The Heritage Foundation

Backgrounder #1387 on Health Care

July 31, 2000

July 31, 2000 | Backgrounder on Health Care

Schemes Will Not Solve Medicare's Financial Problems

Taxpayers should always beware of accounting gimmicks that would merely move funds from one federal budget account to another while claiming to reserve tax dollars for a specific purpose. This is especially true when it comes to Medicare, the financially troubled health care program that covers approximately 40 million senior citizens and disabled Americans. Some in Congress have joined President Bill Clinton and Vice President Al Gore in promoting as a remedy for Medicare's problems the establishment of a "lock box," whereby surplus tax dollars would be set aside in a safe place to accrue interest and be used for Medicare expenditures in the future. Taxpayers should indeed be wary.

To be sure, this approach is politically attractive; it connotes security and fiscal conservatism. At best, it indicates Washington's good intentions. But at worst, the lock box proposals rely on an accounting gimmick that could lure taxpayers into believing that this approach somehow will fix Medicare's problems. Neither the Administration's proposed lock box mechanism nor the congressional approach would substantially improve Medicare's financial condition; one might even make the situation worse for beneficiaries. Regardless of what the phrase "lock box" implies, there is no sure way to keep future Congresses from "picking the lock" to spend that money on other federal priorities.

Medicare spending is projected to increase rapidly, beginning in 2007, even before the 77 million baby boomers start to retire and their unprecedented demand for technologically sophisticated medical services begins to consume ever larger shares of the federal budget. Historically, Congress has responded to rising Medicare costs by cutting back on reimbursements to doctors, hospitals, home health agencies, and nursing homes. But as it learned following its reimbursement cuts included in the Balanced Budget Act of 1997, the result is cuts in real services to senior citizens. For these and other reasons, top experts from such government agencies as the U.S. General Accounting Office (GAO) have stated that the Medicare program in its current form is unsustainable. 1

The Mechanics of Creating a "Lock Box" Account

A major weakness shared by the lock box proposals put forth by Members of Congress and both the President and Vice President is that they only offer broad outlines of what they are meant to accomplish; they do not describe the specific mechanics that must be followed to accomplish those objectives.

Federal accounts do not simply spring up at the first suggestion in Washington. As the following steps show, a proposal for a lock box account will not cause even a paper shuffle of funds until:

  • A specific agency has been selected and federal financial managers are given authority by law, regulation, or direction from their supervisors to establish a new line item account;

  • The line item account is recorded and an identification number assigned using guidelines established by the U.S. Department of the Treasury's Financial Management Service; and

  • Regulations and/or policies are published describing the nature of the account, how deposits are recorded, and the uses and limitations on outlays from the account.

Thus, the process is involved, transparent, and specific.

A Medicare lock box account could be established in the budget of one of several federal agencies or departments (within the Health Care Financing Administration, the Department of Health and Human Services, the Bureau of the Public Debt, the Financial Management Service, or the Treasury). It could be recorded and identified as a revolving account or as an expenditure account (with different guidelines), or a new form of identification could be created with new regulations. Financial managers administering the account could be directed to deposit its assets in Federal Reserve banks, to purchase and hold special issue Treasury notes, or with congressional authorization to invest in private-sector equities.

The implications of these decisions for the operation of a lock box are profound. Essentially, these decisions would determine whether Medicare continues to be treated as an insurance program or becomes a welfare program.

The fact that neither the congressional proposal nor the plan backed by the President in 1999 and now by the Vice President includes such details indicates that the proposals are merely statements of good intention, not serious policy proposals to fix Medicare.


There is no question that Medicare costs will begin to rise sharply or that, under the current system, America's taxpayers would have to pay more taxes to insure the health care of retirees. The important question should be how to make Medicare spending more efficient while reducing the tax burden on working families and retirees and guaranteeing that seniors have access to high-quality medical care. As the majority of members of the congressionally appointed National Bipartisan Commission on the Future of Medicare, chaired by Senator John Breaux (D-LA) and Representative William Thomas (R-CA), have concluded, a system based on patient choice and competition would accomplish these goals. The system they recommended should be modeled after the Federal Employees Health Benefits Program (FEHBP), which covers Members of Congress, their staffs, federal retirees, and their families. The FEHBP offers its 9 million beneficiaries premium support and a choice of plans that compete for enrollees, and the result has been high-quality service and a variety of coverage options.

Rather than resorting to accounting gimmicks like a lock box, Congress should build upon the success of the FEHBP and get down to the hard business of structurally reforming the troubled Medicare program.

HOW EACH LOCK BOX PROPOSAL WORKS

As Chart 1 and Chart 2 show, the lock box proposals put forth by some Members of Congress and by the President and Vice President share several similarities: 2  

  • Neither approach creates an additional source of income or reduces federal expenditures, the only effective methods for improving the financial health of any program.

  • Both proposals assume that payroll taxes will continue to exceed Medicare payments to beneficiaries and thereby generate surplus revenue for the Medicare trust fund. 3

  • Both plans would transfer the excess funds to other federal accounts.

  • In addition, both assume that the trustees of the Medicare trust fund would continue to use Medicare payroll tax dollars to purchase special issue Treasury bonds (T-bills), depositing them as IOUs in the Medicare account, while depositing the cash to buy the T-bills into the general fund to be used later for general fund expenditures or to reduce the debt.

These plans, however, also differ in some respects. The congressional proposal assumes that continual economic growth will cause personal income tax revenue to increase steadily and generate surplus revenue in the general fund that will be equal to or larger than the surplus generated by the Medicare portion of the payroll tax. This plan proposes using this general fund surplus to pay down the national debt by annual amounts equal to or greater than twice the surplus revenues deposited in the Medicare trust fund. This is not a lock box in the sense of a separate account, but is often referred to as a lock box by Members of Congress.

Vice President Gore has proposed a lock box approach that essentially is the same as one proposed by President Clinton in 1999. 4  It assumes that surplus payroll tax dollars will be deposited in a lock box account controlled by the Medicare trust fund. Trust fund administrators would use the funds to purchase special issue T-bills (IOUs), depositing the cash to buy them in the general fund. This plan does not assume that personal income taxes will generate a surplus in the general fund. It does propose paying down the national debt by an amount equal to or greater than the surplus revenues deposited in the lock box account.

The Administration-backed plan also would credit the lock box with IOUs equal to the interest payments saved by paying down the national debt. At this time, it is unclear whether this approach would calculate the interest savings by comparing real annual interest payments to a given benchmark, such as the high level in 1998 of $363 billion, or by calculating the interest saved on the debt that is actually retired during a given year. The former method would result in a $363 billion annual general fund transfer to Medicare, a big bite on the taxpayer, while the latter would yield diminishing annual payments as the federal debt is retired.

The congressional proposal shuffles funds between accounts on paper and will have little effect on the underlying problems of the system. But the Administration-backed proposal is potentially more harmful. When the U.S. General Accounting Office examined President Clinton's 1999 proposal on transferring general fund surpluses to Medicare, David M. Walker, Comptroller General of the United States, concluded:

The President's proposal to grant Medicare additional Treasury securities creates the risk of reducing transparency about the underlying financial condition of the HI Trust Fund. Although arguably justified as a way to lock in debt reduction, the transfers are not necessary to do this. What concerns me is the transfers extend the solvency of the HI Trust Fund on paper without making the hard choices needed to make the whole Medicare program more sustainable in economic or budgetary terms. Increasing the HI Trust Fund balance alone, without underlying program reform, does nothing to make the Medicare program more sustainable--that is, it does not reduce the program's projected share of GDP or the federal budget. From a macro perspective, the critical question is not how much a trust fund has in assets, but whether the government as a whole has the economic capacity to finance all of Medicare's promised benefits--both now and in the future.

In fact, the transfer would interfere with the vital signaling function that trust fund mechanisms can serve for policymakers about underlying fiscal imbalances in covered programs. The greatest risk is that the proposed transfer will reduce the sense of urgency that impending trust fund bankruptcy provides to policymakers by artificially extending the solvency of the HI program through 2027--well into the peak of the baby boomers' retirement. 5

A BIPARTISAN SOLUTION TO MEDICARE'S PROBLEMS

Instead of resorting to accounting gimmicks like "lock boxes," Congress and the Administration should build on the recommendations that the majority of members of the National Bipartisan Commission on the Future of Medicare put forth in 1999. 6  These commission members recommended a system of financing health insurance services that relies on premium support, with generous federal contributions being made to various competing plans chosen by patients. This is what Members of Congress, their staffs, and millions of federal workers and retirees have to assure their access to quality care in the popular Federal Employees Health Benefits Program. It is similar to many private-sector health plans that make premium payments directly to health insurance providers selected by individual employees.

Under the model proposed by these commission members:

  • Medicare patients would be given access to a package of health benefits far more generous than those available to them in the current program, which would include prescription drug and catastrophic coverage;

  • Low-income patients (with incomes up to 135 percent of the official poverty level) would have drug coverage fully subsidized, with no displacement of the private market by the additional government spending; and

  • Private health plans would have to compete directly for Medicare patients' dollars.

The principal difference between the commission majority's proposal and the lock box mechanisms backed by the Administration and some Members of Congress is that the former relies on the use of premium support payments to allow each Medicare recipient to choose the health plan most suited to their individual needs. (See Chart 3.)

Although the lock box proposals focus on how funds would be transferred between federal accounts--neither increasing revenue nor decreasing expenditures--the commission majority's plan would create a mechanism that actually reduces expenditures. By allowing individuals to choose their own health insurance plan to find the most beneficial package of services, the premium support feature would reduce the level of federal outlays that are needed to achieve equal or higher levels of health care. More than a mere paper shuffle, the commission majority's proposed premium-support accounts would maximize the effectiveness of Medicare's health care expenditures.

By building on the recommendations of the majority of the Bipartisan Commission chaired by Senator Breaux and Representative Thomas, Congress could improve access to high-quality care, including prescription drug coverage, for America's retirees while effectively addressing Medicare's financial problems. Indeed, as Dan Crippen, Director of the Congressional Budget Office, wrote to Senator Breaux after analyzing the preliminary premium support proposal, "Your proposal would foster greater competition among plans and greater choice for beneficiaries. We believe increased competition will reduce costs.... [T]he general direction of the proposal is clearly promising." 7

With premium support, Medicare patients would have an incentive to choose their plan of coverage wisely and reap the reward of premium savings by switching from less efficient to more efficient plans. This would reduce Medicare's costs by forcing health plans to compete on price and benefits; it would slow the growth in Medicare spending; and Medicare patients would not have to buy supplemental (Medigap) health plans to cover gaps in coverage.

Independent analyses of Medicare by the Congressional Budget Office 8  and the Office of the Actuary at the Health Care Financing Administration (HCFA) have concluded that real savings in Medicare could be achieved by moving to a premium support system like the FEHBP. For example, according to a 1999 analysis by the Office of the Actuary, Medicare savings from such an approach would pass $40 billion by 2006 and reach somewhere between $347 billion to $372 billion by 2009, resulting in an overall reduction in Medicare spending of between 11 percent and 12 percent through the year 2030. 9

CONCLUSION

Few disagree that the Medicare system is in financial trouble. Prospects of an explosion in the number of senior citizens in a Medicare population that will soon be twice the size of today's beneficiary group makes reforming the system more urgent. But President Clinton, Vice President Gore, and some Members of Congress continue to debate meaningless lock box plans that are little more than accounting gimmicks and will do little to solve Medicare's underlying problems.

Washington should concentrate instead on serious reform proposals, such as the one recommended by a majority of members on the National Bipartisan Commission on the Future of Medicare. This approach would create a system modeled on the successful Federal Employees Health Benefits Program, which serves over 9 million federal workers and retirees and their families. In the FEHBP, health care costs are controlled more efficiently and effectively by the market forces of patient choice and competition. This approach would reduce costs and generate real savings in Medicare. Congress should stop wasting time with accounting gimmicks, needlessly worrying seniors by delaying reform.

Peter Sperry is formerly Grover M. Hermann Fellow in Federal Budgetary Affairs, and Robert E. Moffit, Ph.D., is Director of Domestic Policy Studies, at The Heritage Foundation.


1. David M. Walker, Comptroller General of the United States, Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal , statement before the Committee on Finance, U.S. Senate, 106th Cong., 1st Sess., GAO/T-AIMD/HEHS-99-133, March 10, 1999, p. 2.

2. The congressional "lock box" plan is set forth in H.R. 3859, the Social Security and Medicare Safe Deposit Box Act of 2000; see http://thomas.gov. The Vice President's plan may be found at http://www.algore2000.com/briefingroom/releases/pr_0706_IL_1.html

3. The Medicare program has three parts: Part A finances hospital insurance (HI); Part B finances supplemental medical insurance, which covers outpatient services and physicians' fees; and Part C, the Medicare+Choice program that became the centerpiece of the Balanced Budget Act of 1997, creates a highly regulated market of private, mostly managed care plans for seniors who wish to enroll in them. Part A provides premium-free coverage of part of the costs associated with certain hospital stays that have limited follow-up services, skilled nursing care services, and a limited number of home health visits (with deductibles and other limits). It is financed through a 2.9 percent payroll tax, shared by the employee and employer, that is deposited in the HI trust fund, which is currently operating with surplus revenues.

4. A description of the President's Medicare proposal is included in the U.S. General Accounting Office, Medicare Reform, Observations on the President's July 1999 Proposal , GAO/T-AIMD/HEHS-99-236, July 22, 1999.

5. Ibid. , p. 17 (emphasis added).

6. The draft version of the report of the Bipartisan Commission was approved by 10 of the 17 members, a clear majority but one short of the number required to issue a formal report. A copy of the proposal may be found at http://thomas.loc.gov/medicare/fiscal.html .  For additional analysis, see Stuart M. Butler, "Reorganizing the Medicare System to Ensure a Better Program for Seniors," Heritage Foundation Backgrounder No. 1294, June 14, 1999, at http://www.heritage.org/library/backgrounder/bg1294es.html

7. Dan L. Crippen, Director, Congressional Budget Office, in a letter to The Honorable John B. Breaux, February 18, 1999, at http://www.cbo.gov/showdoc.cfm?index=1092&sequence=0&from=5  (July 25, 2000).

8. Congressional Budget Office, "A Preliminary Review of the Premium Support Model as a Foundation for Medicare Reform," February 9, 1999, attached to ibid.

9. Based on a February 23, 1999, analysis by HCFA's Office of the Actuary as cited by Senator John Breaux on February 24, 1999, at a meeting of the National Bipartisan Commission on the Future of Medicare, at http://thomas.loc.gov/medicare/fiscal.html  (July 21, 2000).

About the Author

Robert E. Moffit, Ph.D. Senior Fellow
Center for Health Policy Studies