Medicare Math

This article appeared in the Wall Street Journal on April 15, 2004.

Some economists are suggesting that the Medicare Trustees’ report — released recently — reveals only about a third of the truth. It shows that out of Medicare’s three subprograms, only one faces a financial shortfall. However, the report counts general revenue transfers as dedicated resources for the other two subprograms. This is an accounting convention that negates the very purpose of financial reporting — which is to provide useful information to policymakers. It should be changed.

A program’s financial imbalance can be neatly summarized in one number — the amount of additional money in an interest‐​bearing account today that would be sufficient to plug all future shortfalls between its projected outlays and receipts. According to the Trustees’ report, Medicare Part A — which reimburses hospital services for retirees — faces a financial imbalance of just under $22 trillion.

The Supplementary Medical Insurance program (Medicare Part B) and the new Prescription Drug program (Medicare Part D) receive funding out of general revenues. (Medicare Part C — also called Medicare Advantage — under which retirees can opt to join HMOs, does not have its own trust fund, and its costs and financing are included in Parts A and B.) General revenue transfers to Parts B and D are decided each year to make up the difference between expected benefit payments and expected premiums collections from the program’s enrollees during the next year. Because the law requires such general revenue appropriations, Medicare’s actuaries assumed general revenue availability for Medicare Parts B and D throughout the future — and reported zero unfunded obligations for these subprograms.

However, economists, including those with the Private Enterprise Research Center run by Thomas Saving (one of Medicare’s public trustees) have released briefing notes suggesting that Medicare’s total shortfall is much larger — about $62 trillion. Unlike the Trustees’ report, PERC does not treat general revenues as a dedicated funding stream for Medicare when calculating its financial imbalance.

Neither approach is “wrong,” given the law. However, the question remains about which of the two is more appropriate and useful. A simple argument suggests that PERC’s method is better: To decide on future spending priorities and reforms, a nation’s leaders would direct all public departments to report their financial status by assuming continued provision of public goods and services at current levels. If some departments — such as Medicare’s Parts B and D — include general revenues as an inexhaustible resource, they will always report a zero imbalance irrespective of spending levels.

Financial imbalances over an extended future are not reported for most federal programs that are funded out of general revenues — such as defense, the criminal justice system, highway construction etc. Were they reported, however, and were they to adopt the convention of including general revenue sources, they would all report zero imbalances. This accounting convention, therefore, hides competing claims on the same general revenue dollar when no one — not even Congress — can spend the same dollar multiple times.

It is, of course, entirely appropriate to include general revenues when evaluating the financial imbalance for all federal programs together. However, if the objective is to provide useful information to policymakers, the financial reports of individual programs should exclude general revenue funding — even if current practice or laws extend such funding to them.