Drug Patents and the Government Debt: Written So Even an Economist Can Understand

With the Republicans promising big tax cuts for their wealthy backers, we are again hearing talk about the budget deficit and national debt. Needless to say, most is pretty badly confused.

At the most basic level, insofar as there is a burden of the debt, it is the interest payments on the debt. This is the amount of money that the government has to cough up each year to pay bondholders as opposed to using for other purposes.

While the debt is high relative to GDP, interest on the debt is actually fairly low. It is currently around 0.8 percent of GDP, or roughly $160 billion a year. This is near a post-World War II low. In the 1990s, the interest peaked at more than 3.0 percent of GDP.

Many people overstate the interest burden because they ignore the money that the Federal Reserve Board refunds to the government, which is presently around $90 billion a year. The Fed is collecting a substantial portion of the interest paid by the federal government due to the fact that it holds a large amount of government bonds. It keeps some of the interest to fund its operations and then rebates the rest to the Treasury.

Incredibly, there has been literally no coverage in major news outlets of the budgetary implications of the Fed's plans to reduce its asset holdings. When the Fed sells off these assets, the interest will instead be paid out to the people who buy the bonds rather than refunded to the Treasury. The difference could come to as much as $600 billion over the next decade, roughly the amount of money at stake with Obamacare repeal, but no one seems to care.

Anyhow, let's get to patent monopolies. The government grants patent (and copyright) monopolies as a way to finance research. In effect, the government is telling the private sector that it will give corporations or individuals a monopoly, allowing them to charge prices far above the free market price, in order to give them the incentive to invest in research or do creative work.

The monopoly can be thought as being equivalent to a privately imposed tax. The impact is clearest in the case of prescription drugs where we will spend close to $450 billion this year. These drugs would almost certainly sell for less than $80 billion in a free market without patent or related protections. Drugs are almost invariably cheap to manufacture, so in nearly all cases they could be profitably sold at relatively low prices without the government imposed monopolies.

This gap between the $450 billion patent-protected prices and the $80 billion free market price can be thought of as a $370 billion annual tax that we pay to support research into prescription drugs, this comes to a bit less than 2.0 percent of GDP. If we throw in other sectors where the protection is a large part of the price, like medical equipment, software, fertilizers and pesticides, recorded music and movies, the implicit tax would almost certainly be at least twice as large.

This is not just a question of semantics and name calling. By granting these monopolies, the government is committing the public to pay much higher prices for the protected items, just the same as if it were imposing an excise tax. The difference is that the money goes to a private company rather than the government.

Now let's imagine an alternative scenario in which the government directly spent the money on the research. It could even pay the same companies to do the work, but instead of rewarding them with a patent monopoly, they will reward them with a check paid out every quarter. In this case, the cost of the research shows up directly on the government books and adds to the deficit and debt.

There is no way that it can make sense to say that we should worry about the debt the government directly accrues, but not care about the burdens that patent and copyright monopolies will be imposing on the public. But this is exactly how the Peter Peterson-Washington Post deficit hawk gang does its accounting.

That is a methodology for those who have an agenda about cutting back the size of the government, it is not a methodology that should be taken seriously in policy debates.

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