What Americans Will Pay If Congress Fails to Reform Medicare: The State and Congressional District Impact


What Americans Will Pay If Congress Fails to Reform Medicare: The State and Congressional District Impact

September 19, 1995 10 min read Download Report

Authors: Robert Moffit, David Winston and John Liu

(Archived document, may contain errors)

September 19. 1995


By Robert E. Moffit, John C. Liu, and David H. Winston Medicare's increasingly dangerous financial plight leaves Congress with only two options if the program is to continue providing health care to seniors: either restructure and reform the pro- grain or significantly increase payroll taxes on America's businesses and working families. While payroll taxes technically are shared between employers and employees, in reality most taxes on busi- ness are shifted to workers in the form of reduced wages or compensation-in some cases, even job loss. Thus, any new payroll tax to shore up the financially failing Medicare system will be another tax on America's working families. Medicare's seven-member Board of Trustees, which includes President Clinton's Secretaries of Health and Human Services, Treasury, and Labor, has determined that the Medicare Hospitalization (HI, or Part A) Trust Fund, which finances hospital services to the nation's elderly, will be insolvent in the year 2002. It urges "prompt, effective and decisive action" to address Medicare's financial condition. In the words of David Walker and Stanford Ross, the Board's two "public trustees" (pri- vate citizens), Medicare "is clearly unsustainable in its present form," and its reform "needs to be ad- 992 dressed urgently as a distinct legislative initiative. Several proposals have been advanced to restructure Medicare. Using a well-tested model for con- gressional reform, Heritage Foundation analysts have proposed transforming the current Medicare system into one that would look like the Federal Employees Health Benefits Program (FEHBP), the popular 35-year-old consumer-driven program that covers retired congressional and federal workers. The FEHBP, unlike Medicare, is based on the market principles of consumer choice and competi- tion.3This would allow Medicare enrollees to pick government-certified private insurance plans and, like retirees in the FEHBP, receive a government contribution toward the purchase of those plans. Similar legislation is being considered on Capitol Hill. Americans are beginning to understand that unless Congress restructures Medicare to preserve high quality medical services but at lower cost, Congress will have to cut the supply of medical serv- ices available to enrollees or significantly increase the HI payroll tax to avoid the bankruptcy of the HI Trust Fund. 4 With the notable exception of the 1989 repeal of the costly Medicare Catastrophic Coverage Act of 1988,5 Congress has expanded, not deleted, Medicare's benefits and services. Its failure to reform the program means that Congress will likely resort to higher taxes on working families to cover Medicare's soaring costs. But given the gravity of Medicare's financiil condition, particularly the threatened bankruptcy of the HI Trust Fund, the level of taxation on workers and businesses that would be needed just to finance the program in its current form would be enormous, dwarfing even the Clinton Administration's tax hike of 1993, the largest single tax increase in U.S. history. Taxpayers also should realize that in addition to any HI payroll tax, they will pay general taxes to maintain the solvency of Medicare Part B, which covers doctors' fees and other services. Taxpayers already subsidize 71 percent of the cost of Part B's premiums. Unless Congress implements changes, the taxpayer's share will increase automatically to 75 percent on January 1, 1996. Accord- ing to the Congressional Budget Office, the taxes required to fund Part B will jump from an esti- mated $57.5 billion in 1996 to $93.5 billion by the year 2000. 6 Medicare's Payroll Tax. Middle-class American families with children today surrender well over one-third of their income to federal, state, and local taxation. Federal taxation alone takes ap- proximately 25 percent of this average family income.7 And among many families, federal payroll taxes for Social Security and Medicare even exceed the federal income tax. 8 Medicare's hospital insurance program currently is funded through a 2.9 percent federal payroll tax, divided equally between employers and employees with each paying 1.45 percent, except for the self-employed, who pay the full 2.9 percent. The imposition of an even higher Medicare payroll tax, like the imposition of a mandate on an employer to purchase health insurance for employees, is an additional labor cost on business.9 But business labor costs are largely passed on to workers in re- duced wages, benefits, or even employment. Standard economic analysis confirms this well-known "pass through" effect of business labor costs on the wages of employees. A survey of the economic literature by Lewin-VFH, one of the nation's leading econometrics firms, indicates that for every additional $ 100 in mandated benefits an employer must provide for an employee, an average of $88 will be paid for in reduced wages. 10 Today, the Medicare FH tax is still a relatively modest payroll tax. But over the years it has grown steadily to finance the hospitalization program, and it will get bigger if Congress cannot reform Medicare in a cost-efficient fashion. When the HI tax was first imposed in 1966, it was limited to the first $6,600 of taxable income per year. In the years since the enactment of the Medicare pro- grain, the maximum taxable amount has been raised 23 times. 11 Through the Omnibus Budget Rec- onciliation Act of 1993 (P.L. 103-66), Congress, upon the recommendation of the Clinton Administration, repealed the legal limitation on taxable income as part of its major 1993 tax initia- tive This means that all earnings today are subject to the HI payroll tax.


As explained in the Medicare Trustees' Report, the "adequacy of the HI program's scheduled fi- nancing to support program costs in the future is examined under three alternative sets of assump- tions: low cost, intermediate, and high cost. The low cost alternative is a more optimistic set of assumptions from the standpoint of HI financing and the high cost alternative is a more pessimistic SP12 set of assumptions. Further, continues the Report, "[the] intermediate set of assumptions repre sents the Trustees' best estimate of the expected future economic and demographic trends that will affect the financial status of the program." The analysis used in this study uses the intermediate as- sumption. The reality is that under any of the three assumptions, the HI Trust Fund will face insol- vency in from six to eleven years. Because the current political environment has focused the debate in terms of "preserving the solvency" of the HI Trust Fund, long-tern! solutions are necessary. The Medicare trustees have outlined three possible scenarios for Congress should it choose not to reform the Medicare program and decide simply to raise the HI payroll tax. The options range from taking immediate action to various stages of delay. Naturally, if Congress fails to take immediate steps as suggested by the trustees, the required increase in the HI payroll tax will be higher in the fu- ture than it would be if they raised the HI tax immediately. Because the trustees believe that "prompt, effective, and decisive action is necessary," 13 the analysis in this study centers around their estimate that the increase required to achieve long-term actuarial balance is 3.52 percent of tax- able payroll. 14 In order to achieve a long-term actuarial balance in the FH trust fund (permanent fiscal sol- vency), 15 the Medicare trustees have stated that HI payroll taxes could be increased immediately or by a higher amount at some future time. If Congress opts to place the HI Trust Fund on a course towards permanent fiscal solvency through an additional increase in the percentage of taxable income, this will mean 3.52 percent in additional taxation, bringing the total HI payroll tax to 6.4 percent, di- vided equally between employers and employees.


Using the Heritage Foundation health care simulation model (see appendix for technical specifica- tions), Heritage analysts have computed both the magnitude and the wage effects, by state and con- gressional district, of an additional 3.52 percent HI payroll tax on workers throughout the country. This analysis represents a "snapshoe' of the impact of the payroll tax based on 1993 earnings data, the most recent data generally available. It indicates the impact if the tax had been in effect in 1993. Given the general growth of earnings, total costs would be even greater if the new tax were levied in 1996 or thereafter. Assuming that such a tax increase went into effect, households would face seri- ous financial consequences. CONSEQUENCE #1: A 3.52 percent increase in the Hl payroll tax would result in a total of $123.03 billion in new taxes levied on employers and employees in its first year of imple- mentation. Had the increase been in effect in 1993, the aggregate increase in taxes would range from $101.2 million on wage earners in Wyoming to a high of $7.74 billion on wage earners in California during the first year. Businesses in those states would face a similar levy. Other high tax states would include New York ($9 billion, split between employers and employees), Texas ($8 billion), and Florida ($5.9 billion). As earnings and payroll costs increase in future years, tax revenues also would increase.

Earners in different congressional districts in some cases would face heavy new tax burdens. In aggregate, the 14th district of New York would be hardest hit ($362,000 each on workers and employers), followed by the 29th district of California ($303,000). CONSEQUENCE #2: A 3.52 percent increase in the HI payroll tax would have a significant impact on employees' earnings, equal to a $115.6 billion loss in earnings if its effect had been felt fully in 1993. Since most of the payroll tax on employers in practice is passed through to employees in reduced earnings, the total impact on workers is larger than the increase in direct payroll taxes. On average, using an 88 percent "pass through," and had the tax increase been fully in effect in 1993, the combined tax and wage loss to employees would range from $656 in Arkansas to $1,081 in New Jersey. To put this in perspective, average wage earnings ranged in 1993 from $19,840 in Arkansas to $32,659 in New Jersey. Thus, the loss would not be insignifi- cant for the average wage earner. Workers, on average, would experience a negative impact on their earnings exceeding $ 1,000 per year in both the District of Columbia ($1,052) and Alaska ($1,002). Other states in which the negative impact on workers' earnings would be substantial in- clude Connecticut ($996), Massachusetts ($992), Maryland ($980), and New York ($954). This is based on 1993 earnings. In future years, the size of this cost to employees would increase pro- portionately with the increase in employee earnings compared with 1993. CONSEQUENCE #3: A 3.52 percent increase in the HI payroll tax would be larger than the tax increase of 1993. Enacted as part of the Omnibus Reconciliation Act of 1993, the Clinton Administration's tax recommendations amounted to $262.5 billion over five years, the largest single tax increase in American history. But if Congress fails in its efforts to reform and restruc- ture Medicare, and resorts to a 3.52 percent additional payroll tax to shore up the financially trou- bled hospitalization program, the HI tax increase could exceed it. According to the analysis conducted by the Medicare trustees, the revenues of such a payroll tax could reach $711.0 billion over just five years, 16 almost tripling the huge 1993 Clinton tax increase.


If Congress fails to reform Medicare and resorts instead to a heavy new payroll tax to rescue the Part A Trust Fund from bankruptcy, even an increase as high as 3.52 percent, that new level of taxa- tion on America's working families will still be insufficient to maintain the program in its current form. The reason is that the other part of Medicare, the Supplemental Medical Insurance Program (SAG, or Part B), will require an alarming increase in general tax support to continue paying for phy- sician and outpatient services. VVhile Medicare Part B, because of its design, is not threatened with financial insolvency, its costs are exploding. Over 70 percent of these costs today are bome by tax- payers. Under current law, the Congressional Budget Office projects that taxpayers already will be spending $370.5 billion in taxes over the next five years, subsidizing 75 percent of the Supplemen- tary Medical Insurance program.

General Tax Subsidies Needed for Part B (billions of dollars)

Fiscal Years

Taxpayers' existing obligation to subsidize Part B program

1996 $57.5

1997 65.1

1998 72.3

1999 82.1

2000 93.5

5-year total 370.5

Source: Congressional Budget Office, March Baseline, May 11, 1995.


State-Level Analysis Assumptions The national aggregate of employee earnings was derived from the March 1994 Current Popula- tion Survey. These earnings are for 1993. The cost calculations assume the payroll tax increase had been in effect that year: the normal growth in earnings means that the payroll tax and its associated costs would be higher in 1996 and subsequent years. Due to the nature of self-reported income surveys, the CPS generally underestimates earnings. In order to compensate for this, we compared the CPS total with the national employee and proprietor earnings reported in the Statistical Abstract of the United States table on national income in 1993 (as determined by the U.S. Bureau of Economic Analysis, Survey of Current Business, April 1994) in order to develop a multiplier to adjust the CPS reported earnings. After April 1986, all state and local employees were required to pay Medicare taxes. In 1991, however, the law was amended to allow those hired prior to that date to opt out. The Congressional Research Service has estimated that as of March 1994, 1.7 million workers were not covered by Medicare. Using the 1.7 million figure we removed those workers and their earnings from our totals based on the state-by-state distribution of state and local employees and their earnings in the March 1994 Current Population Survey. Based on a survey of economic literature estimating the "pass-through" wage effect of employer mandates by health care econometrics firm 1&win-VHI, we assumed 88 percent of the cost of the ad- ditional tax to be passed to employee in reduced compensation. 17 We also assumed that the pass- through had fully occurred. Therefore, we assumed the total cost of the additional Medicare tax to employees to be 88 percent of the business's share of the Medicare tax (about 1.56 percent) in addi- tion to the 1.76 percent tax on wages paid directly by the employee. Total cost to employees (direct and indirect pass through) was divided by the total number of wage earners who did not opt out to determine the average cost per wage eamer by state.

Congressional District Analysis Assumptions To calculate the cost of the Medicare HI tax at the congressional district level, we used the 1990 U.S. Census STF-31) file in addition to our state-level findings, calculated using the 1994 Current Population Survey. The 1990 STF-31) file contains congressional district data, while the Current Population Survey data can be analyzed at the individual and state levels. In order to account for increases in earnings that occurred 1990-1993, we compared the 1990 STF-31) numbers with the earnings for each state, calculated using the 1994 Current Population Survey. We assumed that for each state, increases in wages were normally distributed within the state. It also was necessary to remove from our analysis the earnings of those state and local employees exempt from Medicare taxes. To do so we again compared the distribution of state and local employ- ees in congressional districts, calculated using the 1990 STF-31) numbers, with the 1994 CPS state- level distribution of earnings of the exempt 1.7 million state and local employees. As in the case of earnings, we assumed those state and local employees were normally distributed throughout the state's congressional districts. In addition, we did not account for state and local employee wage dif- ferentials between congressional districts. The total number of households per congressional district also has changed since 1990, so we compared the total households from the STF-3D file with total households in the 1994 Current Population Survey to calculate the number of households per CD in 1993. We determined the cost per household in our analysis; however, because this includes households with no income, the ac- tual cost to households with income will be higher.

I Research Analyst Rea Hederman contributed to this study.

2 Social Security and Medicare Boards of Trustees, Status of the Social Security and Medicare Programs, A Summary of the 1995 Annual Reports, April 1995, p. 13.

3 See Stuart M. Butler, Robert E. Moffit, and John C. Liu 'Vhat To Do About Medicare," Heritage FoundationBackgrounder No. 1038, June 26, 1995.

4 Cutting back benefits is not likely to be the option of choice. In combination with other methods of cost control, liberals in Congress can be expected to pursue a more subtle, but indirect, way of limiting the services through regulation, particularly tightening the already tight Medicare price control system while imposing even more effective restrictions on the volume of medical services to the elderly and disabled.

5 For an account of the explosive politics surrounding the adoption and repeal of the Medicare Catastrophic Coverage Act of 1988, see Robert E. Moffit, "Ibe Last Time Congress Reformed Health Care: A Lawmaker's Guide to the Medicare Catastrophic Debacle," Heritage Foundation Backgrounder No. 996, August 4, 1994.

6 Congressional Budget Office March Baseline, "Medicare Outlays by Fiscal Years, in Billions of Dollars," May 11, 1995.

7 For an excellent discussion of the tax burden on America's working families, see Robert Rector, "Reducing the Crushing Tax Burden on America's Families," Heritage Foundation Backgrounder No. 98 1, March 7, 1994.

8 "In fact, the median two earner'family paid more last year for Social Security than federal income tax: $8,163-15 percent of its income-vs. $5,58 1 - 10 percent." Joseph S. Coyle, "How to Beat the Squeeze on the Middle Class," Money, May 1995, p. I 10.

9 For a discussion of the effects of employer mandates on wages and employment, see John C. Liu, "Clinton Heavy: The Kennedy Health Bill," Heritage Foundation Issue Bulletin No. 197, July 21, 1994.

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

11 David Koitz, "Medicare Taxes, Premiums, and Government Contributions for 1995," CRS Reportfor Congress, December 20,1994, p. 3.

12 1995 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, April 3, 1995, p. 1; cited hereafter as Trustees' Report.

13 Ibid., p. 4.

14 Ibid., p. 21.

15 In general, long-range actuarial solvency is achieved if for each of 65 valuation periods within the full 75-year-long range projection period, under intermediate assumptions, the actuarial balance is not less than zero or is negative. For a more detailed explanation of the Test for Long Range Close Actuarial Balance, see Trustees' Report, p. 9 1.

16 See Trustees' Report. See also, Stuart M. Butler, "Me High Cost of Not Reforming Medicare," Heritage Foundation F. Y.L, No. 56, May 4, 1995, p. 2.

17 See footnote 10.


Robert Moffit

Senior Fellow

David Winston


John Liu

Senior Policy Analyst