Medicare: Past, Present and Future

Policy Reports | Health

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

Medicare's Future Spending Path

Medicare is on a spending path that will be difficult to sustain without unprecedented boosts in revenues.  We have experienced decades of growth rates of health care spending in excess of the growth rate for the economy as a whole; consequently health care is growing as a share of the economy. 

“Health spending grew two to three times faster than the economy over the past half century.”

Health Care Spending versus National Income.   Figure I shows the rate of growth of per capita health care spending compared with the rate of growth of per capita GDP over the past half century.  As the figure shows, health care spending has been rising at a rate two to three times faster than per capita GDP.  If this pattern continues, health care's share of the economy will grow considerably: 7

  • 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 would consume almost 80 percent of GDP by 2075. 
  • Continuation of past growth rates 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 spending path is not feasible.  So in projecting the future the Trustees assume that the rate of growth of per capita health care spending will moderate, eventually slowing to the rate of growth of per capita GDP after 75 years.  This study uses the same assumptions as the Trustees report. 

“The Trustees assume health care spending increases will slow to the rate of economic growth over the next 75 years.”

Medicare Spending versus GDP.   Figure II compares past growth rates in real per capita GDP and real Medicare spending per capita and pro-jects future growth, reflecting the growth path adjustments adopted by the Trustees in their 2006 annual report. 8   From the 1970s to the 1990s, the annual growth rates in per capita spending declined due to the adoption of the prospective payments system and reforms in the Balanced Budget Act of 1997. The noticeable growth in the decade between 2000 and 2010 is due to the addition of prescription drugs under Part D.  The future projections show per capita GDP declines slightly as the baby boomers move from contributing to GDP while working to entering their retirement years. 

Additionally, as the baby boomers enter Medicare, the average age of the Medicare population will decline.  Since spending on younger retirees is lower than on older retirees, the growth rate in average spending across all retirees will be lower.  This is evidenced in the figure for the decade of the 2010s.  However, as the baby boomers get older, the average age of the retired population will rise, as will spending.  This movement of the baby boomers through retirement is reflected in the changing pattern of spending growth for the decades of the 2020s to the 2040s. 

Figure 2

Examining the Reasons for Medicare's Rising Spending.   What is driving Medicare's growth?  In 1970, five years into the program's payment of benefits, Medicare paid benefits equaling 0.74 percent of GDP; by 2005 the program paid out benefits equal to 2.75 percent of GDP.  Of this growth:

  • Thirty-nine percent resulted from an increase in the number of beneficiaries.
  • Fully 61 percent came from growth in per beneficiary spending in excess of the underlying growth of the economy. 

“Average Medicare spending will decline in the short run as younger, healthier baby boomers become beneficiaries.”

Medicare's Impact on the Federal Budget.   Until recently, Social Security and Medicare payroll taxes, Social Security benefit taxes and premium revenues combined exceeded spending on Social Security and Medicare.  However, last year these two programs paid out $113 billion more than they collected.  In the next few years the funding gap will rise rapidly.  If no other changes are made in these programs, benefits will be paid only if we draw on the general revenues of the federal government.

“In order to pay benefits in 13 years (2020), the government will have to stop doing one in every five things it does today.”

Currently the two programs use 6.3 percent of nonentitlement revenues (federal revenues dedicated to all other programs besides Medicare and Social Security).  By 2010, the combined projected deficits of Social Security and Medicare will equal almost 8.5 percent of nonentitlement federal revenues.  By 2020, the deficits will grow to almost 25 percent, assuming no additional taxes.  This means that within 13 years, in order to pay projected benefits to retirees and the disabled, the federal government will have to stop doing about one out of every five things it does today.  Alternatively, it will have to raise taxes by about 20 percent, significantly cut benefits or make beneficiaries pay for substantially more of their benefits.  Any of these options will be very painful. 

Figure 2

By the time all of the baby boomers have reached their retirement years, projected Social Security and Medicare benefits will require almost one in every two nonentitlement tax dollars.  By 2050, they will require nearly two-thirds. 

“By 2050 the government will have to stop doing 60 percent of the other things it does today if taxes are not raised.”

Medicare's Unfunded Liability.   Another way to summarize Medicare's projected drain on general revenue under current law is to compare the present value of its funding requirements to the dedicated funding sources over the same period.  As Figure III shows:

  • Medicare's general revenue funding requirements in excess of dedicated sources (payroll and Social Security benefit taxes, premiums and state transfers) is $32.4 trillion over the next 75 years. 
  • Looking indefinitely into the future, the unfunded liability is $70.8 trillion. 

“Medicare's shortfall in 2080 could be funded with a 57 percent increase in taxes not already dedicated to entitlement spending.”

If the current level of general revenue transfers, as a share of GDP, continued over the next 75 years they would pay for $9.9 trillion of the $32.4 trillion.  Stated another way, the current level of general revenue transfers, as a share of GDP, would cover only 30 percent of the program's general revenue obligations.  This implies:

  • An additional $22.5 trillion is required over and above continuation of the current general revenue commitment to fund Medicare's spending over the next 75 years. 
  • If the figures are extended to the infinite horizon, the additional funding gap is $55.1 trillion.

Figure 3 

Read Article as PDF