Medicare: Past, Present and Future

Policy Reports | Health

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

Seventy-Five Years of Health Care Spending

Medicare and Medicaid have had a dramatic effect on the public sector's role in the health care market. 2  Since the two programs were signed into law in 1965, the govenment's share of the health care market has increased substantially, while the share individuals spend out of pocket has declined.  Total health care spending in the United States remained below 5 percent of gross domestic product (GDP) until 1958; since then, it has more than trippled. 3

Public versus Private Health Spending.   The distribution of total health care spending between public and private payers has also changed.  From 1929 to 1965, the government share of total spending averaged 22.5 percent of total health care spending.  In the years since the creation of Medicare and Medicaid, the average public share has been 41.5 percent of the total.  Medicare's share of total health care spending rose during the 1970s but has been relatively stable since then.  However, Medicare's share will increase in the future as the prescription drug benefit enacted in 2003 is fully phased in. 

Private Spending and the Rise of Third-Party Payers.   Private health spending exhibits two key trends:  First, there has been a marked transition over the years from first-party to third-party spending; that is, the share of health costs borne by consumers has declined dramatically and other entities (private insurance and public programs) are increasingly picking up the tab.  Second, there has been a dramatic shift of health care financing from the private sector to the government, particularly since the introduction of Medicare and Medicaid. 

The rise of third-party payment - and the decline of the out-of-pocket share - is rooted in policies enacted during World War II.  Since wages were frozen, employers sought other means to attract employees, including increasingly generous employer-sponsored health benefits.  A 1943 ruling by the Internal Revenue Service allowed the exclusion of employer-paid health care benefits from income and payroll taxes, providing preferential treatment for insurance purchased through an employer over policies purchased in the individual market.  In 1954, the employer exclusion was formalized in the tax code. 4

Between 1948 and 1965: 

  • Out-of-pocket spending as a percentage of total health spending in the United States dropped from 71.2 percent to 52.2 percent, a 19 percentage point drop. 
  • Private health insurance grew by almost the same percentage, from 6.3 percent to 25.1 percent, a gain of 18.8 percentage points. 
  • At the same time, public spending as a percentage of the total increased slightly from 18.5 percent to 20.4 percent.

Clearly, out-of-pocket spending is declining, while third-party spending - particularly from government sources - is rising.  These compositional changes help frame the current health care reform discussion.

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