Projections of Future Medicare Spending and Revenue
Sources of Spending.
Since Medicare was created in 1965, total spending on all of its programs has grown steadily. As noted above, total Medicare spending was 2.7 percent of GDP in 2005 and is projected to be 11.0 percent of GDP in 2080. These values for Medicare spending, however, actually understate the total spending for Medicare beneficiaries because the private payments for cost sharing are not included. For instance, in 2006, Part A requires individuals to pay $952 of the cost of each hospitalization (this $952 is called a deductible), and Part B generally requires them to pay 20 percent of the Medicare-approved payment (this 20 percent is called coinsurance) in addition to a deductible. Some beneficiaries pay Medicare deductibles and coinsurance amounts from their own pockets, while others obtain private insurance to cover these costs. Some of this private coverage is included in employer-sponsored retirement benefits, while some is provided by directly purchased Medigap plans. Some low-income Medicare beneficiaries are also eligible for Medicaid. For these dually eligible people, Medicaid covers most of these cost-sharing amounts required by Medicare.
Including private spending by Medicare beneficiaries and Medicaid spending on Medicare beneficiaries presents a more complete picture of beneficiaries total consumption. In 2006, beneficiaries bore about 37 percent of Medicarerelated spending, and about 63 percent was financed by payroll taxes and general revenues. However, these amounts shown here do not include the portion of Medicaid spending on long-term care services, such as nursing homes, because this type of care is not covered by Medicare.
Medicare Solvency.
The Medicare program does not have enough projected revenue to cover projected future spending. Under current projections made by the Medicare Actuaries and presented in the 2006 Medicare Trustees Report, the Medicare HI Trust Fund is projected to be exhausted in 2018. The projected 75-year deficit for the Medicare HI Trust Fund is 3.51 percent of taxable payroll. That is, the Medicare HI payroll tax would have to be immediately increased from 2.90 percent to 6.41 percent to cover all projected spending over the next 75 years. Alternatively, a reduction in Medicare Part A expenditures by 51 percent would be necessary to make the Medicare Trust Fund solvent. As a comparison, this Medicare deficit is relatively larger in magnitude than the Social Security Trust Fund deficit. An increase in the Old Age, Survivors, and Disability Insurance (OASDI) payroll tax from 12.4 percent to 14.4 percent or a reduction in Social Security benefits by 13 percent is projected to make the Social Security program solvent over 75 years.
The Medicare Supplementary Medical Insurance (SMI) program is considered to be solvent by the Medicare Trustees only because Part B and Part D spending is required by law to be financed by general revenues. However, the consequences of increased spending on Medicare SMI may be just as dire. Without large reductions in Medicare SMI spending or increases in taxes, either Federal budget deficits will grow rapidly or dramatic reductions in spending for other Federal programs will have to be made.
Spending on Medicaid is also funded by general revenues. The elderly and disabled covered by Medicare account for about one-quarter of Medicaid enrollees, but they account for about two-thirds of Medicaid spending, mainly because of spending on acute and long-term care. An additional challenge for funding Medicaid is the inverse relationship between the proportion of the population eligible for benefits and the tax base available to fund the program. During economic downturns, lower personal income causes State governments with balanced-budget requirements to face the strain of both a decrease in tax revenue and a higher number of residents who meet the low-income eligibility threshold and are thus in need of assistance.
Implications for Reform.
In light of the mounting fiscal pressures on entitlement spending, it is critical to increase the efficiency of spending on benefits. Reforms of the Medicare program should aim to reduce the growth of spending by redirecting resources toward the highest value uses and away from inefficient care of low value. Controlling cost growth while preserving the vital financial and health protections offered by the program is particularly important in light of the large negative consequences of raising taxes. An increase in the payroll tax rate would decrease incentives to work, increase efforts to receive compensation in forms not subject to taxation, and be a drag on economic growth.
As noted above, Medicare taxes on current workers wages essentially fund an insurance pool from which benefits are paid on behalf of retired or disabled workers. A pay-as-you-go system of intergenerational transfers is consistent with the basic idea behind insurance if the aggregate amount paid into the pool (in the form of taxes on workers) equals the aggregate amount of expected benefits to be paid from the pool. In private insurance markets, policyholders must have confidence that future claims will be covered by the insurer. To help alleviate consumer concerns, government regulations often place solvency requirements on insurers that require them to have enough assets to cover their liabilities. Thus, for Medicare's pay-as-you-go financing mechanism to function as a social insurance program, younger generations must have confidence that the government will indeed meet its future insurance obligations to them. The rapid increase in Medicare spending over time clearly threatens the confidence that younger generations have in the solvency of the program. Indeed, a recent survey found that almost two-thirds of workers are "not too confident" or "not at all confident" that Medicare "will continue to provide benefits of at least equal value to the benefits received by retirees today".
The next section of this chapter examines the reasons behind this projected growth in Medicare spending. The average annual growth rate of Medicare spending is projected to be 2.8 percentage points higher than GDP growth per year between 2006 and 2040. Part of this increase in spending is due to growth in the number of Medicare beneficiaries, and part of this increase in spending is due to growth in real (inflation adjusted) Medicare spending per beneficiary.