The Basics of Medicare
A primary motivation behind the passage of Medicare in 1965 was that many of the elderly at the time had no health insurance. Medicare was structured to mimic the prevalent form of private health insurance at the time, Blue Cross and Blue Shield. Blue Cross plans covered inpatient hospital services, and Blue Shield plans covered physician and hospital outpatient services. The "Blues" were the basis for separate Part A and Part B plans that reimburse hospitals and physicians on a fee-for-service basis, respectively. Seniors who have worked at least 40 quarters in qualified employment are automatically enrolled in Part A at age 65. Seniors who lack 40 quarters of employment can buy into Part A by paying a monthly premium. People under the age of 65 with certain disabilities or end-stage renal disease are also eligible for Medicare. Enrollment in Part B is optional and requires a premium contribution, although there is a penalty for not immediately enrolling and the amount is higher for individuals making more than $80,000 per year. The Centers for Medicare and Medicaid Services (CMS) administers the Medicare program by implementing the statutes that determine the form of payments to hospitals, physicians, and outpatient providers.
Most outpatient prescription drugs were not covered by Medicare until the implementation of the Medicare Modernization Act (MMA) of 2003, which created Part D of Medicare. Like Part B, Part D is optional, requires a premium contribution, and has a penalty for late enrollment. Unlike Part B, however, Part D is administered by private health insurance plan sponsors. Seniors have the alternative option of enrolling in a private Medicare Advantage insurance plan if one exists in their region. These are private health insurance plans that provide Part A, Part B, and, in most cases, Part D services. These plans often provide additional benefits to seniors at lower costs.
Medicare spending is financed by a combination of payroll taxes, general revenue, and premiums paid by beneficiaries. Part A of Medicare is financed by a Hospital Insurance (HI) payroll tax of 2.9 percent. The HI payroll tax is split evenly between employees and employers, but economists generally believe the employer tax is ultimately paid by workers in the form of relatively lower wages. Part A is a pay-as-you-go system in which payroll taxes on current workers wages finance the benefits of those currently retired. If the payroll tax revenues exceed spending for the year, the difference is placed into the HI Trust Fund. If taxes are lower than spending, money is withdrawn from the HI Trust Fund. Parts B and D constitute the Supplementary Medical Insurance component of Medicare and are financed by general Federal government revenues and beneficiary premiums, which are set to equal approximately 25 percent of total Part B and Part D spending, respectively.
Nations around the world provide various forms of social insurance for their elderly populations. One of the purposes of health insurance is to ensure that people are protected against the financial risk associated with uncertain medical spending. Economists generally attempt to justify government intervention into private market outcomes by suggesting potential market failures that may exist in the absence of any government intervention. Many economists would justify the existence of Medicare (and its government provision of health insurance for the elderly and disabled) with three potential explanations. The first potential explanation is that many people may lack sufficient information to plan properly for the financial hardships that would otherwise arise from expensive medical treatment when they age or become disabled. Medicare requires workers to pay a premium during their working years toward future costs and thus the program can be considered a form of forced savings. In this way, Medicare is similar to Social Security, which requires people to set aside some of their wages now in exchange for a promise of income at retirement. But this reason alone is insufficient to explain the provision of health insurance as opposed to additional income.
A second potential explanation for government intervention in the provision of health insurance for seniors is to avoid having seniors in poor health pay considerably more toward their health care. In the United States, most people participate in health insurance plans through their place of employment. Most people lose these plans upon retirement. (Private retiree health insurance plans only cover what Medicare does not.) Because about 40 percent of people at age 65 have at least one serious preexisting chronic health condition, initiating coverage in a private individual health insurance market after retirement (under the assumption that the Medicare program did not exist) would force insurers to charge higher premiums to those in poor health. Younger people face uncertainty that they may develop a chronic condition in the future (and thus they would face variable premiums in the absence of Medicare). This suggests that there may be efficiency gains from providing future insurance coverage with pooled contributions. (Private health insurance markets handle this intertemporal uncertainty of developing a chronic health condition with "guaranteed renewal at class average rates" provisions that ensure that premiums do not vary with the onset of illness for those with coverage.)
A third potential explanation for government intervention in the provision of health insurance is related to the redistribution of resources toward lowincome people. Economic theory suggests that unconditional transfers of wealth are generally more efficient than in-kind transfers of goods or services for achieving any desired redistribution. In an ideal world, the poor would use some of this transferred wealth to purchase health insurance. However, if the poor believe that society will provide them with additional resources in the event of an uninsured loss, they may have an incentive to forego buying insurance. This precommitment problem, sometimes called the "Samaritan's Dilemma," has been demonstrated to be alleviated by the direct provision of health insurance rather than a direct transfer of wealth. This economic argument, however, justifies the subsidization of, or requirement for, insurance but does not justify a government-run plan.