September 17, 2003

September 17, 2003 | Commentary on Medicare, Taxes

The Coming Medicare Tax Increase

“If you think health care is expensive now, wait until you see what it costs when it’s free,” P.J. O’Rourke once said. He may as well have been describing the Medicare drug benefit being hatched by President Bush and Congress. They’re on the verge of approving the most expensive government expansion since the Great Society.

Yet amid the debate over coverage levels, co-payments, HMOs and “doughnuts,” an important question goes almost ignored:

Who’s going to pay for this?

President Reagan once promised a drug-free America. Lawmakers now promise free drugs for Americans. Except they won’t be free; the costs will simply shift from senior citizens to younger taxpayers. Yes, the same taxpayers who will be tapped to bail out Social Security and Medicare when those programs go bankrupt will soon have to subsidize prescription drugs for all seniors, regardless of need.

Congress says this benefit will cost taxpayers more than $400 billion over 10 years. But that’s merely an educated guess. Once enacted, entitlements take on a life of their own: Enrollment increases, benefits expand, inefficiencies mount. Take Medicare itself, created in 1965 at a projected annual cost of $10 billion. The annual cost by 2003: $244 billion. Congress should move beyond a 10-year cost projection and focus on what this drug benefit will cost further down the road.

Using data provided by Thomas Saving, Ph.D., one of two public trustees of the Medicare trust fund, The Heritage Foundation has calculated those costs. By 2030, a drug benefit will cost taxpayers $148 billion per year (in 2003 dollars). Total cost by 2030: $2 trillion. And that’s on top of the $5 trillion shortfall Medicare is already projected to face that year.

How will Congress pay for this? It could hike Medicare premiums or cut spending elsewhere, but that seems highly unlikely. Deficit spending could temporarily fund the program, but it must be repaid with taxes. And that means current and future workers will be hit with massive tax increases.

Consider a married couple, both 40 years old. They already pay the 15.3 percent payroll tax to fund current Medicare (and Social Security) beneficiaries. Because the tax won’t provide enough revenue to fund Medicare for all retirees, this couple faces nearly $40,000 in additional taxes between now and the time they retire in 2030. The proposed drug benefit would add $16,127 to that tax burden, bringing the total to more than $56,000.

None of these taxes -- the payroll tax, the tax needed to fund the current Medicare shortfall, the tax needed to fund a drug benefit shortfall -- will be set aside for this couple’s own retirement. Every dollar will pay for current Medicare recipients.

Now consider a baby born this year. By age 27, the child has likely married, begun a career, and started a family -- and inherited an overwhelming tax burden. In 2030, her household will pay $1,125 in taxes just to cover the unfunded drug benefits of seniors. This is in addition to the payroll tax, plus $2,855 in extra taxes her household will have to pay to cover the shortfall Medicare faces even without the drug benefit. These taxes will grow rapidly over the next 40 years before her own retirement.

Adding a new drug benefit will accelerate Medicare’s plunge into bankruptcy. It means that income taxes will have to be raised by an average of 18 percent through 2030 just to keep the program solvent. Options for a tax hike of that magnitude include:

Raising most income tax rates by 7 to 9 percentage points each;

Eliminating the home mortgage tax deduction, child tax credit, and earned income tax credit; or

Repealing the tax exclusion that exempts employees from paying taxes on the value of their health insurance.

Of course, lawmakers won’t tell you that. They seem content to spend now and leave the inevitable tax hikes to future Congresses.

President Bush and his allies in Congress cite tax relief as the centerpiece of their economic agenda. Yet lawmakers who vote for the Medicare drug benefit are voting for a $2 trillion tax increase. Who would have thought “free” drugs could cost so much?

Brian Riedl is the Grover Hermann fellow in federal budgetary affairs in the Roe Institute for Economic Policy Studies at The Heritage Foundation.

William Beach is director of Heritage’s Center for Data Analysis.

About the Author

William W. Beach Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Medicare, Taxes