subject to federal income tax.  They are the most well established type of tax-preferred debt (tax exemption dates to the beginning of the federal income tax in 1913) and are issued to finance either the general functions of state and local governments or selected projects undertaken by the private sector. Tax-exempt bonds reduce the issuer’s borrowing costs because purchasers of such debt are willing to accept a lower rate of interest than that of taxable debt of comparable risk and maturity.
• Tax-credit bonds, by contrast, generally provide a credit against the bondholder’s overall federal income tax liability. They are much more recent in origin, and the outstanding amount of tax-credit bonds currently is minuscule in comparison with that of tax-exempt bonds.
• Direct-pay tax-credit bonds, in effect, require the federal government to make cash payments to the issuer of the bond in an amount equal to a portion of each of the interest payments the issuer makes to the bondholder. Such bonds, which were created by the American Recovery and Reinvestment Act of 2009 (ARRA, Public Law 111- 5), in part because the direct payment to the issuer represents a “deeper” subsidy to the issuer than the provision of a tax credit represents to the bondholder.

Increasing the Economic Efficiency of Tax-Preferred Bond Financing

Replacing tax-exempt interest with tax credits could, in principle, increase the efficiency of financing infrastructure with tax-preferred debt. Tax-credit bonds transfer to issuers all of the federal revenues forgone through the tax preference; in addition, the amount of the tax credit can be varied across types of infrastructure projects, thus bringing the federal revenue loss in line with the benefits expected from the investment.

Nevertheless, tax-credit bond programs have not been particularly well received by the market for a number of reasons, including the limited size and temporary nature of tax-credit bond programs and the absence of rules for stripping and selling credits. That situation is likely to change, however, as a result of the ARRA, which greatly expanded the size and range of tax-credit bond programs. As those new programs are implemented, it will be possible to gauge more accurately the practical advantages and disadvantages of tax-credit bonds.

This study was prepared by Nathan Musick of CBO’s Microeconomic Studies Division and the staff of JCT.