Medicare: Past, Present and Future

Studies | Health

No. 299
Sunday, July 01, 2007
by Andrew J. Rettenmaier and Thomas R. Saving


Executive Summary

Although Social Security reform has received considerable attention in recent years, Medicare is the far-bigger problem.  Medicare is growing at a faster rate and has an unfunded liability six times the size of Social Security. 

Medicare is also on a spending path that will be difficult to sustain without unprecedented boosts in revenues.  The reason: Per capita health care spending over the past half century has been rising at a rate two to three times faster than per capita gross domestic product (GDP).  If this trend continues, health care's share of the economy will grow considerably: 

  • If the growth of real per capita health care spending exceeds the rate of growth of real per capita GDP by 2 percentage points, health care spending will consume almost 80 percent of GDP by 2075.
  • Continuation of these past growth rates indefinitely would imply a five-fold increase in health care's share of the economy from present levels, crowding out the consumption of most other goods. 

Clearly this path is not feasible.  Therefore, in projecting the future, the Medicare Trustees assume that the rate of health care spending growth will moderate, eventually slowing to the rate of income growth after 75 years.  This study uses the same assumptions as the Trustees report.  Even with these assumptions, it is evident that the federal government has far more in projected benefit costs than it expects to receive in payroll taxes, premiums and other revenues dedicated to Medicare: 

  • The last Trustees report estimated Medicare's unfunded liability over the next 75 years at $32.4 trillion. 
  • Looking indefinitely into the future, the unfunded liability is $70.8 trillion.
  • This is 14 times the amount of outstanding federal debt. 

Medicare already spends more than it receives in dedicated taxes and premium payments.  As baby boomer retirees begin to flood the system, the impact will be felt by every other federal program: 

  • Currently, Medicare claims about 11 percent of federal nonentitlement tax dollars. 
  • By 2020, Medicare deficits will claim one in every five federal tax dollars that are not already dedicated to Medicare and Social Security.
  • This means that in just 13 years the federal government will have to stop doing one in every five things it does today if taxes are to remain at their current level and projected Medicare benefits are paid on behalf of the disabled and the elderly. 
  • By 2030, the deficits in Medicare will claim one in every three general revenue dollars; by 2050, they will claim one in every two. 

What can be done?  The suggested reforms include raising taxes, making seniors pay for more of their benefits, cutting benefits for higher-income beneficiaries and raising the eligibility age.  Yet these reforms would not directly reduce health care spending growth; rather, they would change the allocation of the program's costs between taxpayers and seniors. 

How, then, can the country get off the spending path it is on?  On the demand side, someone must choose between health care and other uses of money.  That is, someone must decide that the next MRI scan or the next knee replacement, for example, is not worth the cost.  Such decisions could be made by seniors themselves, by the government (as it is in other countries) or by private insurers operating under government rationing rules.  On the supply side, the way health care is produced must change fundamentally, replacing cost-increasing innovations with cost-reducing ones. 

A common technique in other developed countries is to impose a global budget on health care providers.  To estimate the effects of this type of rationing, projections were made that assume, starting with the baby boomer generation, Medicare spending on each year's cohort of newly eligible beneficiaries will be limited.  After a beneficiary begins receiving Social Security benefit payments, they are indexed for inflation only.  A similar method of indexing Medicare benefits is considered.  Upon reaching age 65, beneficiaries would receive a health plan that covers projected lifetime Medicare costs as they exist in the year they retire.  This benefit package would be indexed for inflation only.  Although this reform is unquestionably harsh, it would reduce Medicare's unfunded liability by as much as 40 percent.  

Why don't spending constraints accomplish more?  The reason: 48 percent of the projected growth in Medicare is due to population growth and aging, while 52 percent is due to per capita spending growth in excess of per capita GDP growth.  Reforms which limit reimbursements, therefore - even in a best-case scenario - can only affect part of the expected growth in Medicare spending.

The effects of beneficiaries making their own rationing decisions are also estimated, by creating a $5,000 deductible policy, with retiree Health Savings Accounts (HSAs) to fund spending below the deductible.  The size of the deductible grows through time (as health costs grow) and since deposits to the HSAs would be made with after-tax dollars, withdrawals for any purpose would be tax-free.  In this way, beneficiaries would be encouraged to make their own tradeoffs between health care and every other good or service.  The effects could be substantial.  Like the impact of global budgets, this reform could reduce Medicare's unfunded liability by as much as 40 percent if started immediately. Alternatively, if the reform is phased in, the government could initially make deposits to beneficiaries' HSAs.

Health care supply-side reforms are not simulated in this paper.  However, there is ample evidence that when people spend their own money on health services, supply-side responses are considerable.  This implies that a properly designed Health Savings Account could help move Medicare off its current spending course in two ways:  1) by allowing the elderly to reallocate health care dollars to goods and services they value more and 2) by spurring providers to provide care more efficiently.


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