How to Pay for Medicare

Policy Reports | Health

No. 384
Tuesday, May 31, 2016
by Andrew J. Rettenmaier and Thomas R. Saving

Executive Summary

Medicare, the health care program for the elderly, now provides insurance coverage for over 50 million Americans, and accounts for 20 percent of the $3 trillion spent annually on health care. Its share of the nation’s output and total health care spending has grown significantly over its first 50 years. Over the next 75 years, from 2016 to 2089, Medicare is projected to grow from 3.53 percent to 6.02 percent of gross domestic product (GDP).

Historically, per-capita health care expenditures have risen faster than per-capita GDP; this is referred to as Medicare’s excess cost growth. The difference between per-capita output and per-capita health spending has been ascribed to several factors: a smaller share of health care paid for directly by users, increasing demand for more and better care as citizens become wealthier, and technological advances that have increased the cost of and demand for procedures that improve the quality of life.

One of the goals of the Affordable Care Act and of the majority of Medicare reform proposals has been to reduce or eliminate excess cost growth as it applies to federal spending. Without significant changes in the current program, it is not realistic to think that federal Medicare spending per capita can be constrained to grow at the same rate as percapita GDP.

Estimating Lifetime Medicare Benefits after Taxes. After paying premiums, taxes on Social Security benefits and federal income taxes in support of Parts B and D, do Medicare recipients receive more benefits — measured by the value of their medical care — than they pay into the program in their lifetimes? Estimates based on the Trustees’ baseline forecast indicate that, on average:

  • For medium earning men and women born in 1950 and retiring in 2015, Medicare net benefits at retirement are equal to $77,000 and $98,000, respectively.
  • In contrast, very high earning workers pay over $200,000 more in taxes and premiums in support of Medicare than they receive in benefits over their lifetimes.

Baseline and Alternative Estimates for People Born in 1990. Workers born in 1990 will retire in 2055. For these workers, under both the baseline and alternative forecasts, lifetime taxes grow more rapidly than benefits when compared to today’s retirees, but their net benefits remain positive. However:

  • The 1990 birth cohort’s very high earners’ total taxes and premiums under the baseline forecasts
    are almost three times greater than the benefits they will receive in their lifetimes.
  • In contrast, the very high earners born in 1950 had lifetime taxes and premiums that are less than two times their benefit payments.

For these very higher earners, much of the increase in the ratio of lifetime taxes and premiums to benefits received is due to the means testing of premiums.

How Much Is Medicare Worth? Medicare’s value as a percent of average lifetime earnings (based on
the medium earning profile) has grown by birth year. If the average net value of Medicare benefits, net of
premiums, were “annuitized” as an income payment:

  • For medium earning workers born in 1930, the value of annuitized Medicare benefits would be about 27 percent of their average annual earnings.
  • For today’s retirees, they would be worth about 35 percent of average earnings.
  • For today’s new labor force entrants, Medicare’s annuity value is still 40 percent, if derived from the baseline forecast, but rises to 53 percent, if based on the alternative forecast.

Options to Reform Medicare. Reforming Medicare’s financing requires the younger population to provide funding for some part of their own retirement health care. But if seniors’ individual demand for health care continues growing at a rate faster than the ACA’s implicit spending cap of per-capita GDP growth, then retirees must gradually bear a greater share of their health care consumption. There are four broad options for Medicare reform:

Option I. Raise Beneficiary Premiums to Cover Excess Cost Growth. Reducing federal per-capita Medicare spending growth in the alternative forecast to the baseline estimates from the 2015 Trustees Report could be accomplished by raising seniors’ premiums. 

Option II. Raise Deductibles and Copays to Limit Spending to the Baseline Forecast. Retirees would then be responsible for the rising cost sharing this option requires. Means-tested contributions to Health Savings Accounts (HSAs) by the federal government could complement the reformed insurance. Option II holds promise in expanding the role of prices in the health care market.

Option III. Constrain the Federal Payment Rate by Procedure and Service. Rather than paying the CMS-determined reimbursement to each provider, Medicare would give those amounts to the participants. If the participant chose a provider whose charges were higher than the Medicare reimbursement, the participants would be responsible for the difference. As a result of the expected excess cost growth, the share of total costs borne by participants could be expected to rise over time. However, over time a real market would
emerge for health care due to seniors’ demand for lower prices.

Option IV. Premium Support Payments that Rise at the Same Rate as Per-capita GDP. Option IV would offer a significant level of both individual choice and individual payment responsibility while limiting the role of CMS in the Medicare market. In its simplest form this option provides average premium support payments that in aggregate follow the Trustees’ baseline forecast.

These proposals all are designed to bring the percapita federal cost growth of Medicare, the taxpayer burden, in line with the per-capita growth of GDP and all can incorporate retiree premium payments, deductibles, copayments and contributions that vary inversely with lifetime income.

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