Chapter 8
Medicare
Background:
1. Medicare was established by Congress in 1965 to finance healthcare for the aged. Medicare is
now facing serious problems; its impending financial deficits require substantial changes if it is
to survive. Currently $500 Billion program.
2. Who’s Covered?
Medicare primarily serves the aged. Also, those under 65 who receive Social Security cash
payments because they are disabled become eligible for Medicare after a two-year waiting
period. People requiring kidney dialysis and kidney transplants, regardless of age, were added to
Medicare in the early 1970s.
3. How’s it Work? Medicare has four parts each with different benefits and different financing.
o Part A provides Hospital Insurance (HI) which is financed by the Medicare Health
Insurance (HI) payroll tax (2.9% on all earned income)
o Part B provides Supplemental Medical Insurance (SMI) which is financed through $105
per month premium representing 25% of costs and federal taxes for the other 75%. Has
$155 deductible and 20% copay.
o Part B premium tied to income ($105 for <$85,000 rising to $335/month for > $214,000
individual income (just double for joint returns).
o Part C offers Medicare beneficiaries a greater variety of health plan choices (Medicare
Advantage plans) which are managed care plans. These plans are paid 95% of average
Medicare enrollee age adjusted cost.
o Part D is a new outpatient prescription drug benefit enacted in 2003, with deductibles and
copay and “donut” hole in coverage. Financed by premiums and federal tax revenues
(roughly 25%/75% split). (see slide below)
o Part D costs also tied to income like Part B with highest incomes paying 3X more than
lowest incomes ($105 vs. $35).
4. Medicare’s patient and provider incentives and their effects on efficiency:
o Traditional Medicare was designed to provide limited efficiency incentives for either
beneficiaries or providers of medical services. The elderly had no incentives to choose
less costly hospitals because the deductible was the same and there were no copayments
for inpatient admissions or lengths of stay. Hospitals were initially paid according to
whatever their costs were for caring for an aged patient. In 1984 Medicare changed
hospital payment to a fixed price per admission called DRGs.
o The aged have low copayments and a deductible under Medicare Part B, both of which
are eliminated when the aged person purchases Medi-gap insurance. Thus neither the
patient nor their physician, paid fee-for-service, has any incentive to be concerned with
the use of services.
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Neither hospitals nor physicians have a financial incentive to manage the overall costs of
an episode of care for an aged patient or provide preventive services that lead to lower
acute medical costs.
o Only Medicare HMOs (referred to as Medicare Advantage plans) paid on a capitation
basis have such incentives. Cost-containment and utilization management methods used
extensively in the private insurance market are virtually nonexistent in Medicare.
5. Is the financing of Medicare equitable? No.
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Medicare beneficiaries are heavily subsidized under Medicare Parts A, B, and D. The aged
do not pay the full costs of the medical services they receive
o the aged are subsidized by the working (younger) population who pay federal taxes
and Medicare HI payroll taxes.
o the aged are subsidized by all income earners for Parts B & D which are funded by
the income tax.
o Thus an inequitable situation arises: lower-income employees are taxed to subsidize
the medical expenses of higher-income Medicare beneficiaries.
Payroll taxes are not a desirable method of financing a “welfare” program. Although the
employer and the employee each pay one-half of the Medicare HI tax, studies confirm that
the employees end up paying most of the employer’s share of the payroll tax as well, because
it is shifted to employees in the form of lower wages.
If society wants to help those with low incomes by providing them with a welfare benefit,
the most equitable way to do so would be to provide the majority of benefits to those with
low incomes and finance those benefits by taxing those with higher incomes. Many aged who
receive Part A benefits have higher incomes and assets than those who are providing the
subsidies through payroll taxes. An income tax, which takes proportionately more from those
with higher incomes, would be a more equitable way to finance benefits to those with low
incomes. Federal income taxes are used to subsidize Medicare Parts B and D.
6. How does the Medicare Hospital Trust Fund differ from a pension fund?
The Medicare Hospital Trust Fund is a “pay as you go” fund; current Medicare expenditures are
funded by current employee and employer contributions. The HI taxes from current Medicare
beneficiaries were never set aside for their own future expenses but were instead used to pay for
those who were eligible at that time. This is in contrast to a pension fund, for which a person sets
aside funds to pay for his or her own retirement.
7. Why is it necessary to reform Medicare?
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Unless the system is reformed, the Medicare Hospital Trust Fund is expected to be insolvent
by 2017 (under prior law) and under current law (PPACA), assuming Congress follows
through with the large projected reductions in hospital reimbursement, the new date for HI
insolvency is 2029. (see slide below)
In coming years, with the first of the 77 million baby boomers starting to retire in 2011, the
aging of the population will place great pressures on the HI trust fund. In 1960 just 9.2percent
of the population was over 65 years of age. By 2010 13.0 percent of the population was 65 or
older. Under the demographic pressure of the baby boomers, the number of Medicare
recipients will double by 2040(from 40million to 81million), when the last of the baby
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boomers will have turned 65. At that time almost one in five Americans (20.0percent) will be
older than 65. (see slide below)
Persons older than 65 have five times the medical costs of younger Americans. Large
numbers of retirees, combined with increased longevity and more expensive and advanced
medical technology, will generate huge increases in Medicare spending. Meanwhile, the
employee base supporting Medicare is eroding. (see slide below)
To continue the same Medicare benefits by year 2019 will mean that Medicare’s share of the
nation’s economy will increase from 3.5percent currently to 4.4 percent in 2015. Based on
the most pessimistic projections, the HI tax rate will have to be increased to 10.86 percent by
2030.
The political support for Medicare is likely to decline as the costs to the non-aged increase,
with a consequent increase in intergenerational political conflict. Once the baby boomers
start retiring in 2011, they have certain expectations as to what they will receive from
Medicare. Our political system cannot wait to resolve a political issue that involves such a
large redistribution of wealth among different groups in society
8. Proposed Reforms for Medicare:
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To make Medicare an equitable redistribution system, the “entitlement” myth of Medicare
must be recognized and its large welfare component acknowledged. Medicare should either
become similar to a pension system whereby people save for their own medical (and longterm care) expenses and/or government subsidies should be used for assisting low-income
aged (=welfare program).
Health plans should compete for beneficiaries based on price, quality, outcomes, and enrollee
satisfaction. They will then have incentives to be efficient and responsive to beneficiary
preferences.
It won’t be easy to find an equitable solution to Medicare’s financial problems because of the
political power of the aged & their supporters.
Reform will have to be gradual.
Suggested reforms that would increase efficiency and/or sustainability:
o Increase Medicare age to 67
o Change Medicare to voucher system, where seniors buy their own policies. Value of
voucher would be equal to 100% of the premium for low-income seniors and decline
in value for higher incomes.
o Vouchers more equitable because it doesn’t shift income to high earners as much and
would also induce health insurers to compete for the voucher business promoting
efficiency.
o Given the political power of the aged and their supporters, it will not be easy to find
an equitable solution to Medicare’s financial problems
Simply squeezing payments to providers will not increase efficiency nor equity
Increasing deductibles & copays is inequitable because low-incomes would face larger
relative burden.
9. How difficult will it be politically for Congress to enact Medicare reform? VERY!
 Past commissions unable to reach consensus on reforming Medicare because of potential
political costs to either party.
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The longer it takes, the more difficult it will be to reform. Future changes will have to be
larger causing more pain to affected seniors (& their politicians).
Part D Doughnut Hole:
Hospital Trust Bankruptcy
Medicare Beneficiaries
Spending Trends