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NATIONAL CENTER FOR POLICY ANALYSIS
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| Reforming Medicare |
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"By 2030, Social Security and Medicare deficits will require 37 percent of federal income taxes." |
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In a few years, Medicare and Social Security will significantly burden the federal budget as medical costs escalate and as baby boomers retire. Currently, Medicare requires general revenue transfers equal to 7.0 percent of income taxes. By 2026, it will claim 20 percent of federal income taxes in addition to dedicated payroll tax and premium revenues. When Social Security's claims on general revenues are added to Medicare's, the estimated future burden of elderly entitlements grows significantly. If prescription drug benefits are added, the burden on our children and grandchildren will be even greater.
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"By 2050, Medicare and Social Security will require 54 percent of all federal income tax revenues." |
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The Combined Burden of Medicare and Social Security. Whereas Medicare currently requires a general revenue transfer, Social Security enjoys an offsetting surplus. The two programs combined will provide a small net transfer to the federal budget for the next five years. Once the baby boomers begin to retire, however, the financial picture will worsen rapidly. For example:
- By 2030, deficits in Social Security and Medicare will require 37 percent of federal income taxes. [See Figure I.]
- This means that, within three decades, the federal government will either have to eliminate more than one-third of all the services currently funded by federal income taxes or increase the income tax burden by more than one-third.
The year 2030 is about the midpoint of the baby boomer retirement years. As the subsequent generation replaces the baby boomers, the financial picture for Social Security and Medicare continues to worsen. For example:
- By 2050, when today's college students begin to retire, Medicare and Social Security will require 54 percent of all federal income tax revenues in addition to all dedicated taxes and premiums.
- By 2075, the two programs combined will require almost 75 percent of all income tax revenues - leaving only one out of four dollars for all other functions of the federal government.
As a further indication of Medicare's budgetary burden, Figure II shows the program's funding shortfalls as a percent of federal income taxes using two assumptions about future costs. The upper line shows the costs as projected in the 2003 Trustees Reports. Those reports project that per capita spending will ultimately grow at a rate equal to the growth in per capita gross domestic product (GDP) plus 1 percent. The growth rate assumption is based on the recommendations of a technical review panel convened in 2000. However, suppose reforms could hypothetically reduce spending growth to the rate of increase in per capita GDP (the lower line in Figure II). Even then, Medicare would require substantial budget transfers, in addition to dedicated payroll taxes and premium revenues. While much lower than the currently projected shortfalls, Medicare's general revenue transfers would continue to exceed Social Security's.
Of course, Medicare's costs could grow faster than the Trustees are forecasting - say at a rate equal to the growth of per capita GDP plus 2 percent. That would be consistent with the experience of recent years and would imply that medical care would consume 60 percent of GDP by 2075. Further, Medicare and Social Security combined would consume more than 100 percent of income taxes.
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"Adding a prescription drug benefit to Medicare would create a new commitment for the federal government." |
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The Cost of Adding Prescription Drugs to Medicare. Adding a prescription drug benefit to Medicare would create a new commitment for the federal government. In 1998, Medicare paid for 5 percent of beneficiaries' prescription drugs. Medicaid paid 12 percent, beneficiaries paid 41 percent out of their own pockets, private insurance paid 34 percent, and other payers covered the remaining 8 percent of spending. [See Figure III.]
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"Currently, Medicare pays 5 percent of prescription drug costs for beneficiares." |
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A number of proposals would expand Medicare to cover more of these costs. For example, the House of Representatives passed a bill last summer that would have created a separate benefit package with a separate voluntary premium. It had the following features: a $250 deductible, a $34 monthly premium, a 20 percent copay between $251 and $1,000, a copay of 50 percent between $1,001 and $2,000, and no coverage above $2,001 until a $3,700 cap on out-of-pocket expenditures was reached.
We estimate that under this House bill beneficiaries or other payers would be responsible for 73.4 percent of prescription drug spending, and Medicare would pay the remaining 26.6 percent. Figure IV summarizes the results. The bill would increase Medicare's claims on federal income taxes from 20 to 24 percent in 2026 and from 23 to 39 percent in 2042, the projected exhaustion years for the Hospitalization Insurance (HI) and Old-Age, Survivors and Disability Insurance (OASDI) Trust Funds, respectively.
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"Under last year's House Republican bill, Medicare would pay 27 percent of drug costs." |
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Cautions. These estimates are probably conservative. Since the rising cost of drugs would turn a modest benefit into a major cost if the deductible, premiums, copay ranges and catastrophic coverage threshold were not indexed, the bill indexes these parameters to the cost of prescription drugs. However, basing forecasts on the assumption that full indexation takes place probably underestimates the future cost of the legislation. The history of Supplemental Medical Insurance (SMI) premiums shows why. Originally, SMI premiums were set to cover 50 percent of SMI costs, which are mainly physicians' and clinic fees. But by 1982, the premium covered only 25 percent of SMI costs. The deductible for SMI started at $50 and has been $100 since 1991. This means that the deductible has risen at an annual rate of 1.9 percent, while SMI spending per capita has grown at an average rate of 11.8 percent, more than 6 times faster. As this indicates, Congress has allowed the beneficiaries' share of the cost to fall.
One final caveat is that projected spending does not account for changing third-party payments. Once the price consumers pay falls, the amount they demand naturally will rise. Also, as Medicare begins to pay for prescription drugs, employers may begin to drop such coverage for retired workers.
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Copyright © 2003 National Center for Policy Analysis |
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