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


  1. This is pursuant to a provision of the 2003 Medicare Modernization Act.
  2. The tax revenues credited to Medicare are a function of the expected income taxes on Social Security benefits, so they rise with the size of Social Security benefit income.
  3. This is referred to in the Medicare Trustees Report as the Medicare Part A actuarial deficit.
  4. Assumes that federal taxes other than the social insurance revenues remain at their historical share of GDP.
  5. Deposits to HIRAs will be made much in the same way as deposits are made to retirement savings accounts. The first set of the estimates presented later in the paper are based on the conservative assumption that the accounts earn a real return of 2.9 percent.
  6. Mechanically, funds in the HIRAs of deceased participants will be distributed at the close of each year across all survivors in the decedents' age cohort in proportion to their account values.
  7. The structure of the transition up to the point in time when all retirees have contributed to HIRAs for their entire work lives will affect the costs and benefits of the reform during the intervening years.
  8. The ultimate effect of the HIRA contribution on participants' consumption depends on the beliefs current participants have about the level and form of reductions in benefits that can or will be enacted by Congress to address the pending Medicare shortfalls.  To the extent that individuals base their consumption behavior on the projected effect of the reform, the 4 percent contribution coupled with the reform may result in offsetting consumer saving so that income available for consumption actually rises even as after-tax income falls.
  9. Rettenmaier and Saving, The Diagnosis and Treatment of Medicare (Washington, D.C.: AEI Press, 2007), page 126.
  10. This is the rate used by the actuaries in producing the 2007 Medicare and Social Security Trustees report.
  11. The RAND simulation results on which the two methods are based are from Table 3.4, page 19 and Table G.2, pages 104-105, in Willard G.  Manning et al., “Health Insurance and the Demand for Medical Care,” February 1988, RAND, R-3476-HHS.
  12. Assuming the low-income retiree is not eligible for Medicaid.  Other federal health care programs, particularly Medicaid, pay for health care spending on behalf of low-income retirees by supplementing Medicare and paying for long-term care for eligible beneficiaries.  Also, Medicare as currently structured may ultimately treat beneficiaries differently based on their incomes.  Mark McClellan and Jonathan Skinner suggest that though high income workers pay more payroll taxes and income taxes, they also have higher use of physician and ambulatory services and higher life expectancies which lead to higher lifetime Medicare spending.  Before the taxable maximum was removed on earnings subject to the Medicare payroll tax, intergenerational transfers from low-income to high-income workers resulted.  Once the taxable maximum was removed, McClellan and Skinner found that redistribution from high- to low-income households resulted for later birth years.  When they adjusted for the insurance value of Medicare, they found further redistribution from high- to low-income households.  See Mark McClellan and Jonathan Skinner, “The Incidence of Medicare,” National Bureau of Economic Research, Working Paper No. 6013, April 1997.
  13. In 2007, Part B required income-related premiums for individuals and couples with $80,000 and $160,000 or more in annual income, respectively.  The thresholds will rise with the Consumer Price Index (CPI).  The higher a retiree's income the higher his or her premium will be relative to the base standard premium.  By 2009 individuals with incomes of $200,000, adjusted for inflation, will have premiums 3.2 times the standard premium.  This group of retirees will thus pay a premium equal to 80 percent of the average cost per retiree and as a result may opt not to participate in Part B.
  14. The simulations use data from the April 2007 Medicare Trustees Report, the 2007 Social Security Administration's population estimates, cohort life tables, and projected wage profiles for very low, low, medium and high lifetime wage earners.  Medicare spending by age and birth year is projected based on data from the Continuous Medicare History Sample.  These projections are used to allocate total annual spending on aged beneficiaries to specific birth years.
  15. Medicare-covered services include Medicare's own reimbursements as well as out-of-pocket spending and any third-party payments.  The age-spending profiles are derived from projections of spending by age in future years and are benchmarked relative to the aggregate projections from the 2007 Medicare Trustees Report.  These are the estimated profiles that would exist before determining the effects of the higher cost sharing on spending.  The percentages presented thus illustrate the size of the private payments relative to average anticipated age-specific spending on covered services under Medicare's current structure.
  16. Spending in the year in which an individual turns 65 includes on average one-half of a year's spending given the timing of eligibility based on new entrants' birthdays.  For this reason, spending in the year beneficiaries turn 65 is excluded from the graph.
  17. The average inflation-adjusted age spending profiles rise from the age of 66 until the early 90s for each birth year and then decline at higher ages.  The ratio of total cost sharing to average spending by age has the shape depicted in the figure because the numerator of the ratio is growing in real dollars due to the rising base deductible that is added to a fixed real dollar annuity from the HIRA but the total cost sharing does not rise as rapidly as the age spending profile until is peaks at about the age of 92.
  18. Though Parts A, B and D would be combined into one health insurance package with this reform, it is assumed that beneficiaries would continue to participate in funding some of the cost of the program as they do now through their Parts B and D premium payments.  These payments currently account for 11 percent of the total cost of the program.  With the HIRA reform, beneficiaries could continue to fund this percentage of the program's reformed costs through premium payments.  Whether the premiums are the same across all income classes, or are adjusted for lifetime or current income, is an additional policy consideration.
  19. In addition to the demand-side effects of higher cost sharing, there will also be significant supply-side effects.  Suppliers of health care services will face increased price competition for the services they supply.  The increased price competition will affect services consumed by beneficiaries both below and above the total cost-sharing cap given that the component services used in treating low-expenditure cases overlap significantly with cases which exceed the cost-sharing threshold.
  20. Amy Finkelstein, “The Aggregate Effects of Health Insurance: Evidence from the Introduction of Medicare,” Quarterly Journal of Economics , February 2007, pages 1-38.
  21. The higher rate-of-return assumption brings up the concern that different cohorts may have quite different annuities even if they had similar earnings profiles simply because of market volatility. This concern can be addressed in several ways. One would be to require the insurance providers to smooth some of this risk through time by staggering the timing of annuitization of each new set of retirees, or by requiring them to contribute to a reinsurance fund.  These provisions would reduce the rate of return closer to the government borrowing rate.  However, even in the case in which annuities are allowed to vary with market conditions at the time of annuitization, some of the concerns that plague personal retirement account proposals are not present here, given that for most retirees Medicare will continue to be the ultimate insurer for catastrophic events.  Higher annuities for workers who retire during a stock market boom would produce higher cost sharing requirements.  Similarly, workers who retire in a down market would have smaller cost sharing requirements.
  22. Again, the projected spending on covered services is derived from the 2007 Trustees Reports and as such does not reflect the reduction in spending that would result from the higher cost sharing. The projected spending under the current program's structure is simply used to provide a convenient point of comparison.
  23. Mark V. Pauly, “Should Medicare Be Less Generous to High-Income Beneficiaries?” in Andrew J. Rettenmaier and Thomas R. Saving, eds., Medicare Reform: Issues and Answers (University of Chicago Press, 1999).
  24. Joseph P. Newhouse, Free for All? (Cambridge, Mass.: Harvard University Press, 1993).
  25. Alan Greenspan, The Age of Turbulence: Adventures in a New World (New York City: Penguin, 2007).

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