Reducing Medicare Spending

March 18, 2014

Provisions in the Affordable Care Act (ACA) are supposed to constrain Medicare spending, but there is doubt that those spending reductions will actually occur, say former Medicare Trustee, Thomas R. Saving, and Andrew J. Rettenmaier, both senior fellows at the National Center for Policy Analysis, and their colleagues Liqun Liu and Zijun Wang of the Private Enterprise Research Center.

Medicare Trustees Reports show Medicare spending as being one-third lower than the Medicare spending forecast prior to the passage of the ACA, with unfunded liability obligations declining. However, these estimates are assuming that the spending controls within the ACA (such as lower reimbursement rates to doctors) will actually be realized. The authors looked at two forecasts: the "current law" forecast in the 2013 Trustees Report and the alternative forecast (which assumes that spending constraints are not fully realized).

  • Medicare and Social Security both replace workers' average annual compensation before retirement. Under the alternative scenario, Medicare's insurance value will grow as a percent of retirees' preretirement average compensation.
  • Today, Medicare's annual insurance value is worth 23 percent of average annual compensation of medium earning workers who turn 65 years old this year. By 2030, that number will be at 29 percent, and by 2065, it will be at 37 percent.
  • This rising insurance value leads to increased replacement rates (meaning the replacement of preretirement compensation) for future retirees. What this means is that savings incentives decrease along with investment, which hurts economic growth.
  • Using current law baseline forecasts, however, the analysis produces a much more stable replacement rate.

Lowering spending on Medicare is necessary, but it is unlikely that the United States will actually see lower spending growth from the ACA. Are there more practical ways to lower spending? The authors look at two possible reforms: raising the eligibility age for Medicare (the MEA) and means-testing the government's contribution to Medicare.

  • Raising the MEA is not enough to bring Medicare spending down to the baseline forecasts. Currently, the baseline forecast spending is 50 percent less than the alternative forecast. Increasing the MEA would reduce Medicare spending to 91 percent of the alternative forecast, to a level that is 37 percent higher than the baseline.
  • However, means-testing starting in 2023, in addition to raising the MEA, could result in the same spending levels as the baseline forecast. Retirees with higher lifetime incomes would have to pay higher premiums to participate in Medicare.

By constraining Medicare spending, the United States will see higher national savings as well as decreased welfare loss of taxation, because there would be less reliance on higher taxes to finance the program.

Source: Liqun Liu et al., "Framing Medicare Reform," National Center for Policy Analysis, March 2014.

 

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