Taxpayers will find out this year whether Congress is serious
about grappling with entitlement spending, the single most
important domestic policy issue facing the nation. Medicare, with
44 million enrollees, poses the most serious challenge. The program
is burdened with gigantic debt: $34 trillion in unfunded
liabilities--the benefits promised to current and future Medicare
enrollees but not yet financed by current and future taxpayers.
A trigger in Medicare law requires the President and Congress to
consider budgetary changes in the program this year. Rather than
tweaking the status quo, Congress should focus on proposals that
move the program toward a new system based on free-market
principles.
The Trigger
Former Congressional Budget Office (CBO) staffers Joseph R.
Antos and Tracy Foertsch, in an econometric analysis of the impact
of the Medicare debt, concluded that honest funding of the promised
Medicare benefits would require the current Medicare payroll tax to
increase from today's 2.9 percent to 13.4 percent.[1]
The President has recently submitted his Medicare budget
proposals to Congress, outlining $178 billion in savings over five
years.[2] As they have in the past, senior
congressional leaders are already dismissing these proposals as
unrealistic or "dead on arrival."
Meanwhile, current Medicare law requires the President and
Congress to act on Medicare spending because the Medicare Trustees
have made a formal determination that the program is relying on
excessive draw-downs from general revenues, meaning that outlays
are not being sufficiently financed by dedicated revenues for
Medicare. The Trustees are required to issue a warning when they
find in two consecutive determinations that general revenue
financing of the program would exceed 45 percent of total Medicare
outlays within seven years. The Medicare Trustees made such a
determination in their 2006 report and issued a "funding warning"
in their 2007 report. The law requires the President to submit
remedial legislation to Congress, and Congress must consider it or
an alternative on an expedited basis. [3]
The budgetary changes needed to meet the statutory requirement
that general revenues not exceed 45 percent of Medicare outlays are
not in themselves particularly onerous. The issue is Medicare
policy underlying the budget changes, not the budgetary adjustments
themselves. Medicare is not simply about dollars and cents. Rather,
the problem is the structure of the program as a centralized
bureaucracy that will be unable to absorb efficiently the wants and
needs of the large and diverse baby boom generation within the
boundaries of fiscal responsibility.
When making budgetary changes in Medicare, Congress can choose
between two broad directions: reinforcing the current structure of
traditional Medicare or moving toward comprehensive Medicare
reform.
Reinforcing the Current Structure
Medicare is currently a defined-benefit, open-ended entitlement
program governed by central planning and price controls, with
virtually every aspect of the financing and delivery of medical
goods and services under the regulatory control of the Medicare
bureaucracy.
It is not difficult to fashion budgetary changes to accommodate
the existing structure. The traditional methods are simple: tighten
up the existing system of Medicare price controls on doctors,
hospitals, and other medical providers; add a new system of price
controls to prescription drugs under the guise of "negotiation";
impose new standards or requirements on doctors, hospitals, or
other medical providers as a condition of reimbursement (e.g., "pay
for performance" schemes); reviser payment formulas to exclude
payment for the delivery of care under new or unapproved
circumstances; slow or restrict access to new medical technologies
or medical procedures; or reduce payments to private health plans
serving Medicare enrollees, which are routinely described as
"overpayments" (compared to traditional Medicare's supposedly
"right" administrative payment).
Of course, Medicare's administrative pricing is notoriously
arbitrary and does not reflect real economic conditions of supply
and demand for medical services. The normal result is overpayment
for some services and underpayment for others. Nonetheless, if the
policy objective is to preserve the basic structure of central
planning and price regulation, then traditional methods would be
effective: The Medicare bureaucracy's power would increase, and its
regulatory reach would expand.
The modification of Medicare's administrative payment formulas
may appear complex, but the underlying principle is simple. Without
the interaction of supply and demand in a normal, functioning
market, cost-control options are severely limited. Government
officials cannot control the demand for medical services (or
anything else, for that matter). They can only control the supply.
In a centralized system like traditional Medicare, the most
efficient way to control supply without appearing to cut benefits
for enrollees directly is to cut the payments for those benefits.
That is the main function of price controls as a cost-control
mechanism. It is an undesirable policy for senior and disabled
citizens enrolled in Medicare because, at the end of the day, it
simply shifts costs onto them in distinctly unpleasant ways.
Reform-Based Budgeting
The alternative to reinforcing the traditional Medicare
structure is to make budgetary changes that advance or are
compatible with a movement toward comprehensive Medicare reform.
Such reform would consist of restructuring the entire program
around the free-market principles of consumer choice and
competition.
Though there are a number of variations on the theme of
comprehensive Medicare reform, the central component is a
transition from a defined-benefit system to a defined-contribution
system. Medicare would become a system of competing health plans,
including plans that workers choose to bring with them into
retirement. Government would continue to subsidize the health care
of seniors and the disabled, but the government contribution would
be specific (not open-ended) and could be adjusted for income, age,
or health status. Retirees with incomes higher than 400 percent of
the federal poverty level are affected much less by health care
costs than lower-income retirees are. Also, 10 percent of
beneficiaries--the oldest and sickest--account for more than
two-thirds of Medicare expenditures.[4]
In pursuing comprehensive reform, Congress could incorporate the
best features of competitive models that are already in operation.
For example, the most prominent model for Medicare reform has been
the Federal Employees Health Benefits Program. Originally proposed
by analysts at The Heritage Foundation,[5] this model has been adopted
by the House Republican Study Committee (RSC) as part of its budget
proposal.[6]
Congress should also closely examine the impressive work of the
National Bipartisan Commission on the Future of Medicare of 1999,
particularly the Breaux-Thomas "premium support" proposal. With
this proposal, government and private health plans would compete on
a level playing field, enrollees would get "premium support" toward
the purchase of a plan of their choice, and government
contributions would be income-related. The proposal would reduce
the cost growth of Medicare by 1 to 1.5 percentage points per year,
based on the original 1999 estimates.
Congress should also take notice of the well-performing parts of
the existing Medicare program, particularly the health plan
competition in Medicare Part D, the prescription drug program, and
the new Medicare Advantage program. Competition works, and patients
are more satisfied when they can exercise personal choice. In
Medicare Part D, the projected average monthly premium has dropped
by a stunning 38 percent since the inception of the program.
Additional cost savings of $117 billion are projected from 2008 to
2017.[7] In Medicare Advantage, the new system of
competitive private plans created under the Medicare Modernization
Act of 2003, almost 20 percent of Medicare enrollees have chosen
private health plans with superior benefits, including preventive
care, care management programs, and prescription drug coverage.
The following budgetary options would be compatible with
comprehensive Medicare reform:
Expand income-related subsidies. All Medicare subsidies
should be income-related. More help should go to enrollees with
lower incomes or higher health care costs. To a limited extent,
Congress followed this principle with changes in Medicare Part B,
requiring individual seniors with incomes of $80,000 per year or
couples with annual incomes of $160,000 per year to pay higher
premiums.
Under current law, the income thresholds are indexed annually,
thus limiting the number of enrollees subject to the higher
premiums in later years. Congress could eliminate this indexing
feature for Part B and apply the same new income rules to Part D,
the prescription drug program. In both Part B and Part D, the
taxpayer today pays 75 percent of the costs of benefits. It is not
unreasonable for wealthy seniors to pay slightly more. President
Bush submitted these proposals, which would have saved $10.3
billion over a five year period, last year.[8]
Raise enrollees' share of the Part B premium from 25 percent
to 30 percent. When Medicare was enacted in 1965, the law
provided that taxpayers would pay 50 percent of Part B premiums for
physicians and outpatient medical services. This was based on the
Great Society understanding of the social contract. In the 1960s,
the senior population was comparatively less well-off financially
than it is today. Congress eroded this mutual obligation over time
and in the Balanced Budget Act of 1997 permanently limited the
seniors' share of the Part B premium to 25 percent of the total
premium.
Ideally, Congress should restore the original arrangement of a
direct 50-50 split in Medicare Part B premium payments; in the
short term, Congress should at least raise the basic premium from
25 percent to 30 percent. This change would not negatively affect
the poorest seniors--roughly 7 million enrollees--because Medicaid
pays their Medicare premiums under current law. According to the
CBO, raising the basic Part B premium from 25 percent to 30 percent
of total premium costs would save $6.8 billion this year and $42.2
billion over five years.[9]
Restructure traditional Medicare cost-sharing for Part A,
Part B, and Medigap. Medicare has a variety of cost-sharing
requirements for benefits under Parts A and B.
In 2007, under Part A (the part of Medicare that pays hospital
bills), the basic deductible was $992, and there was a schedule of
cost-sharing, depending on the length of the hospital stay. The
daily amount of Medicare hospital coinsurance rises with the length
of hospital stay, going from no coinsurance at all for the first 60
days to as much as $496 per day after 91 days. Instead of the
traditional protection from progressively rising out-of-pocket
costs that one normally finds with private health insurance,
Medicare Part A schedules the reverse: The sicker one is, the
higher one's out-of-pocket payment. Traditional Medicare, of
course, has no catastrophic benefit, which is why the vast majority
of its beneficiaries must purchase or secure supplemental
coverage.
Home health care is also covered under Medicare Part A, but the
home health benefit has no coinsurance and unlimited home health
care visits. With Part B (the part of Medicare that pays
physicians' services and outpatient benefits), the basic deductible
is $131, and the coinsurance requirement for most medical services,
treatments, or procedures is 20 percent. The exception is
outpatient mental health benefits, which have a hefty 50 percent
coinsurance requirement.
Meanwhile, Medigap supplemental insurance is used not only to
supply the necessary catastrophic coverage, but also to cover the
costs of deductibles and coinsurance in traditional Medicare.
One way to improve this situation is to abolish this complex set
of cost-sharing requirements for traditional Medicare and replace
it with a uniform deductible for both Part A and Part B, a
standardized coinsurance rate, and an annual cap on out-of-pocket
costs. In one scenario, cost-sharing for Part A and Part B would be
replaced with a combined deductible of $500 and a cap on
out-of-pocket expenses of $5,000, indexed to Medicare's per capita
costs. According to the CBO, this proposal would reduce costs by
$11.6 billion over five years.[10]
In a variant of this proposal, the Republican Study Committee
offered a budget proposal in 2006 that would have provided a
uniform deductible of $500, a standardized coinsurance requirement
of 20 percent, and an annual cap on out-of-pocket expenses for each
beneficiary at $2,500. The RSC proposal would also have prohibited
any Medigap policy from covering the standard $500 deductible while
permitting Medigap policies to cover 50 percent of the Medicare
beneficiary's total coinsurance payments.
In another variant of this proposal, Medigap policies would be
prohibited from paying the first $500 of a Medicare beneficiary's
cost-sharing in the first year (2008) and half of any additional
cost-sharing up to $4,500. Medigap would cover Medicare
cost-sharing above that amount. According to the CBO, the proposal
would save $1.9 billion in 2008 and $14.4 billion over five
years.[11]
Establish a co-payment for home health benefits. Home
health benefits are broadly used, and Medicare alone accounts for
38 percent of all home health care spending in the country.[12] As
noted, there are no limits on home health visits, and there is no
coinsurance requirement.
With the rapid growth of the Medicare population over the next
several years, beneficiaries' use of home health benefits will
grow. Since there is no cost-sharing requirement for these
services, the best option for Congress would be to establish some
sort of co-payment. For every episode of home health care usage--60
days--Congress could impose a co-payment of 10 percent of the costs
of the benefit. According to the CBO, this would reduce Medicare
spending by $12.9 billion over five years.[13]
Conclusion
The President has submitted a series of budget proposals to cope
with the immediate and long-term problems confronting Medicare, but
congressional leaders have dismissed the President's proposals out
of hand. They have yet to offer anything substantive to cope with
the enormous challenge of entitlements, notably the $34 trillion
Medicare problem. In any case, the law requires the President and
Congress to act this year on Medicare spending.
Some Members of Congress will doubtless attempt to offer serious
proposals to cope with the long-term challenges facing Medicare, as
well as to fulfill the immediate requirements of the Medicare
funding warning. Members should make proposals that are logically
compatible with real reform: the transformation of Medicare into a
system that is governed by consumer choice, competition, personal
freedom, and a plentitude of health care options. They should avoid
making budgetary changes that only entrench the status quo and
enhance the power of the Medicare bureaucracy.
The budget cycle of 2008 will be another test of congressional
seriousness in the face of America's top domestic challenge:
entitlement spending.
Robert E. Moffit, Ph.D.,
is Director of the Center for Health Policy Studies at The Heritage
Foundation.