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


Is Medicare Reform Really Necessary?

“To fund projected Hospital Insurance (Part A) spending would require tripling the Medicare payroll tax to 8.7 percent.”

In addition to the Medicare funding warning, there are other indicators of the need for reform.  This year and every year hereafter, expenditures for Medicare Hospital Insurance (Part A) are expected to exceed the revenues dedicated to it: the Medicare portion of the payroll tax (2.9 percent) and Medicare's share of income taxes paid on Social Security benefits. 2

Unfunded Obligations. The annual Medicare Trustees Report provides measures of the generational equity problem in Medicare.  Each year the actuaries calculate the program's unfunded obligation, defined as the present value of the difference between projected program costs and revenues.

  • For Medicare Part A, the unfunded obligation over the next 75 years is $11.6 trillion.  Looking indefinitely into the future, the unfunded liability is $29.5 trillion.
  • To make Medicare Part A solvent in the long run would require an immediate tax increase of 5.8 percentage points, bringing the total Medicare payroll tax rate up to 8.7 percent. 3
  • Further, these funds would have to be invested in assets earning at least the rate of return on government bonds.

“To fund all projected Medicare spending would require a 17.5 percent payroll tax.”

Additional Revenue Requirements. In addition to the projected Medicare Part A funding deficits that must be paid by future generations, Supplementary Medicare Insurance (Medicare Part B), primarily covering physicians' and outpatient services, and coverage for pharmaceuticals (Medicare Part D) will require a growing share of projected federal revenue.   After accounting for the premiums paid by beneficiaries, Medicare Parts B and D currently require more than $1 of every $10 of federal tax revenues other than those taxes (mainly payroll taxes) that support social insurance programs.  In the future, things will get worse.  When all three parts are combined, the Trustees' project that Medicare deficits will require more than $1 out of every $5 federal revenues that aren't already dedicated to social insurance by 2020. 4

Spending on Elderly Entitlements.  Over the next several decades, spending on Medicare and Social Security as a share of gross domestic product (GDP) will rise for two reasons: (1) the number of beneficiaries will grow relative to the number of taxpayers and (2) health care spending per capita will grow more rapidly than GDP per capita.  If taxes rise to meet this increased spending, total federal expenditures will rise from 20 percent of GDP today to 25 percent by the time the last of the Baby Boom generation enters retirement.  As a result, tax revenues as a share of the nation's economy will have to rise by one-fourth over the next 25 years.  By midcentury, taxpayers will spend an amount equal to almost one-third (31 percent) of their wages just to support Medicare and Social Security.  That is more than double the current payroll tax burden.

The reform proposal is designed to reduce Medicare's future projected costs by changing retirees' incentives as well as the generational burden of the program. Following is a description of the elements of the plan, the assumptions behind them and how they work together.  Finally, the effects of the plan on Medicare's finances and health care spending by seniors are projected, using projections from the 2007 Medicare Trustees Report as a baseline.


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