A Medicare Reform Proposal Everyone Can Love: Finding Common Ground among Medicare Reformers

Studies | Health

No. 306
Saturday, December 01, 2007
by Andrew J. Rettenmaier and Thomas R. Saving


Executive Summary

Medicare reform will soon be front and center in the public policy arena.  The reason:  Projections in the past two years for Medicare's deteriorating finances have triggered a legal requirement for the President to propose reform legislation within 15 days of the release of the next federal budget.  Congress must consider the president's proposal on an expedited basis.

This paper proposes a comprehensive reform that addresses both Medicare's funding and its spending.  It has these features:

  • The cost of the reform is spread across generations instead of being shifted to future taxpayers.
  • The reform gives retirees control over more of the health care dollars they spend and this patient control grows through time.
  • The reform creates incentives for retirees at all income levels to consider the cost of the health care they consume, allowing beneficiaries to reap more of the financial benefits from their prudent decisions and requiring them to bear more of the cost if they choose to spend more.
  • The reforms will allow patients to choose between health care and other goods and services on a level playing field — without distortions created by the tax code.
  • Because an increasing portion of spending will be controlled by patients using their own health care dollars, health care providers will have new incentives to compete on price  and quality.

The most novel feature of this proposal is the creation of Health Insurance Retirement Accounts (HIRAs).  Through these accounts current workers will partially prepay future Medicare costs and thereby reduce the projected tax burden on future workers.  Under this reform:

  • Workers will contribute a fixed percentage of their total wage income to a HIRA during their working lives.
  • When they enroll in Medicare at age 65, beneficiaries will use their HIRA balances to purchase an annuity paying an annual fixed sum to a spending account, such as a Roth Health Savings Account (HSA).
  • Beneficiaries will use their HIRA annuities to pay for a share of their Medicare costs and any funds remaining at the end of the year can be withdrawn tax free (like a Roth IRA) and spent on nonmedical goods and services.
  • Retirees who have higher incomes during their working years will have higher annuities and therefore will face greater cost sharing during their retirement years.
  • The annuities will replace government spending obligations, and as the annuities grow through time they will relieve an increasing amount of the burden on future taxpayers that would exist under the current financing arrangement.
  • The new economic incentives for patients to become more prudent consumers of health care will further reduce the funding burden on the next generation by reducing both the level and rate of growth in health care spending by retirees.

Under reasonable assumptions:

  • Average income workers entering the labor market today will have annuities that pay an amount equal to 29 percent to 59 percent of their projected spending on Medicare covered services at the midpoint of their retirement years.
  • High income workers will have annuities that pay 46 percent to 95 percent of their retirement health care costs.
  • By midcentury, reformed Medicare spending is estimated to be 20 percent to 35 percent less than the current program.
  • By midcentury or earlier, total spending on the reformed program, including contributions to HIRAs, is estimated to be less than the spending on the current program.

This reform proposal should appeal to reformers across the political spectrum because it reduces the tax burden on future workers, puts Medicare on a sounder footing, retains the progressivity of the current program's funding, and produces cost sharing incentives that rise with lifetime income.


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