NCPA - National Center for Policy Analysis


January 12, 2006

While President Bush remains focused on Social Security, an even bigger fiscal time bomb is ticking away in the United States -- Medicare, say Thomas J. Healey and Robert Steel, senior fellows at the Kennedy School of Government.

Medicare is a structurally broken system that will run completely dry in 2020 and will require an immediate 107 percent increase in revenue to bring it into balance. Even more significant, the present underfunding of Medicare ($29.7 trillion) is more than seven times that of Social Security ($4 trillion), which suggests that Medicare is not just an undercapitalized system but a severely flawed model, say Healey and Steel:

  • One of its biggest defects is the inherent mismatch between revenues and expenditures; Medicare is largely funded through a payroll tax of 2.9 percent and through premiums from Supplementary Medical Insurance (SMI).
  • Because they are tied to the rate of business growth, payroll revenues have proven to be insufficient, particularly in economically stressed times.
  • SMI premiums only cover 12 percent of total Medicare costs and Medicare trustees predict that the program's assets will be exhausted by 2019.

So why hasn't the problem been fixed? Because few, if any, incentives exist to manage the cost of medical treatment, say Healey and Steel:

  • Retired people will undertake treatment as long as the value of that care is more than the copayment for which they are responsible.
  • In the case of providers of medical care, any desire to restrain costs through less-expensive alternatives is often overridden by self-interest or the perceived need for treatment that is, in fact, excessive.
  • Politicians have virtually no short-term inducements to tackle the Medicare problem.

Moreover, there is unlikely to be a single solution; policies need to target the inequities caused by misaligned incentives if they are to bring costs and benefits closer together, say Healey and Steel.

Source: Thomas J. Healey and Robert Steel, "Rx for Medicare," Hoover Institution, Hoover Digest, no. 3, Fall 2005.


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