The Cost of No Medicare Reform: What Industry and Government Would Pass on to Consumers, Investors, Taxpayers, and Workers


The Cost of No Medicare Reform: What Industry and Government Would Pass on to Consumers, Investors, Taxpayers, and Workers

October 16, 1995 3 min read Download Report

Authors: Rea Hederman, Christine Olson and David Winston

(Archived document, may contain errors)

October 16, 19 9 5


By David H. Winston, Christine L. Olson, and Rea S. Hederman

If an unreformed Medicare program is to be able to pay the hospital bills of today's workers when they reach retirement, industry and government will have to pass on additional yearly costs of at least $7.4 billion to investors and consumers. In addition, workers will face additional annual costs of at least $115.7 billion in direct taxes and reduced wages. These costs will be the result of the additional payroll taxes, on top of current payroll taxes, needed to assure long-term fiscal sol- vency of the cash-strapped Medicare hospitalization trust fund if no reforms are enacted. The reason the burden is so heavy on employees is that an increase in payroll taxes technically is shared by both the employer and the employee. Experience indicates that about 88 percent of the cost of addi- tional employer taxes is passed on to workers in the form of reduced wages and compensation. I Moreover, the cost of stabilizing the hospital trust fund is only part of the necessary burden if re- forms are not implemented. To cover the rising costs of Part B, which covers physicians' costs, Congress would have to raise taxes even further. The current financial status of Medicare is precarious. Without significant structural reform of the system or increases in the current payroll tax to maintain the level of benefits and spending, Medi- care will go bankrupt. For Medicare to remain financially solvent and legally able to pay for hospi- tal care for today's "baby boomers" when they retire, Congress needs either to find additional money for the hospital trust fund or to slow down its rate of spending. Trustees'Tax Options. The seven members of Medicare's Board of Trustees have determined that the Medicare Hospitalization (111, or Part A) Trust Fund that finances hospital services for the elderly will be insolvent by 2002. In addressing the tax question, the trustees have outlined three possible options to solve the financing problem if no structural reforms are enacted: a short-term op- tion of an immediate 1.3 percent additional payroll tax, needed to keep the hospital program solvent for 25 years; an intermediate option of a 3.52 percent payroll tax, needed now to make the hospital program permanently solvent; and a high-cost option of a 3.9 percent payroll tax, needed if no action is taken until the actual depletion of the Medicare trust fund in seven years.2 For purposes of econometric analysis, the authors of this study used the trustees' intermediate option of a 3.52 percent payroll tax, under which Congress, rather than adopt structural changes in the pro- gram, would keep Medicare basically the same and finance the same level of benefits and projected costs through tax increases. Under this scenario, the trust fund would be able to pay for hospital care for the foreseeable future, not just for the next 25 years. V Under this option, an additional tax of 3.52 percent of taxable payroll would be Afshared" between employers and employees. According to earnings data by industry taken from the March 1994 Current Population Survey, the total yearly cost of this additional HI payroll tax would have been $123 billion, or about two percent of Gross Domestic Prod- uct, had such a tax gone into effect in 1993. On average, using an 88 percent "pass through," and had the tax increase been in effect in 1993, the combined d 'irect tax and indirect wage loss to employees would have been about $862 per employee, for a total cost to employees of $115.7 billion (out of the $123 billion).3 The amount of new tax not paid directly by employees or indirectly passed through to them would take the form of additional costs to customers and investors. The analysis delineates the impact by industry of a 3.52 percent increase in the HI payroll tax. Overall, us- ing the 88 percent "pass through" effect on employee wages and compensation, and had the tax been in effect in 1993, industry would have $7.4 billion to pass on to consumers and inves- tors, rather than to employees. If the tax were imposed now, that number could be much larger because of the growth in earnings since 1993. V Retail trade, educational services, and public administration would be the hardest hit by such a tax, together shouldering nearly $15 billion, or 25 percent of the cost of the additional tax before passing it on to employees, customers, and investors. The retail trade industry alone will have to pass at least $800 million on to customers and investors, with educational services and public administration passing on $542 million and $487 million, re- spectively. Unlike the private sector, public-sector employers do not have the luxury of passing on costs such as additional Medicare payroll taxes to customers and investors. Taxes must be increased or programs cut to pay for whatever costs are not passed on to employees in the form of reduced wages and compensation. Moreover, taxpayers potentially could fund a larger share of the burden of the additional payroll tax than customers and investors in the pri- vate sector since government pay scales and contracts could restrict their ability to pass on ad- ditional costs to employees.

1 The 88 percent is based on such analyses as Jonathan Gruber and Alan B. Krueger, 'The Incidence of Mandated Employer-Provided Insurance: Lessons from Workers Compensation Insurance," Tax Policy and Economy (199 1); Jonathan Gruber, "The Incidence of Mandated Maternity Benefits," American Economic Review Vol. 84 (June 1994); and Lawrence H. Summers, "Some Simple Economics of Mandated Benefits," American Economic Review, Vol. 79, No. 2 (May 1989).

2 For a discussion of the trustees' tax options, see Stuart M. Butler, 'Ile High Cost of Not Reforming Medicare," Heritage Foundation F Y.L No. 56, May 4, 1995. 3 See Robert E. Moffit, John C. Liu, and David H. Winston, "What Americans Will Pay If Congress Fails to Reform Medicare: The State and Congressional District Impact," Heritage Foundation F. YL No. 62, September 19, 1995.


Rea Hederman

Former Director, Center for Data Analysis and Lazof Family Fellow

Christine Olson

David Winston