estimates of the new Medicare law are at the center of a national
Senate's budget rules last year put an absolute limit of $400
billion on how much Congress could spend in adding a new
prescription drug benefit and making other changes in the Medicare
program. The Medicare Prescription Drug, Improvement, and
Modernization Act of 2003, signed into law last December, came in
just under that limit. According to the Congressional Budget Office
(CBO), the new law (since dubbed "MMA" for Medicare Modernization
Act) would cost $395 billion from 2004 to 2013. The drug benefit
itself would cost $410 billion over the coming decade, with the
extra spending offset by cuts elsewhere in Medicare.
Less than two months after the President signed the MMA
into law, the White House released a new, higher estimate: $534
billion from 2004 to 2013. The drug benefit suddenly costs
one-third more, even before the program has begun. This revelation
stirred demands from conservatives in Congress to establish
stronger cost-containment measures to hold additional spending to
the original $400 billion limit.
There is no way to determine which number
is more accurate, but no one should be surprised if the additional
amount actually spent by Medicare over the next decade exceeds even
the Administration's new estimate. Since the drug benefit is an
entitlement, Medicare will pay its share of seniors' drug costs no
matter how much is ultimately spent. Moreover, the drug benefit is
permanent and does not sunset in 10 years even though the cost
estimates span only a decade.
Douglas Holtz-Eakin, director of the CBO,
noted in December that new spending for the drug benefit could
reach $2 trillion between 2014 and 2023, and that assumes the lower
$395 billion cost through 2013. That estimate could substantially
understate the program's ultimate cost if a future Congress makes
drug coverage even more generous, perhaps by filling in the
"doughnut hole" in
the current benefit structure.
By any estimate, the new drug benefit has added greatly to
the cost pressures facing Medicare. The first wave of baby boomers
will reach age 65 beginning in 2011. Over the succeeding two
decades, there will be an unprecedented movement of people from
jobs to retirement as some 76 million baby boomers enroll in
Medicare. This will decrease our ability to pay for the needs of
seniors just when the demand for health services and other support
is at its highest. Prudent cost-containment measures are essential
if Medicare is to meet this challenge.
new MMA law contains important design elements that could help
constrain Medicare spending in the long term. The drug benefit will
be delivered through competing private plans, which will have a
strong incentive to negotiate price discounts that will help
constrain costs for both seniors and taxpayers. The law attempts to
reinvigorate competition among health plans in Medicare, and
bidding mechanisms will eventually mean that cost growth could be
moderated. Other initiatives include efforts to improve the quality
and appropriateness of care, disease management and related
mechanisms to optimize treatment for the sickest patients, and
greater use of information technology in Medicare. Such steps are
promising but unlikely to take Medicare off its spending binge in
the immediate future.
addition to building those cost-containment features into
Medicare's payment and delivery systems, the MMA includes an early
warning system intended to prompt legislative action if program
spending outpaces dedicated program revenues. The effectiveness of
such a system is only as good as the willingness of policymakers to
take what could be unpopular actions to limit Medicare spending.
Stronger actions could be required if the warning system is
triggered, but automatic policy responses carry their own
In an era of rising federal budget deficits, policymakers
may look for ways that can take effect almost immediately to halt
the runaway growth in Medicare spending. Quick fixes to reduce
program spending often do not work and might slow the development
of reforms that would have a longer-lasting impact on incentives
facing health plans, providers, and patients.
There is, however, another approach that
can work. A payment formula similar to that used in the Federal
Employees Health Benefits Program (FEHBP) would constrain Medicare
spending and protect beneficiary interests. But that would require
Congress to take on the difficult task of Medicare reform once
What the New Medicare Law Says About Cost
Title VIII of the Medicare Prescription
Drug, Improvement, and Modernization Act of 2003 establishes for
policymakers an early warning system that reflects the financial
activities of all parts of Medicare. That new system improves upon
the financial analysis offered in the annual report of the Medicare
trustees. Until recently, that report focused attention on the
solvency of the Hospital Insurance, or Part A, trust fund without
integrating information about the flow of funds through the
Supplemental Medical Insurance, or Part B, component of Medicare,
which is almost as large as Part A and is growing more rapidly.
A is funded by the Medicare payroll tax, a tax on Social Security
benefits, and other revenue sources that are specifically dedicated
to the Hospital Insurance trust fund. Consequently, solvency is an
issue for Part A. By contrast, beneficiary premiums pay 25 percent
of Part B costs, and the rest is covered by general revenue,
primarily from the personal income tax. The law provides unlimited
infusions of general revenue sufficient to cover Part B spending.
Part B cannot become insolvent, but the fiscal impact of Part B
spending is the same as that of Part A spending.
The introduction of the new Part D prescription drug
benefit makes a more comprehensive annual financial analysis of
Medicare necessary. Part D is a major expansion of the federal
Medicare entitlement, and all of the new program costs are paid out
of general tax revenue--primarily the personal income tax--rather
than from new funds specifically earmarked for the program.
Spending under Parts B and D combined will
exceed Part A spending in 2006, the first year that the full drug
benefit will be available. The proportion of Medicare spending
accounted for by Parts B and D will grow over time, and traditional
approaches to assessing the financial status of the program will be
decreasingly informative as a result. The new indicator established
by the MMA is the percentage of total Medicare spending that is
financed by general revenue.
The new law establishes a trigger for subsequent
legislative action if Medicare's draw on general revenue grows too
large. General revenues may not exceed 45 percent of total Medicare
outlays over a seven-year period in two consecutive annual reports.
(By comparison, general revenue covers about 35 percent of Medicare
spending today.) If
that condition is met, the President must submit legislation that
addresses Medicare financing.
Expedited procedures for consideration of
such legislation by the House and Senate are included in the new
law. The law does not require passage of that legislation and does
not preclude the enactment of provisions that would increase
Medicare spending despite the excess general revenue condition.
In addition to the new financial reporting mechanism,
Title VIII includes a change in the premiums paid for Part B by
high-income beneficiaries. Beginning in 2007, Medicare
beneficiaries with incomes over $80,000 for an individual or
$160,000 for a married couple will pay a higher premium if they
choose to participate in Part B. Beneficiaries below those income
levels will continue to pay Part B premiums equal to 25 percent of
the cost of the benefit. Premiums will rise with incomes, and
beneficiaries with incomes over $200,000 (or couples with incomes
over $400,000) will pay 80 percent of the average cost of Part B.
Those higher premiums would phase in over five years.
Social Security Administration will determine the incomes of all 40
million Medicare beneficiaries, using data from the Internal
Revenue Service and other sources. These data may reflect incomes
two years earlier than the year of a premium increase. Social
Security must take changes in family circumstances into account
when determining whether a beneficiary is required to pay the
The Impact of the Cost-Containment
new drug benefit moves Medicare very rapidly to the 45 percent
general revenue zone, which would trigger legislative consideration
of cost-containment action. In 2003, before passage of the MMA, the
Medicare trustees estimated that general revenue accounted for
about 31 percent of program spending. If the MMA had not been enacted, that
figure would have grown a few percentage points by 2013, still
comfortably below the 45 percent trigger level.
picture has changed dramatically. According to the CBO, the drug
benefit and other changes in the MMA will drive general revenue to
45 percent of Medicare spending in 2013. And even that might be optimistic.
Spending for prescription drugs might grow more rapidly than
projected, and Congress might make the benefit more generous or
make changes elsewhere in the program that raise spending without
adding to earmarked revenue. In that event, the general revenue
provision could be triggered in only a few years.
It is not clear how much of an impact the financial early
warning system will have on the public or policymakers. Regardless
of how poorly the concept is understood, reports of Part A's
impending insolvency have attracted widespread attention and
appropriate concern. Such reports may occasionally have prompted
cost-cutting moves by Congress. The 45 percent standard seems
technocratic and is unlikely to have the same public impact, even
though it is a more comprehensive measure of Medicare's financial
Policymakers may also be less responsive
to the more comprehensive statistic. There is no compelling reason
to set the standard at 45 percent instead of 44 or 46 percent, and
there is no clear or immediate consequence to exceeding the
standard by a percentage point or two. There is no requirement to
enact program changes in response to an excess general revenue
condition and little reason to think that the majority in Congress
would take what could be unpopular actions simply because a
statistic has exceeded an arbitrary level.
However, there is considerable value in
requiring the President to propose legislation to address rapidly
rising program costs. That, rather than the financial statistic,
will provoke the public debate necessary to stimulate the enactment
of future Medicare reforms.
Title VIII also requires high-income beneficiaries to pay
a higher share of the cost of Part B, which makes more explicit the
income redistribution that occurs through Medicare. High-wage
workers pay more in payroll and income taxes than workers earning
less, and high-income seniors were already contributing more to the
operation of Medicare because of the tax on Social Security
benefits. The higher Part B premium reduces further the subsidy
given to high-income seniors, although most will continue to gain
more than they have paid into the program over their lifetimes.
Policymakers were concerned that raising
the direct cost of participating in Part B, which is voluntary,
could cause high-income seniors to drop out of that program.
Consequently, the Part B premium is capped at 80 percent of the
average cost of covered outpatient services, ensuring that seniors
affected by the higher premium would still receive a subsidy of at
least 20 percent.
addition, the premium increase is limited to a small fraction of
the Medicare-eligible population. Even a substantial dropout rate
among high-income seniors would result in the loss of only a few
thousand people from the program.
Raising the Part B premium, even for a
small subset of seniors, poses a challenge and an opportunity for
Medicare: Consumers who pay more are likely to demand a health
program that is more responsive to their needs. Congress has taken
some initial steps toward reforming Medicare by enacting the MMA,
but the program remains overly regulatory and rigid. Future
initiatives can complete the job that has just begun by more
thoroughly reshaping Medicare.
Federal Employees Health Benefits Program has shown that government
health programs can offer greater variety in insurance offerings,
adapt to changes in medical technology, and constrain cost growth
while ensuring that consumer and taxpayer interests are
How to Improve the Cost-Containment
Congress is facing high and rising federal
budget deficits. There are pressing demands to increase spending
for defense, homeland security, tax relief, and many other policy
priorities. In that context, some approach that could constrain
Medicare costs and reduce the chance of a fiscal surprise due to
unexpected growth in Medicare spending would be welcome. One could
consider strengthening the budgetary control provisions in Title
VIII of the MMA, but cost controls that appeared to be effective
might make matters worse.
cost containment is possible only if the efficiency with which
resources are used in Medicare is improved. That means establishing
appropriate incentives for providers and beneficiaries, as well as
promoting competition and more cost-effective use of health
Other titles of the MMA introduce reforms
that begin to restructure Medicare and reduce unnecessary spending.
Title VIII, however, does not add meaningful cost containment to
Medicare. Instead, it adds a notification process that by itself
does not improve the structure or functioning of the program.
Serious cost containment will require further steps.
Step #1: Improve the Notification
real value of the general revenue trigger as currently written is
to initiate the policy debate over exploding Medicare costs. Since
there is no requirement to enact cost-cutting legislation in
response to that trigger, it makes little sense to delay the debate
for as long as envisioned in Title VIII. Nothing happens the first
time the Medicare trustees project excess general revenues, despite
the fact that a significant financial imbalance is likely to occur
within seven years. Instead, Congress and the President can wait
for a second report a year later before starting to develop
policies in response to the problem.
is likely that the President will not wait for the second report to
develop new proposals, but there is no reason why this could not be
made a requirement. As the entry of the baby boomers into Medicare
beginning in 2011 nears, the excess general revenue warning might
be sounded annually until comprehensive reforms that build on the
MMA are adopted. That will force the debate into the public eye and
may promote broader understanding of the issues and the policy
addition, the President's charge could be strengthened. As
currently written, the law requires the President to submit
legislative proposals to Congress in response to the warning issued
by the trustees, but there is no requirement that the proposals
reduce program cost. Proposals that increase Medicare's dedicated
revenue, such as increases in the payroll tax or Part B premiums,
do not address the program's inefficiency and might delay more
thorough reforms. The President's response could be required to
contain a preponderance of cost-reducing proposals.
Step #2: Avoid Automatic Spending
general revenue provision in Title VIII could be given some teeth.
For example, the law could be changed to require automatic
reductions in Medicare payments to providers and health plans once
general revenues are expected to exceed the 45 percent
Automatic increases in payroll taxes and
premiums for Parts B and D could also be imposed, which would raise
program revenue (and help reduce the overall federal deficit) but
would not reduce program cost. Alternatively, one could tie
automatic cost-cutting policies to the new drug benefit itself. A
proposal to keep Medicare drug spending to $400 billion was
advanced last year but was ultimately dropped from
automatic provisions would alter the political climate of cost
containment in Medicare. Once enacted, spending cuts that are
triggered by some financial indicator could be overridden only by
new legislation, which could prove to be difficult. Such a policy
puts the burden of proof on policymakers who oppose spending cuts
rather than on those who support cuts. This is the reverse of the
current situation, which requires new legislation to address an
excess spending problem in Medicare.
There are, however, drawbacks to putting
cost containment on autopilot. Mechanisms that automatically
trigger cuts in Medicare may be inflexible and not responsive to
new circumstances that call for changes in cost-containment
policies. Cost controls will not foster sustainable improvements in
Medicare, and automatic across-the-board cuts might inadvertently
undo reforms that have already been accomplished.
Targeting automatic cuts on specific
health services may not be an improvement. In particular, price
controls on drugs offer short-term savings, but controls also would
retard the research and development necessary to create new
treatments for diseases common to the elderly.
Automatic payment cuts are blunt tools and may not be
appropriate in future years. Market conditions facing providers,
economic conditions affecting beneficiaries, or the balance of
political power among competing interests in subsequent years may
create a need to alter previous policy, which would be
Congress is familiar with this problem. In
1997, lawmakers created the sustainable growth rate (SGR) formula
to constrain the growth of Medicare physician payments. The formula
created a trigger for automatically cutting physician fees paid by
seemed like a good idea until 2002, when fees were cut by 5.4
percent. Seniors in certain parts of the country found it
increasingly difficult to make appointments with some doctors, who
chose to close their practices to new Medicare patients in reaction
to the lower payment rates, and the physician community was up in
arms over such a substantial cut.
fee reductions do not seem to have been effective in slowing
Medicare spending, however. Although some physicians were paring
back their Medicare business, others reacted to the fee cut by
increasing the volume of services paid by the program. Medicare
physician payments increased by nearly $3 billion over the year
even though the average fee for each service was reduced.
Since then, Congress has tried several
times to reverse the policy, succeeding for short periods of time
but at some political cost. The biggest obstacle to changing
Medicare's physician payment policy is the loss of billions of
dollars of budget savings if the SGR formula were permanently set
aside. The advantage of the SGR policy--cuts in fees that would not
require new legislation--has become the barrier to making Medicare
payments to physicians more realistic or more politically
Proposals to cap the cost of the new drug benefit or
automatically limit Medicare spending rely on government price
controls rather than market competition. Such approaches can cut
costs in the short term by limiting the supply of health care
services to seniors. They do nothing to improve the efficiency of
health care delivery in Medicare, and may result in continued
subsidies to inefficient providers or continued waste in the use of
services. Controlling Medicare costs through automatic
across-the-board reductions in payments threatens to undo the
reforms already accomplished by the MMA.
Medicare+Choice (M+C) program illustrates this point. Congress
tried to expand the range of private health plan choices available
to seniors by creating M+C in 1997. Rather than enhancing choice
and competition, new payment rules that were expected to keep
Medicare costs under control contributed to an exodus of private
plans from Medicare. Those rules did not allow payment growth to
keep pace with the rising cost of services. Consequently, one of
the essential elements of competitive Medicare reform--the presence
of plan competitors--was dealt a blow by excessively tight price
would be ill-advised to repeat the M+C experience. Proposals to
apply new price controls to provider payments in the name of
limiting Medicare spending and reducing the federal deficit could
have the same unwelcome consequence for Medicare Advantage.
Savings, Long-Term Costs
An across-the-board reduction in Medicare payments to
providers is a blunt instrument that is unlikely to gain political
acceptance. Cuts also could be targeted on specific health
services, although the program's experience with the SGR policy
used to determine physician payments should give anyone pause.
Policymakers of all political stripes have
proposed various forms of price controls for prescription drugs,
ranging from direct federal price negotiation with pharmaceutical
manufacturers to importation of pharmaceuticals from Canada or
other countries that have their own price controls. It is a short
step from government price setting to an automatic mechanism to cut
those prices once some measure of excess spending is triggered.
a strategy could reduce program outlays without immediately
reducing the supply of pharmaceuticals available to seniors.
Manufacturers typically set prices that are substantially above the
cost of producing an additional dose of a drug, but those high
margins are needed to cover the costs of research and development
for that same drug and the large number of others that fail to
reach the market. If prices remain above the cost of production and
distribution, manufacturers will continue to sell existing
products, and shortages are unlikely.
the long term, however, a federal price-cutting mechanism will
discourage private funding for research and development. Fewer new
drugs will enter the market, particularly drugs that are used
primarily by seniors and thus are subject to price controls. Total
Medicare spending might be even greater in the long term with
controls on pharmaceutical prices if new cost-saving therapies for
diseases like cancer or heart disease never come on the market.
Step #3: Enhance Real Competitive
Various schemes to impose top-down cost
containment on Medicare are quick fixes that merely fine-tune a
flawed program. Without other changes in Medicare's structure,
patients and providers continue to face incentives that promote
overuse of services. The growth of program spending can be reduced
over the long term if we adopt measures that promote a better
functioning market in Medicare--one that enhances consumer choice
and rewards the delivery of effective, high-quality care.
MMA includes provisions that promote competition among private
plans in Medicare, and it introduces some new initiatives to
improve the quality and effectiveness of care delivered to seniors.
Those first steps could be improved upon by moving to a payment
structure modeled after the Federal Employees Health Benefits
Rather than attempting to set the prices
of thousands of individual health services delivered in every local
market in the United States, the FEHBP uses a payment formula that
sets the government's contribution to the premium charged by
competing health plans. Currently, the government pays 72 percent
of the weighted average premium of all health plans participating
in the FEHBP. The government contribution can be no greater than 75
percent of any plan's premium.
FEHBP's formula limits federal outlays but keeps the federal
contribution in line with general health cost increases. It also
allows enrollees to select the health plan that best meets their
needs. But enrollees who select a plan with high premiums must pay
the full amount over and above the maximum federal contribution.
Since the federal contribution is capped, health plans have an
incentive to price their products competitively. As a result, FEHBP
costs have grown at about the same rate as those of Medicare even
though the FEHBP has offered superior benefits (including
Medicare adopted a "premium support" approach similar to the FEHBP
payment method, adjustments would be necessary to ensure that
beneficiaries with low incomes or chronic health needs were
protected. The MMA introduced income-related subsidies for the new
drug benefit and tied Part B premiums to income, setting the
precedent for more explicit recognition that low-income
beneficiaries need more financial support through Medicare. Payment
risk adjusters have been developed for plans participating in M+C
to account for enrollees with higher health costs, and those
adjusters could be adapted to an FEHBP-style formula.
Premium support would change the
inappropriate financial incentives built into traditional Medicare.
Providers in traditional Medicare are paid on a fee-for-service
basis and are guaranteed federal payment for all necessary
services--a loose concept at best. Beneficiaries typically have
additional coverage from private insurers or Medicaid that pays for
most of their out-of-pocket costs.
Cost-containment methods that rely on
price controls and on lowering payment rates are often ineffective
because providers can expand their services while beneficiaries
have little financial reason to refuse care that has only minimal
health benefits. Where traditional cost-control methods are
effective, patient access to care is often interrupted.
Premium support would create incentives
for both providers and beneficiaries to seek appropriate and
efficient care. Over the long term, such an approach can slow the
growth of Medicare outlays, reduce unnecessary care, and promote
customer service and quality improvements.
Concern over the skyrocketing cost of
Medicare is well-founded. Medicare will spend $300 billion in 2004,
and those outlays are expected to grow 9 percent a year for the
next decade. That growth is fueled in part by the new drug benefit,
the cost of which is even now being debated by policymakers and
estimators. The one certainty is that taxpayers must pay whatever
is demanded of a program that remains an open-ended
formal cost-containment provisions in Title VIII of the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 do
little to address the cost problem in Medicare. The provisions
require the Medicare trustees to give a more comprehensive measure
of Medicare's financial status, and they also require that the
President submit legislative proposals to Congress if Medicare
requires too large an infusion of general revenues.
Title VIII does not include stronger cost
controls, such as spending cuts that are triggered in response to
the new financial measure, but that is fortunate. Those types of
cuts are at best palliative and do not address the underlying
incentive structure that drives Medicare spending growth.
we hope to control Medicare spending over the long term, Congress
must build on the competitive reforms contained in the MMA. While
political consensus on further reforms would be very difficult to
muster, simpler approaches are unsustainable.
Instead of working on new and more
complicated ways to set thousands of prices, Medicare should adopt
a premium support framework modeled after the Federal Employees
Health Benefits Program. Such a framework makes responsible cost
containment possible. Beneficiaries can be offered realistic
choices among health plans. Instead of imposing arbitrary payment
cuts, the federal government can make contributions under premium
support that can be limited while providing necessary protections
an arrangement would be far superior to the promise of a Medicare
entitlement that cannot be kept.
--Joseph R. Antos, Ph.D., is Wilson H. Taylor
Scholar in Health Care and Retirement Policy at the American