Department of Economics

807 Union Street

Lippman Hall
Union College
Schenectady NY 12308
518-388-6200

Economic Analysis of an Excise Tax on Prescription Opioids

Lewis Davis, Ph.D.

Professor of Economics

and

Jia Gao, Ph.D.

Assistant Professor of Economics

Feb. 26, 2019

Executive Summary

This report provides an economic analysis of Governor Andrew Cuomo’s February, 2019, proposal to tax
prescription opioids. The proposed law is likely to 1) reduce the quality and affordability of healthcare in
New York State, 2) negatively impact New York’s pharmaceutical wholesale and distribution industry,
and 3) do little to stem the opioid crisis.

The proposed tax will decrease the quality and availability of healthcare in New York State. The absence
of close therapeutic substitutes for prescription opioids suggests that consumers will pay the lion’s share
of the proposed tax. As a result, the law is expected to result in increased insurance premiums, higher
out-of-pocket drug costs, and higher taxes for NY residents. In particular, the tax will increase the cost of
healthcare associated with pain medicine, including the management of chronic pain and end-of-life care.
The proposed tax is effectively a tax on pain.

Second, the proposed tax will have a significant negative impact on the level of economic activity. By
taxing New York distributors who sell out-of-state, the proposed law will place these firms at a significant
disadvantage relative to their competitors in other states and will provide a substantial incentive for them
to relocate or cease distribution of prescription opioids altogether.

Finally, the law will do little to stem the opioid crisis in New York State. 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 illegally sourced fentanyl, with dramatically
increased overdose risks. As a result, the proposed tax may actually increase the rate of opioid-related
deaths in NY State.

2
I. Overview

The 30-day amendment to the budget proposed by Governor Andrew M. Cuomo includes a bill that
would establish a tax on the sale of prescription opioids in New York State.1 The tax would be levied at
the point of first sale within New York State and would have a two-tier structure, with a rate of 0.25 cents
per milligram of morphine equivalent (MME) for medications that cost less than $0.50 per unit and at a
rate of 1.5 cents per MME for medications that cost $0.50 or more per unit. Morphine, buprenorphine,
and methadone would be exempt. Pharmaceutical manufacturers and distributors would be liable for the
tax even if the final sale of an opioid occurred outside the state. Revenues raised by the tax would
contribute to the general fund.

II. Effects of the Law

A. Tax Incidence and Healthcare Quality

A key issue in the economic analysis of any tax is determining tax incidence, or how the burden of a tax is
shared between producers and consumers. Both theory and experience indicate how the tax is collected,
e.g. from manufacturers, wholesalers, retailers, or consumers, is largely irrelevant for determining tax
incidence. To cite a familiar example, while the gasoline tax is collected from gas stations, in practice
most of this tax is paid by consumers in the form of higher prices at the pump.

Analysis of the market for pharmaceutical opioids suggests most, if not all, of the cost of the proposed
opioid tax will be borne by consumers. This reality is explicitly recognized in Section 498(a) of the
current bill, which notes that “The economic incidence of the tax imposed by this article may be passed
on to a purchaser.” An earlier version of the proposed law, the Opioid Stewardship Act, which imposed a
surcharge on prescription opioid sales within the state and was passed as part of the 2018 NY State
Budget, prohibited passing any portion of this surcharge on to consumers. However, the United States
District Court for the Southern District of New York found that this “pass-through prohibition” violated
the Dormant Commerce Clause of the US Constitution. The current bill explicitly recognizes that taxes
affect consumer prices.

Three aspects of the market for pharmaceutical opioids are relevant for determining tax incidence. On the
demand side, the most important determinant of tax incidence is the degree of substitution between taxed
and non-taxed goods. When close substitutes are available, consumers may avoid a 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 nearly 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, and ultimately to patients; pharmacy benefit managers, to
insurance companies and HMOs, also play a role as they purchase the drug on behalf of patients.
Pharmaceutical distribution is a highly concentrated industry, with three companies accounting for over
70% of the national drug distribution market.2 These supply chain entities are unlikely to attempt to pass

1
Parts of this report draw on “Economic Analysis of the NY State Prescription Opioid Tax,” March 8, 2018, which was written
by the same authors and considers a similar bill proposed last year.
2
Fein, Adam J., 2015-16 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors, Drug Channel Institutes,
2015.

3
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 New York
State accounts for only around 8% of the national market for pharmaceuticals.3 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.4 This pricing strategy is used in many markets; familiar
examples include the use of need-based financial aid in higher education 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 could limit the share of the tax borne by
manufacturers.

Because the cost of the tax will mostly be passed on to final purchasers, 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 increase public
outlays to cover the cost of prescription opioids and significantly reduce the effect of the law on net
revenue collection.

The rate of opioid prescribing is greatest for medical treatments associated with the treatment of painful
conditions such as the management of chronic pain, physical medicine and rehabilitation, emergency
medicine, surgery, dentistry, and end-of-life and hospice care. 5 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. In short, the proposed tax is a tax on pain.

B. Effect on Pharmaceutical Distributors

The social cost of a tax is closely related to how much it changes economic behavior, generating what
economists call market distortions. In this regard, the proposed tax is expected to have significant
negative effects, arising especially from to its impact on pharmaceutical distributors in NY State. In
particular, the proposed law would tax the first sale of prescription opioids in the state, even when the
final purchaser is located outside the state. For example, if a manufacturer sold prescription opioids to a
wholesaler located within NY State, which then distribute these to hospitals and pharmacies outside the
state, the manufacturer would be liable for the excise tax.

This tax would place NY distributors at a substantial disadvantage relative to out-of-state distributors for
two reasons. First, distribution is highly competitive and subject to very small profit margins, making it
unlikely that NY distributors would recoup the cost of the tax when the sell to out-of-state customers.
Second, distribution activities are not subject to significant, state-specific locational advantages. As a

3
“Health Expenditures by State Provider, 1980-2009”, Centers for Medicare and Medicaid Services. Available at:
https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-
Reports/NationalHealthExpendData/Downloads/prov-tables.pdf .
4
Pratap Khedkar, a principal at pharmaceutical marketing consultancy ZS Associates, cited in Forbes:
https://www.forbes.com/sites/matthewherper/2012/05/10/why-astrazeneca-gives-insurers-60-discounts-on-nexiums-list-
price/#21bf227c2b25.
5
Levy, Benjamin, Leonard Paulozzi, Karin A. Mack, and Christopher M. Jones. “Trends in opioid analgesic–prescribing rates by
specialty, US, 2007–2012." American journal of preventive medicine 49, no. 3 (2015): 409-413.

4
result, the displacement of NY pharmaceutical distribution services can be expected to be especially large.
For example, in response to the Opioid Stewardship Act, a national distributor indicated it would no
longer accept prescription opioids for distribution in its NY distribution center.6

This aspect of the tax will have large social costs for NY State. Not only will the state lose valuable
wholesale activities, but to the degree that the tax forces wholesalers to move out of state or discontinue
distributing taxed medications, there will be fewer transactions for the state to tax. This outcome is
particularly perverse as there is no obvious public policy objective that is served by discouraging the
wholesale pharmaceutical distribution of opioids to out of state customers.

C. Effects on Opioid Abuse and Overdose Deaths

In principle, taxes may be used to reduce consumption of goods that society deems to be harmful, such as
alcohol and cigarettes. However, three factors suggest the proposed tax will have a limited impact on the
opioid abuse crisis and may, in fact, make it worse.7 First, public and private insurance cover over 80%
of the cost of prescription opioids nationally, blunting the impact of price changes on opioid
consumption.8 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 shared broadly
across NY residents, independent of their opioid consumption, in the form of higher state taxes and
insurance premiums, and not by opioid consumers per se, limiting its impact on consumption of
prescription opioids.

Second, to the degree that the cost of the tax results in higher out-of-pocket expenses for patients, the tax
will affect both opioid abuse and medically legitimate opioid use. In fact, 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.9 Moreover, New York ranks 49th among US states in the number of opioid prescriptions
per capita. This metric suggests relatively low rates of over-prescription 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 between prescription
opioids and their illegal counterparts. 10 Survey evidence indicates that prescription opioids are already
“far more expensive and harder to obtain” than illegal opioids.11 Moreover, the shift to illegal opioids is
associated with decreased drug quality and increased variability in drug purity and potency, which
dramatically increases the risk of fatal poisoning or overdose.12 In particular, heroin is often laced with
illegally sourced synthetic opioids, such as fentanyl, which together account for nearly 65% of opioid-

6
See US District Court Southern District of New York, Case 1:18-cv-06168-KPF, Document 56, Filed Dec. 19, 2018, page 11.
7
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 2016.
8 Zhou, Chao, Curtis S. Florence, and Deborah Dowell. "Payments for opioids shifted substantially to public and private insurers

while consumer spending declined, 1999–2012." Health Affairs 35, no. 5 (2016): 824-831.
9
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): 569-576.
10
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 1181.
11
Cicero TJ, Ellis MS, Surratt HL, Kurtz SP. 2014. The changing face of heroin use in the United States: a retrospective analysis
of the past 50 years. JAMA Psychiatry 71:821–26.
12
Miron, Jeffery A., and Jeffery Zweibel (1995), “The Economic Case Against Drug Prohibition,” Journal of Economic
Perspectives 9(4), pp. 175–192.

5
related overdose deaths nationally.13 Indeed, opioid overdose deaths associated with commonly
prescribed opioids have been essentially stable since 2010. 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 could be offset by a much more socially destructive
rise in illegal opioid abuse and overdose deaths.

III. Summary

The proposed NY State excise tax on prescription opioid

• will be borne primarily by NY State residents, in the form of higher taxes, insurance premiums,
and out-of-pocket drug costs,
• will have a significant negative effect on pharmaceutical distributors in the state, substantially
increasing the economic costs of the law,
• fails to target prescription opioid abuse, and is expected cause some residents suffering from
opioid dependence to switch to illegal opioids with a dramatically higher risk of accidental
overdose.

This report was produced at the request of the Pharmaceutical Research and Manufacturers of America
(PhRMA).

13
Centers for Disease Control, Understanding the Epidemic, Opioid Overdose Deaths. Available at:
https://www.cdc.gov/drugoverdose/epidemic/index.html.