Commentary

How to Save Medicare

This article appeared in the San Francisco Chronicle on April 3, 2005.

The late economist and Nixon adviser Herb Stein used to say that if something cannot go on forever, eventually it must stop.

The 2005 Medicare Trustees Report issued last month makes plain that Medicare cannot go on forever. But no one wants to confront the reality that the escalating costs of this entitlement program must be curbed.

Medicare, which subsidizes health care for the elderly and disabled, accounts for 2.6 percent of gross domestic product. But because the cost of medical care is growing faster than the economy and the number of people drawing Medicare benefits will soar when Baby Boomers start turning 65, Medicare’s trustees predict the program will grow to 13.6 percent of GDP by 2079.

Not that the federal government has the money to pay for all that. The revenue sources created for Medicare can cover only a portion of its current costs, let alone its projected growth. According to Medicare trustee and economist Tom Saving, last year Congress had to dip into general revenues to cover Medicare’s funding shortfall — to the tune of almost 9 percent of all federal income-tax revenue.

As Medicare grows, so will this deficit. Saving and his Texas A&M colleague Andrew Rettenmaier estimate that it will reach 25 percent of federal income-tax revenue by 2020, and 50 percent by 2040.

Clearly, this cannot go on forever. It’s unlikely that Congress will agree to “save” Medicare via massive transfers away from national defense and other programs. Nor can Congress fill in the gap by raising taxes. According to Jagadeesh Gokhale, a senior fellow at the Cato Institute, Congress would have to immediately increase the Medicare payroll tax from 2.9 percent to 17.8 percent of all wages — an increase of more than 500 percent — to cover Medicare’s future deficits. If Congress waits until 2008, the required rate would be 19.8 percent — an increase of nearly 700 percent.

Such a tax increase would be politically unfeasible. Workers would revolt at the thought of losing another 15 percent of their wages to the IRS. As Harvard economist Martin Feldstein points out, it would be economically unwise as well. The resulting drop in economic activity would make “the total burden of the extra spending nearly twice as large as the additional health resources. ” It would also be insufficient. Even if taxpayers went along, so long as seniors’ health consumption is heavily subsidized, Medicare spending will continue its rapid growth.

All this suggests that Medicare cannot go on forever as it exists today, and that at some point Congress will have to cut benefits. If Congress takes the lead, it could impose a package of cuts that could include:

— raising the eligibility age;

— requiring higher copayments from wealthy seniors;

— reducing seniors’ choice of doctors; or

— eliminating covered services.

Such cuts would be imposed on seniors, who would have little choice but to go along. That is just one reason Congress should act now to give seniors ownership over their Medicare benefits. It could do so by moving Medicare from a system where the political process defines (and revokes) benefits to a system where seniors choose the benefits that matter most to them.

Under the latter option, Medicare could give each senior a voucher with which to purchase health coverage. Seniors could supplement the voucher with their own funds if they want more generous coverage. If seniors choose, the voucher could fund a health savings account as well. Congress could adjust the size of vouchers according to health risk. Giving seniors with more expensive health conditions a larger voucher would prevent insurers from avoiding those with high medical bills.

Better yet, Congress could give seniors ownership over their Medicare benefits from day one. Feldstein, Saving and Rettenmaier have all proposed allowing workers to place their Medicare payroll taxes into a personal- retirement health savings account. They argue this would allow the power of compound interest to help prefund Medicare’s future liabilities. Such a reform would also guarantee that future politicians cannot revoke seniors’ health benefits.

Giving seniors ownership over their health-care dollars would give them maximum latitude to preserve the benefits that mean the most to them as individuals, and it would spare them the misery of having politicians and bureaucrats eliminate the coverage they value the most.

That Medicare must change is inevitable. What is not inevitable is that we will preserve seniors’ right to control their own health care.

Michael F. Cannon is director of health policy studies at the Cato Institute