Medicare's approaching financial distress is enormous and well
publicized. The Medicare trustees calculate Medicare's total excess
costs at $85.6 trillion. This is the amount in present
value by which Medicare's future spending exceeds its dedicated and
internal revenues, such as payroll tax receipts and premium income.
As this calculation illustrates, the Medicare program is
unsustainable. Medicare's finances are not the only reason to
reform the program, but they are a compelling one.
As with any difficult task, it is important to have a simple,
bottom-line measure of success. Eliminating the program's excess
costs is an obvious goal for Medicare reform. Medicare's projected
total excess costs reflect the extent to which Medicare funds
promised benefits by drawing on general revenues of the U.S.
Treasury, that is, tax collections from all other sources.
Eliminating Medicare's excess costs entirely would eliminate all
general fund support. In 2007, that would have meant eliminating a
$179 billion transfer from the general fund to Medicare.
While eliminating Medicare's total excess costs would be ideal,
it is more than what is necessary to achieve sustainability. A
lesser fiscal goal would be sufficient, and there are several from
which to choose. As with all budget matters, the reduction to be
achieved is a matter of setting priorities and weighing financing
demands against other revenue and spending priorities.
While Medicare's drain on the economy and on the federal
government's general revenues is significant, it has so far
been manageable. This suggests that a rule to guide Medicare reform
could be to hold constant Medicare's level of general revenue as a
share of gross domestic product (GDP). In effect, such a rule would
hold the budget pressures Medicare imposes at today's levels
relative to the size of the economy.
In 2007, Medicare's claim on general revenues amounted to 1.3
percent of GDP. Establishing a rule that Medicare not claim more
than this share of GDP reduces the dollar amount by which reforms
must cut costs by more than 25 percent, leaving a more achievable
$63.4 trillion in needed Medicare reform savings.
The Necessity of Reform
As a basic element of the nation's social safety net, Medicare
is a vital program for senior citizens. Yet the needs of seniors
change over time, as do health care markets and the practice of
medicine. Medicare needs to change accordingly, and many dimensions
of the program should be reviewed as part of reform. Modernizing
Medicare by adding a drug benefit, for instance, was sound, despite
the serious flaws in design and implementation.
Reforms are needed for many reasons, but the compelling fact is
that Medicare is unaffordable in its current form. Already
expensive to seniors and burdensome to taxpayers, its costs will
soon outstrip its own resources by a wide margin, putting
enormous pressures on the federal budget and the economy. Left
unchecked, Medicare's claim on national resources will rise from
2.7 percent of GDP in 2007 to 5.9 percent in 2030, and eventually
to 15.6 percent in the following years. Making Medicare fiscally
sustainable challenges the nation's will and capacity to act.
One element driving Medicare spending is the imminent retirement
of the baby boom generation, an enormous demographic bulge tracing
back to the end of the World War II. Americans qualify for Medicare
on their 65th birthday, and the first baby boomers turn 65 in
A second and more important driver of Medicare spending is
health care inflation--which has exceeded inflation in the rest of
the economy for many years and is expected to continue to do so.
This relative excess in health care inflation has many causes, and
is itself a main cause of the growing interest in reforming the
broader health care markets. If health care markets are
substantially reformed, and if the reforms reduce the rate of
health care inflation, these reforms would significantly
reduce the rate of growth in Medicare spending.
However, health care reform will take time to devise, legislate,
and implement, and its consequences will take time to
materialize. In the meantime, the retirement of the baby
boomers remains an abiding problem. Thus, even with highly
successful reforms to the nation's health care markets,
Medicare will still require major reforms to achieve long-run
A Suitable Budget Rule and an
In every endeavor, especially a difficult one, it is important
to set goals that reflect success and justify the effort, but
also to set goals that are achievable and not unduly
aggressive or unrealistic. Setting an appropriate goal for Medicare
reform is all the more important because of the related and equally
difficult tasks of reforming Social Security and Medicaid.
In 2007, Medicare tapped the general fund of the Treasury for
$179 billion, or about 1.3 percent of GDP. To put this in
perspective, this was equivalent to about half of all federal
corporate income receipts. On the spending side, this was more than
enough to cover the total outlays of the Departments of
Homeland Security, Housing and Urban Development, Interior,
Justice, Labor, and State. By any measure, $179 billion in general
revenue support for Medicare represents a substantial use of
Budgeting is an exercise in setting priorities. Medicare is
already placing enormous demands on the federal budget, limiting
the government's ability to dedicate resources to other purposes or
to cut taxes. However, given the lack of outcry or comment to the
contrary, Medicare's claim on general revenues equal to 1.3 percent
of GDP was apparently manageable from both budgetary and
economic perspectives, suggesting that this level of support
is a reasonable and feasible limit for Medicare reform.
A second important aspect is that by limiting Medicare revenues
to 1.3 percent of GDP, reforms can proceed without risk that these
reforms would make Medicare's financial condition worse, and
without entanglement in debates about Medicare's effects on
competing budget priorities. Once Medicare's sustainability is
assured, subsequent debates may address questions of competing
Holding Medicare's general fund support at 1.3 percent of GDP is
a practical rule for Medicare reform consistent with long-term
sustainability. Following the rule would reduce the amount of
Medicare's excess costs that must be cut by about 25 percent to
about $63.4 trillion. This is still an enormous sum, but a
more attainable goal.
Can the Medicare Goal Approach Extend
to Social Security and Medicaid?
Setting an appropriate goal for Medicare reform is especially
important because the nation must also confront the similarly
daunting and crucial tasks of reforming Social Security and
Medicaid. Can the approach offered here for Medicare be applied to
these two programs?
Social Security is supposed to be funded through payroll taxes
and interest earned on amounts held in the Social Security trust
fund. Yet according to the 2008 Social Security trustees' report,
beginning in 2017 Social Security's outlays will exceed payroll tax
receipts. By 2041, the Social Security trust fund
will be depleted and Social Security will be unable to pay promised
benefits in full.
The Social Security trustees estimate the program's total excess
promised benefits in present value terms to be $13.6 trillion. This
figure is comparable in nature to Medicare's $85.6 trillion excess
costs. Social Security reform efforts typically assume the entire
$13.6 trillion must be eliminated. But is there a more limited,
sustainability-based goal for Social Security analogous to the one
proposed for Medicare?
Unfortunately, no. Eliminating Social Security's excess costs
requires a combination of reducing the growth of promised benefits
and increasing the growth of dedicated tax receipts. Social
Security reform that retains some level of excess costs implies
using non-payroll tax revenues to cover these costs. This
would be inappropriate for at least two reasons:
- Using tax revenue from sources other than payroll taxes to fund
Social Security would be a fundamental and unwarranted departure
from the basic premise that Social Security is to be a
self-contained pension program, not a welfare program.
- Social Security today operates at a cash surplus. Allowing it
to operate at a perpetual cash deficit financed by other tax
revenues would necessarily and permanently deprive all other budget
priorities of these resources. This would be inconsistent with
the advantage of the proposed Medicare sustainability
approach, which is the reform's neutrality with respect to
other budget priorities.
The federal portion of Medicaid, on the other hand, was always
intended to be funded predominantly with general revenues, so
it is reasonable to establish a practical sustainability goal for
Medicaid reform. In 2007, the federal government spent $191 billion
on Medicaid, equal to about 1.4 percent of GDP. Like for
Medicare, Medicaid's costs are projected to outpace economic
growth. According to the Medicare trustees, under current law the
federal government's expenditures on Medicaid are projected to
increase an average of 7.9 percent a year over the next 10 years,
reaching $673.7 billion in 2017--roughly doubling as a percentage
While no long-run projection is yet available for Medicaid
comparable to Medicare's $85.6 trillion in total excess costs,
projected growth in Medicaid spending in just the next decade
clearly indicates that Medicaid's present drain on the general fund
is in the tens of trillions of dollars. Reforming Medicaid to
bring its federal costs under control is as important as reforming
Medicare and Social Security. As with Medicare, Medicaid
reform should be guided by reasonable goals that restore the
program to sustainability. And, similar to Medicare, a
reasonable policy-neutral goal for Medicaid is to hold
federal expenditures equivalent to the current level of 1.4
percent of GDP.
The Medicare program is in great need of modernization, but
above all, it must be put on a sustainable financial footing.
Medicare today is grossly unaffordable. To succeed, the debate on
Medicare needs a clear, achievable measure of success for
correcting Medicare's long-term finances. The Medicare
trustees' estimate of Medicare's excess costs provides the basis
for such a measure. This estimate shows the extent of general fund
support necessary to pay projected Medicare claims.
Eliminating Medicare's future excess costs entirely, while
ideal, is also a more difficult undertaking than necessary.
Medicare receives a significant amount of general fund support,
equal to 1.3 percent of GDP today. This diversion of resources
constrains other budget options, such as tax relief and funding
other spending priorities, yet this level of support for Medicare
appears manageable. Therefore, a suitable rule for Medicare reform
is to hold Medicare's level of general fund support at 1.3 percent
of GDP. A second important advantage of this rule is that it allows
Medicare reform to proceed without risk that other reforms would
worsen Medicare's financial condition, and without the need to
address Medicare's effects on other spending priorities. This
rule implies a 25 percent reduction in costs that must be cut
through Medicare reform, leaving a still-difficult task, but one
that is sufficient to do the job and sustainable--and more
likely to be achieved.
J. D. Foster, Ph.D., is Norman B. Ture Senior
Fellow in the Economics of Fiscal Policy in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage Foundation.
See also Medicare Path to Sustainability.