On Reforming Medicare

Policy Backgrounders | Health

No. 151
Friday, February 04, 2000
by John Hoff

The Financial Instability of Medicare

Figure I - Medicare Financing Sources

While the threat of imminent bankruptcy of the Part A trust fund drew attention in 1997, that is only a small part of the problem.

The Medicare trust funds are a government accounting device, unlike private trust funds that can invest money to pay future liabilities. The Part A trust fund merely shows the extent to which payroll taxes are available to pay for hospital and other care covered under that part. When there is no balance in that trust fund, Medicare cannot spend money for Part A services. For most of the 1990s, the Part A trust fund spent more each year than it took in, drawing down the balance of the fund. While 1998 and 1999 were better than expected, the trust fund will run out of money; it is only a question of when.

"Medicare is a pay-as-you-go program; increased future spending will require higher and higher taxes."

The Part B trust fund is even more of a fiction; it represents an estimate of the amount of general revenues needed (on top of the 25 percent paid by beneficiaries through their premiums) to cover medical expenses in the upcoming year.

The payroll taxes that fund Part A continue to contribute an increasingly smaller portion of the total tax revenues needed to sustain Medicare.

  • Part A payroll taxes accounted for 54 percent of all Medicare spending in 1997. [See Figure I.]
  • The commission estimated that by 2025 payroll taxes will fund only 21 to 25 percent of total Medicare expenditures.1 [See Figure II.]
Figure II - Percent of Medicare Spending Funded by Payroll Taxes

"Payroll taxes have been shrinking as a source of Medicare funding."

Government expenditures for Part B services are not funded by a dedicated payroll tax, nor are they limited to a predetermined amount of money. A Medicare beneficiary who enrolls in Part B pays a premium ($45.50 per month in 1999 and 2000) to cover 25 percent of Part B, and the remainder is financed by a mandatory appropriation; Congress must appropriate whatever is necessary to pay for Part B services.

In one sense, Medicare Part B does not pose the same problem that Part A does. The money is there, funded automatically. In another sense, however, this is the problem. Part B has a first and automatic call on general tax revenues with no limit as to how much can be spent. Spending decisions are made by default without consideration of other governmental needs for the money (except as expenditures are limited by the effect of specific programmatic changes in covered services).

The dedicated funding source for Part A provides a mechanism to alert Congress of the financial needs as evidenced when trust fund dollars are low. However, President Clinton's proposal to precommit money from future general tax revenues for Part A is based on the assumption that projected surpluses will materialize. Most importantly, precommitting future general revenues eliminates the current mechanisms in place that are necessary to gauge the fiscal soundness of Medicare, predetermines future budget priorities (which is impossible) and undercuts the need to make the program more efficient. In essence, it lets Medicare run out of control.

Figure III - Medicare as a Percent of the Federal Budget

The real economic issue relates not to the future exhaustion of the Part A trust fund, but to the total amount of Medicare spending and the funds necessary to sustain this overall spending.

  • When Part A costs exceed the balance in the trust fund, those costs will have to be paid, either by diverting general tax revenues to Part A, which leaves less money for other government programs, or by increasing the payroll tax.
  • The rise in Part B costs will automatically consume a larger percentage of general revenues, forcing relative cutbacks in other government programs or requiring an increase in income taxes.

"Although Medicare takes 12 percent of the federal budget today, it will take up to 38 percent in 2030."

Whether funded through payroll taxes, income taxes or some new taxes, total Medicare spending increasingly will burden the federal budget and the general economy. As Figure III shows:

  • Medicare now accounts for 12 percent of the federal budget.
  • The commission projected that this would grow to 28 to 38 percent (depending on assumptions) in 2030.

The financing problem consequently is not only a question of when the Part A trust fund will be depleted but also of the mechanism by which the total amount spent on Medicare is determined.

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