We Must Defuse the Medicare Time Bomb Now

June 7, 2005
Thomas Healey and Robert Steel

The Financial Times

While President George W. Bush remains focused on Social Security, an even bigger fiscal time bomb is ticking away in the US — Medicare.

The Social Security trust fund is projected to become exhausted in 2041; but the public health system runs completely dry much sooner: in 2020. What is more, to bring Social Security into balance over the next 75 years would require a 15 percent increase in payroll taxes today (or a corresponding reduction in benefits), while bringing Medicare into balance would require an immediate 107 percent increase in revenue (or a 48 percent reduction in outlays).

Even more significant, the present under-funding of Medicare (Dollars 29,700bn) is more than seven times that of Social Security (Dollars 4,000bn).

Few leaders in Washington seem willing to face the fact that Medicare is a structurally broken system in far worse shape than Social Security that could bring the American economy to its knees in a relatively short amount of time.

As accumulating evidence makes abundantly clear, Medicare is not just an undercapitalised system, it is a severely flawed model. One of its biggest defects is the inherent mismatch between revenues and expenditures. Medicare is largely funded through a payroll tax of 2.9 per cent, and through premiums from Supplementary Medical Insurance. Because they are tied to the rate of business growth, payroll revenues have proven to be woefully insufficient, particularly in economically stressed times such as the past few years. SMI premiums, for their part, only cover 12 per cent of total Medicare costs. Not surprisingly, the Medicare trustees predict that the programme’s assets — which are held in Medicare trust funds to cover the hospital insurance portion of the health plan — will be exhausted by 2019. To illustrate the deterioration, four years ago the prediction was for depletion by 2025.

Exacerbating the problem is the fact that over the past 40 years, medical costs have outstripped economic growth by three percentage points. One of the chief drivers of this increase has been dramatic advances in medical technology and patient treatment — obvious benefits that unfortunately carry a huge price tag.

Faced with this looming crisis, why have no serious efforts been made to treat the root of the problem?
Few, if any, incentives exist to prudently manage or control the cost of medical treatment. In the case of retired people, they will undertake treatment as long as the value of that care is more than the co-payment for which they are responsible. In the case of providers of medical care — doctors, nurses and other health professionals — any desire to restrain costs through less expensive treatment alternatives is often overridden by self-interest or the perceived need for treatment that is, in fact, excessive. Finally, politicians have virtually no short-term inducements to tackle the Medicare problem. Any change that leaves the elderly worse off will lead to ballot box reprisals by a large and vocal segment of the population. On the other hand, pressure from much younger workers who fund Medicare is nearly non-existent.

Given the magnitude of the problem, 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. Even this may be insufficient, however, creating the need for reductions in entitlements and/or increases in taxes and costs to beneficiaries (possibly involving some form of means-testing). Implicit in such policy change is the realisation that all stakeholders — not just the young — need to bear the burden of making Medicare sustainable. We cannot keep blindly passing on Medicare’s costs to future generations. While this is a daunting task, it is not without precedent. A similar, albeit smaller, imbroglio involving Social Security was effectively addressed in the early 1980s by a bipartisan commission headed by Alan Greenspan. This presidentially-appointed panel was strikingly successful in strengthening the fabric of a fraying Social Security system.

That model could — and clearly should — be adopted for Medicare. The sooner we get started the better; delay exacerbates the problem and makes solutions even more painful.

Thomas Healey is a former assistant secretary of the Treasury and a retired partner of Goldman Sachs. Robert Steel is a former vice-chairman of Goldman Sachs. Both are senior fellows at the Kennedy School of Government, Harvard University.

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