Medicare funding in perspective

Keith Hennessey's Medicare primer* highlights a rather obvious funding fact recently brought into sharp focus by James Kwak. First, the basics of Medicare funding, courtesy of Hennessey:

There are three main sources of financing the program.

• There are three financing sources:  dedicated payroll taxes, beneficiary premiums, & general revenues (income taxes).
• payroll taxes:  2.9% of all wages.  ½ paid by employee, ½ by employer.
• premiums:  25% of “part B” costs ≈ $96-115 per month.  High income seniors (income > $85K/person) pay higher premiums.
• premiums:  a % of “Part D” drug costs.  (complex formula). High income seniors pay higher premiums.
• general revenues = total spending – (payroll taxes + premiums)

Then, an elegant solution to Medicare funding per se, courtesy of Kwak (my emphasis):

We have to recognize that there are two separate problems, and they are not equal. The primary problem is health care inflation. The secondary problem is the long-term Medicare deficit. That’s a secondary problem because it’s largely a result of the primary problem.


Of these two, the Medicare deficit is the easier problem to solve: index the payroll tax to actual health care costs. This should automatically solve the Medicare deficit because as Medicare’s costs go up, its funding will go up at the same rate.*

This may sound like just raising taxes whenever the government wants to spend more. But the key is that the more taxes you pay, the more you get back. To see this, assume for now that Medicare is a pure price taker: it has no impact on health care costs but just has to pay what the market charges. Then, if health care costs go up by 5 percent, your taxes go up by 5 percent, but the expected value of your future Medicare benefits also goes up by 5 percent. You get all the insurance benefits of traditional Medicare, but now that insurance is worth 5 percent more, so you should be willing to pay 5 percent more.**

Raising taxes can have macroeconomic effects, but anything that solves the Medicare deficit problem will have macroeconomic effects: any solution involves either higher revenues or lower spending.

As Kwak makes clear, learning to love and roll with healthcare inflation is not a solution to the broad problem of equitably sharing healthcare costs and risks.  The real challenge is finding ways to restructure incentives for providers and patients in ways that will reduce our massive overutilization -- and our overpayment for treatment relative to every other wealthy country in the world. But the direct relationship between the Medicare payroll tax and the deficit does put the challenge in perspective.  Were the country not pathologically tax-phobic, we would recognize that we can pay for Medicare while we wrestle -- measure by measure, pilot by pilot -- with the cost curve.

* Flagged by the Dish, natch.