The 2004 Medicare and Social Security Trustees Reports

Policy Reports | Health | Social Security

No. 266
Friday, June 04, 2004
by Andrew J. Rettenmaier & Thomas R. Saving, Ph.D.


Figure II - Medicare Expenditures and Income by Source

As noted above, Medicare is funded by a combination of payroll taxes, taxes on Social Security benefits, general revenue transfers, premium payments, and now - with the passage of the prescription drug bill - transfers from state governments. Medicare's differing components, coupled with the unpredictable nature of future medical expenditures, make its financial burden on the rest of the budget subject to more uncertainty.

"Medicare spending as a share of gross domestic product will grow from under 3 percent of GDP to more than 13 percent by 2075."

With the passage of the prescription drug benefit (the Medicare Modernization Act), Medicare now has three parts. First, Hospitalization Insurance (called HI, or Medicare Part A) helps pay the costs associated with hospital stays and the costs of home health, hospice, and skilled nursing facility care. Medicare Part A is financed by a dedicated 2.9 percent payroll tax and some revenues from taxing Social Security benefits. Second, Supplementary Medical Insurance now includes both Parts B and D. Part B helps pay the cost of physician visits, outpatient bills and home health bills, and is financed by beneficiaries' premium payments and general revenues. These premiums cover about 25 percent of the program's costs, with the remainder paid by general revenues. Third, the new prescription drug benefit (Medicare Part D) is also financed by premium payments and general revenue transfers, along with state transfers that are reimbursed from the Medicaid program for those Medicare beneficiaries who are also eligible for Medicaid. The combination of premiums and state transfers are expected to cover about 25 percent of the total cost of the prescription drug benefit, with general revenues covering the remainder.

Figure II shows the relative composition of Medicare's total funding sources along with its total costs as a percentage of Gross Domestic Product (GDP).10 In 2004, Medicare spending is expected to be 2.69 percent of GDP; by 2022 its share will double; and by 2038 its share will triple. By 2075 the program will be almost five times its current share of GDP. However, as the figure makes clear, the program's funding will not rise commensurately. In 2004 dedicated funding sources equal 1.74 percent of GDP, rising to 3.47 percent by 2075, due in large part to premiums that will grow along with total Medicare spending on Parts B and D. In 2004 these dedicated funding sources will account for 65 percent of total Medicare spending, but by 2019 when the Part A Trust Fund is exhausted, they will account for less than half of the funding requirements. By 2042 - which is the same year the Social Security Trust Fund is exhausted - dedicated resources for Medicare account for less than one-third of the system's projected expenses, and by 2075 they shrink to only 26 percent of expenditures.11

Table II - Composition of Medicare's Revenue Shortfalls

Table II summarizes the differences between expenditures and revenues for each part of Medicare for the indefinite future, in 2004 dollars.12 For Medicare Part A, the present value of this difference is $14.2 trillion for current participants and another $7.8 trillion for future participants - a total of $22.1 trillion. This means that the current value of the additional resources necessary to fund Part A alone is almost double the amount required to fund Social Security.13

The additional funding required by Medicare, Part B, comes to $8.8 trillion for current participants and $14.4 trillion for future participants - producing a $23.2 trillion total. The Trustees Report does not label this as an "unfunded" obligation, however, because it is assumed that general revenues, no matter how large, will be automatically appropriated and transferred to Part B, as current law requires. The amounts reported as revenue shortfalls in our Table II for Parts B and D are reported in the Trustees Reports, Tables II.C17 and II.C23, as "general revenue contributions." Regardless of the labeling, these amounts reflect the transfers from the rest of the budget necessary to pay the difference between projected benefits and premium payments.14  

The passage of the Medicare Modernization Act added a significant general revenue obligation to the federal budget, identified in the Part D column of Table II. Current Medicare participants are expected to receive $6.2 trillion in benefits over and above expected premium payments and state transfers. Future Medicare participants add $10.3 trillion in spending that must be made up from federal general revenues, for a total of $16.6 trillion. Therefore, the prescription drug benefit adds a general revenue commitment to the federal budget that is almost 40 percent higher than the additional funding requirements needed to make the Social Security program solvent. The combined obligations of the Medicare program are staggering. For current beneficiaries, the present value of Medicare spending over and above all dedicated funding sources is $29.2 trillion. For future participants, another $32.5 trillion is required, resulting in a total burden of $61.9 trillion above expected revenues. Note that the new prescription drug benefit also increased Medicare's additional funding requirements by 37 percent, from $45 trillion to the $61.9 trillion.

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