Is War Between Generations Inevitable?

Policy Reports | Social Security

No. 246
Friday, November 30, 2001
by Jagadeesh Gokhale and Laurence J. Kotlikoff

Medicare's Long-Term Funding Imbalance

The current Medicare payroll tax rate for hospital insurance (the HI or Part A program) is 2.9 percent. The Medicare tax is levied on all labor earnings, whereas the OASDI tax is levied only on earnings up to the Social Security covered earnings ceiling, which is currently $80,400. In addition, the supplementary Medical Insurance program (SMI or Part B) currently accounts for two-fifths of total Medicare expenditure. This program is 25-percent-financed by participant premium payments from the enrollees and 75-percent-financed by general revenue.

Like the OASDI trustees, the Medicare trustees use a 75-year truncated projection horizon and make the same longevity assumptions. And like the OASDI trustees, they report a major funding shortfall over this period. According to their calculations, the 75-year actuarial deficit in the HI program is 1.46 percent of payroll. (For reasons that aren't clear, Medicare's trustees do not specify the income tax hike needed to eliminate the 75-year Medicare Part B funding gap.)

"Workers need to contribute more than twice as much as at present to eliminate the Medicare deficit."

In a recent analysis of Medicare's long-term costs, Harvard economist David Cutler and Federal Reserve economist Louise Sheiner extended the Medicare trustees' projection beyond the 75-year horizon. They also measured, as a percent of total labor income, the future costs of paying for the 75 percent of the SMI program not funded by enrollee premiums. Cutler and Sheiner found that the long-term actuarial deficit in both parts of Medicare is 4.1 percent of payroll. Thus, the real deficit is almost three times that acknowledged by the Medicare trustees.5

To eliminate it, workers need to contribute more than twice as much as they do at present - an increase in payroll taxes from 2.9 percent to 7.0 percent! As with Social Security, these increased funds would need to be invested in interest-earning assets that could be sold to pay future benefits. Again, whether the assets are held privately or by the federal government is irrelevant from a financial point of view.

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