Medicare faces trillions of dollars of unfunded liabilities, but legislators are constantly tempted to increase benefits and thus spending. They should resist their inner darkness as the Bush administration attempts to create a more rational reimbursement system for cancer drugs.

Although Medicare has never covered pharmaceuticals -- the benefit package passed last year won't kick in until 2006 -- it made an exception for cancer drugs administered by oncologists. The cost was $10.5 billion in 2003.

Yet rather than pay physicians a fair fee, Congress set drug reimbursements based on the industry's official Average Wholesale Price (AWP), rather like the sticker price of new automobiles. Observes Grace-Marie Turner of the Galen Institute, doctors used the resulting "spread" between cost and reimbursement "to cover Medicare's underpayments for their practice expenses."

A 1997 study by the Office of Inspector General of the Department of Human Resources figured that Medicare was paying as much as ten times actual drug costs. Occasionally the disparity
was even greater.

The AWP for the drug vancomycin ran 76 times the price to doctors. Physicians even charged for drugs, such as Lupron, used to treat prostate cancer, which they had received as free samples from manufacturers. All told, 70 percent of oncologists's Medicare revenue came from drug mark-ups.

The system unfairly penalized beneficiaries, responsible for a 20 percent copayment, as well as Uncle Sam. The system also biased treatment decisions, since price spreads varied by drug. Sometimes older, less effective medicines were more profitable than better treatments.

Medicare officials long noted the problem, but Congress, lobbied heavily by oncologists, would only make marginal cuts in pharmaceutical reimbursements.

Critics often blamed the drug companies -- state attorneys general and left-wing activists even sued some drugmakers on a variety of charges -- but the industry gained nothing from the scheme. The fault belonged to Congress.

Last year's Medicare bill amended Part B to bring reimbursements into line with costs. Medicare is supposed to use the Average Sales Price, what drugs actually sell for, including discounts and rebates. Medicare recently issued rules expected to save the government about $530 million and beneficiaries roughly $270 million.

In return, Congress doubled the average payment for administering drugs. There's also a transition bonus for 2004. The Centers for Medicare and Medicaid Services (CMS) acknowledges that overall cancer payments will fall, but indicates that it will consider future adjustments.

Few physicians defend the old system. Dr. David Johnson, head of the American Society of Clinical Oncology, says "We would agree with a premise that the way the system has operated for some years has been out of balance."

However, many oncologists nevertheless denounce the reform scheme as providing inadequate returns. Some are threatening to stop providing drugs in their offices, which would force patients to turn to hospitals. They are lobbying Congress to freeze payments.

Fixing reimbursement rates obviously isn't easy. As Grace-Marie Turner points out, "the overall problem of government setting prices -- and trying to get them right -- is endemic to a benefit-based entitlement program." Medicare has long created incentives towards overuse as a fee-for-service reimbursement system while generating the inefficiencies that naturally occur with price controls.

Getting it right, however, is critical. Frank Lichtenberg of Columbia University figures that more than half the increase in cancer survival rates over the last quarter century is due to new and improved drugs. Maintaining that progress is critical.

Thus, Congress shouldn't retreat from its reliance on sales rather than list prices. The old system never made sense. Uncle Sam should drive a stake through the heart of the beast.

At the same time, where necessary CMS should increase oncological reimbursements for administering drugs. The federal government needs to come as close as it can to a quasi-market price in a non-market environment.

In the longer-term, Congress should revamp Medicare to make it more friendly to both patients and physicians, while creating incentives for cost-saving. That means integrating the new drug benefit into Medicare's overall structure,

Moreover, Congress should transform the program from a system of defined-benefits -- for which it must set specific reimbursement rates -- to one in which a defined contribution is made to retirees for use to buy the health care plan which best meets their needs. This would get the government out of price-setting entirely.

Unfortunately, legislators have routinely proved to be irresponsible when they touch Medicare. With the budget wildly out of balance and taxpayers facing huge liabilities as the Baby Boom generation starts collecting Medicare and Social Security, Congress must learn to say "no." It should start when responding to oncologists who hope to return to last year's broken system for reimbursing cancer drugs.

Doug Bandow is a Senior Fellow at the Cato Institute.