Economic Analysis of the NY State Prescription Opioid Tax

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1 Department of Economics 807 Union Street Lippman Hall Union College Schenectady NY Economic Analysis of the NY State Prescription Opioid Tax Lewis Davis, Ph.D. Professor of Economics and Jia Gao, Ph.D. Assistant Professor of Economics March, 2018

2 Executive Summary This report provides an economic analysis of the FY Executive Budget proposal to tax prescription opioids. Specifically, it addresses the likely impact of the law on 1) the quality and affordability of healthcare in New York State, 2) the opioid crises in New York State, including abuserelated fatalities and access to treatment, and 3) New York State revenues. The proposed surcharge is a tax, and taxes raise prices. While the language of the proposed law attempts to place the burden of the tax on drug manufacturers, in practice market forces determine how the burden of the tax is shared between producers and consumers. The absence of close therapeutic substitutes for prescription opioids, the relatively small share of NY State in the national drug market, and the manufacturer s ability to adjust rebates to final purchasers all suggest that insurers and patients will bear the lion s share of the tax burden. This will result in a decrease in the quality of care received by patients, with likely impacts including 1) higher insurance premiums and 2) higher out-of-pocket costs for patients. Because it fails to target opioid abuse, the proposed tax is poorly designed policy for addressing the opioid crisis. First, only around 20% of the cost of prescription opioids is borne by consumers, limiting the effect of the tax on consumption. Most of the tax will be paid by non-consuming NY residents in the form of higher insurance premiums and higher taxes to cover public health programs. Second, to the extent that the cost of the tax is passed on to consumers, it will have a high cost to society in terms of reduced access to medically appropriate use of opioids. Third, by increasing the cost of prescription opioids, the proposed tax will encourage NY residents suffering from opioid dependence to switch to cheaper illegal opioids, including heroin and fentanyl, with increased rates of accidental overdose. Finally, the Governor s revenue projection for this proposal is overstated. It fails to account for the impact of the law on the cost of providing public health insurance in NY State and, consequently, overstates the revenue gains by roughly 20%. Even disregarding this omission, the expected increase in funding for treatment is sufficient to fund medically assisted treatment for only 2% of 145,000 New York residents who suffer from opioid abuse and dependence. 2

3 I. Overview The budget proposed by Governor Andrew M. Cuomo includes a law that would establish a surcharge or tax on prescription opioids in NY State. The tax would be levied at the point of first sale within NY State at a rate of 2 cents per milligram of morphine equivalent (MME). Revenues from the tax would be placed in a newly created Opioid Prevention, Treatment and Recovery Account, which would fund opioid treatment, prevention and recovery and education efforts. According to budget documents, the tax would generate $126 million in FY2019. II. Effects of the Law A. Effects of the Tax on the Quality and Availability of Healthcare in NY State The proposed opioid surcharge is a tax, and taxes raise prices. This is precisely why NY State does not tax the retail sales of food and medicine. 1 Indeed, only one state Illinois currently taxes prescription medications. 2 NY State s historical commitment to affordable healthcare is one reason it is currently one of only eight states that also exempt over-the-counter drugs from sales taxes. 3 Taxation is a policy instrument that is generally used to increase prices and reduce consumption of the affected good or service, neither of which is desirable with regard to healthcare. A central confusion regarding the economics of taxation involves the distinction between tax administration and tax incidence. Tax administration refers to how taxes are collected, e.g. from manufacturers, wholesalers, retailers, or consumers. Tax incidence refers to how the burden of a tax is shared between producers and consumers. The manner in which the proposed surcharge is administered suggests that the State intends for producers to bear the burden of the tax. However, both theory and experience indicate that market forces determine tax incidence. The manner in which the tax is collected is largely irrelevant. To cite a familiar example, while the gasoline tax is collected from gas stations, in practice most of this tax is paid by consumers, rather than gas stations or oil companies, in the form of higher prices at the pump. In the current context, there are three aspects of the pharmaceutical opioids drug market that suggest the burden of the tax would largely be passed on to consumers in the form of higher prices. On the demand side, the most important determinant of tax incidence is the degree of substitution between taxed and nontaxed goods. When close substitutes are available, consumers may avoid the tax by shifting consumption to non-taxed goods, reducing the burden of the tax on consumers. However, the proposed opioid tax is designed to be comprehensive in its coverage in prescription opioids, which severely limits the ability of doctors and patients to substitute away from targeted medications. Limited substitution between opioids and non-opioid pain management medications will tend to increase the share of the tax paid by consumers and other end-users. Second, the structure of the US pharmaceutical supply chain is likely to insulate drug manufacturers from the effects of the tax. This supply chain has several links, with a typical drug going from the manufacturer to a distributor, to hospitals and pharmacies, to pharmacy benefit managers, to insurance companies and HMOs, who purchase the drug on behalf of patients. Pharmaceutical distribution is a highly concentrated industry, with three companies accounting for roughly 75% of the national drug distribution market. 4 1 NY State Department of Taxation and Finance, website: Sales Tax Support, website: 4 Fein, Adam J., Economic Report on Pharmaceutical Wholesalers and Specialty Distributors, Drug Channel Institutes,

4 These companies are unlikely to attempt to pass a significant share of the tax back to drug manufacturers, since they negotiate wholesale prices, the so-called wholesale acquisition cost (WAC), based on conditions in the national market, and NY State accounts for only around 8% of the national market for pharmaceuticals. 5 As a result, most of the cost of the tax is likely to be passed forward to wholesalers, pharmacies, insurers and patients. A final factor affecting the incidence of the tax is the use of manufacturer rebates. These discounts are both substantial and highly variable, averaging around 30% of a drug s list price and ranging from the single digits to over 50% for a given drug. 6 Rebates play a critical role in the pharmaceutical market by increasing the availability of drugs to customers who would not otherwise be able to afford the list price. This pricing strategy is used in many markets; familiar examples include the use of need-based financial aid in higher education and senior and student discounts for a variety of consumption goods. As a result of this pricing strategy, the net price of a drug to the final purchaser is the list price less the rebate. This point matters for understanding the economics of the proposed tax since any downward pressure on the manufacturer s price could be subsequently offset by an equivalent reduction in the manufacturer rebate. Again, this will tend to limit the share of the tax borne by manufacturers. These considerations indicate that most if not all of the cost of the proposed opioid tax will be borne by consumers and, as a result, the proposed law is likely to have a number of unintended consequences. Private insurance companies are likely to respond to higher opioid prices by 1) increasing policy premiums, and 2) passing additional costs on to consumers in the form of higher prescription copayments. State-run health insurance programs, such as NYSHIP and Medicaid, will face similar pressures from increases in the cost of pharmaceuticals, which will likely result in an increase in public outlays to cover the cost of prescription opioids and, ultimately, increased taxation to cover these outlays. The rate of opioid prescribing is greatest for medical treatments typically associated with the treatment of painful conditions such as pain medicine, physical medicine/rehabilitation, emergency medicine, surgery, and dentistry. 7 In practical terms, then, the proposed tax is a tax on cancer treatment, emergency medicine, surgical intervention, dental care, the treatment of chronic pain, and end-of-life and hospice care. B. Effects of the Tax on Prescription Opioid Abuse The proposed tax is poorly designed to address the opioid crisis. 8 Three points are especially relevant here. First, the tax does not target opioid users. According to a recent estimate, consumers pay only 18% of the total cost of opioid prescriptions, with the remaining share is paid by public and private health insurance programs. 9 This is not surprising: the primary economic purpose of health insurance is to spread the cost of healthcare between users and non-users. Thus, most of the cost of the tax will be 5 Health Expenditures by State Provider, , Centers for Medicare and Medicaid Services. Available at: Reports/NationalHealthExpendData/Downloads/prov-tables.pdf. 6 Pratap Khedkar, a principal at pharmaceutical marketing consultancy ZS Associates, cited in Forbes: 7 Levy, Benjamin, Leonard Paulozzi, Karin A. Mack, and Christopher M. Jones. Trends in opioid analgesic prescribing rates by specialty, US, " American journal of preventive medicine 49, no. 3 (2015): For best-practice policies, see Sarah Axeen. Assessing the Effectiveness of State Policies for Altering Opioid Use and Misuse Among Medicare Beneficiaries (2016). Presented at 6th Annual Conference of the American Society of Health Economists in Philadelphia, PA in Zhou, Chao, Curtis S. Florence, and Deborah Dowell. "Payments for opioids shifted substantially to public and private insurers while consumer spending declined, " Health Affairs 35, no. 5 (2016):

5 shared broadly across NY residents, as consumers of health care, in the form of higher state taxes and insurance premiums, limiting its impact on consumption of prescription opioids. Second, to the degree that the cost of the tax is passed on to consumers, the tax will affect both opioid abuse and medically legitimate opioid use. In addition, the vast majority of prescription opioids are not abused. National data indicates that among patients prescribed opioids for chronic pain, which comprise the group of patients most prone to opioid dependence, only 8-12% develop opioid addiction. 10 Moreover, rate of opioid abuse relative to use is likely to be significantly lower for New York, which ranks 49 th among US states in the number of opioid prescriptions per capita. This metric suggests relatively low rates of over-prescription and abuse within the state, and a correspondingly high cost in terms of legitimate opioid use for price-based policies designed to limit abuse. Finally, among opioid abusers, existing studies indicate a high rate of substitution prescription and illegal opioids. 11 Recent evidence indicates that 75-80% of heroin users transitioned from prescription opioids, which are far more expensive and harder to obtain. 12 The shift to illegal opioids is associated with decreased drug quality and increased variability in drug purity and potency, which increases the risk of fatal poisoning or overdose. 13 The substitution of heroin for prescription opioids is particularly troubling because heroin is often laced with illegally sourced fentanyl, a powerful synthetic opiate that is linked to unexpected overdose deaths. The available evidence suggests extreme caution in adopting policies that may reduce the availability of prescription opioids, as any gains in public health from the reduction of prescription opioid abuse will likely be offset by a much more socially destructive rise in illegal opioid abuse and overdose deaths. C. Effect of the Proposed Tax on the Availability of Treatment for Opioid Use Disorder The state estimates revenues from the proposed tax equal to $126 million for FY2019, which will be placed in a newly created account for the purpose of providing support for the provision of opioid treatment, recovery and prevention and education services. 14 However, credible news sources indicate that these funds will primarily replace existing funding, such that the net increase in funding for these purposes would only total $18 million. 15 The National Institute on Drug Abuse provides estimates for the annual cost of medically assisted treatment for OUD involving methadone, buprenorphine, and naltrexone at $6,550, $5,980, and $14,112 per patient, respectively. 16 Using the lower two treatment cost estimates, the additional revenues could fund between 2,747 and 3,010 additional patients in medically assisted treatment programs, which is just % of the 145,000 estimated individuals in NY State who suffer from opioid abuse and dependence Vowles, Kevin E., Mindy L. McEntee, Peter Siyahhan Julnes, Tessa Frohe, John P. Ney, and David N. van der Goes. Rates of opioid misuse, abuse, and addiction in chronic pain: a systematic review and data synthesis. Pain 156, no. 4 (2015): Alpert, Abby, David Powell, and Rosalie Liccardo Pacula (2016) Supply-Side Drug Policy in the Presence of Substitutes: Evidence from the Introduction of Abuse-Deterrent Opioids, Rand working paper Cicero TJ, Ellis MS, Surratt HL, Kurtz SP The changing face of heroin use in the United States: a retrospective analysis of the past 50 years. JAMA Psychiatry 71: Miron, Jeffery A., and Jeffery Zweibel (1995), The Economic Case Against Drug Prohibition, Journal of Economic Perspectives 9(4), pp FY 2019 New York State Executive Budget, Memorandum in Support, page National Institute on Drug Abuse, How Much Does Opioid treatment cost? 17 Targeting an Epidemic: Opioid Prescribing Patterns by County in New York State, December NYS Health Foundation. Link: 5

6 Moreover, the $126 million projected revenue gain may overstate the net fiscal impact of the law as it fails to account for the impact of the proposed tax on State health care spending. Nationally, state-level public health insurance programs pay ten percent of prescription opioid expenditures, and Medicaid pays an additional nine percent. 18 Using these numbers as a guideline for New York, we expect roughly ten percent of the proposed tax to be paid by NY State in the form of higher cost of pharmaceuticals for NYSHIP. The federal government reimburses states for Medicaid costs at a rate of 50%, which reduces the State s burden. Offsetting this, the opioid tax is paid prior to rebates by pharmaceutical manufacturers, which have averaged just over 50% for NY Medicaid pharmaceutical expenses in recent years. The presence of these rebates doubles the effective tax rate on Medicaid pharmaceutical spending. Taken together these numbers suggest the tax will increase pharmaceutical outlays by NY State by $24 million, which is equal to roughly 20% of the expected revenue gain. III. Summary The proposed NY State tax on the sale of prescription opioid will be paid for primarily the NY State residents, in the form of higher taxes, insurance premiums, and out of pocket costs, fails to target prescription opioid abuse, as it affects both abuse and appropriate medical use of these drugs, will cause some residents suffering from opioid dependence to switch to illegal opioids, including heroin and fentanyl, increasing the rate of opioid-related fatalities, will only increase funding for the treatment, recovery and prevention of opioid abuse by an amount sufficient to provide treatment for 2% of the opioid dependent population, and will increase spending in the state employee health plan and by state public health programs, reducing the projected revenue gains to the State by roughly twenty percent. This report was produced at the request of the Pharmaceutical Research and Manufacturers of America (PhRMA). 18 Zhou, Chao, Curtis S. Florence, and Deborah Dowell. "Payments for opioids shifted substantially to public and private insurers while consumer spending declined, " Health Affairs 35, no. 5 (2016):