Flatlined

An Upcoming Budget Crisis

The United States has about one decade to rein in Medicare spending or face the prospect of unplanned reform under the duress of a federal budget crisis. The Congressional Budget Office stated, “Rising health care costs and their consequences for federal health insurance programs constitute the nation's central fiscal challenge.” To provide some background for that statement I should explain how Medicare and Medicaid are financed.

Medicare

  • Medicare Part A is the hospital insurance program that pays for inpatient hospitalization. Part A is financed by a 1.45 percent payroll tax paid by the employee and matched by the employer. Medicare payroll taxes are put into a Medicare Hospital Insurance Trust Fund which draws interest.
  • Medicare Part B pays for physician and outpatient services. Seventy-five percent of Medicare Part B is paid by general tax revenue and 25 percent by the premiums and co-pays of Medicare beneficiaries.
  • Medicare Part D is the prescription drug benefit which is also paid 75 percent by general tax revenue and 25 percent by the premiums and co-pays of Medicare beneficiaries.

Medicaid

  • Medicaid is a program that funds the health care of poor children, their parents in a few states, and pays the premiums and co-pays of impoverished Medicare beneficiaries.
  • Medicaid finances 41 percent of all long-term care (nursing homes primarily) in the United States.
  • Federal general tax revenue pays for on the average 60 percent of Medicaid cost and the individual states pay 40 percent.

Including payroll taxes, premiums, and co-pays as federal revenue, Medicare and Medicaid together accounted for 22.9 percent of the federal budget in 2007; are on track to consume 30.6 percent of the budget by 2018 and all of it by 2050. (1) It would be necessary to double payroll taxes or cut hospital spending in half to bring Medicare’s hospital program into long-term fiscal balance. (2)

Considered another way, Medicare’s percentage of income tax revenue (at current-law taxes and premiums) will rise from 11.6 percent of income tax spending in 2006 to 21.2 percent in 2020 and over one-third by 2030. (3)

These relationships are illustrated graphically in the figure below from the Congressional Budget Office. Taxes have averaged about 18 percent of gross domestic product (GDP) since World War II. The economy works when taxes range from 16-20 percent of GDP. Social Security spending as a percentage of GDP projected out to 2050 is shown in black. It is a problem, but a problem that is manageable. The cost of Medicaid and Medicare, however, escalate so rapidly that by 2050 they account for 15 percent of GDP, almost the entire federal budget. To maintain Federal obligations other than health care and Social Security in the future will require tax revenues that are an experiment into the unknown. These figures mean that medical cost growth is within one decade of becoming intolerable. While the younger generation bears the future burden, the day of reckoning is not likely to wait more than a decade. Serious measures to control health care spending must start now.

The states are not in a better position than the federal government. The year 2003 was the first time that total state health care costs ever exceeded the cost of elementary and secondary education, historically a states highest spending category.(4) Most states constitutionally may not run a budget deficit. Medicaid roles typically swell during a recession as people are laid off and their incomes fall. The result is that just when Medicaid is most needed to act as a safety valve, primarily for children, the states are least able to accommodate.

Reforming the US health care system is like turning a giant aircraft carrier; it will take some time. We have less than a decade to accomplish reform to reduce cost and improve quality or face the prospect of unplanned and abrupt reform in the face of a federal and state budget crisis.

  1. Congressional Budget Office, “The Budget and Economic Outlook: Fiscal Years 2008 to 2018,” Congress of the United States, January 2008. http://www.cbo.gov/ftpdocs/89xx/doc8917/01-23-2008_BudgetOutlook.pdf (accessed online June 17, 2008)
  2. Social Security and Medicare Boards of Trustees, “Status of the Social Security and Medicare Programs,” 2008. http://www.ssa.gov/OACT/TRSUM/trsummary.html (accessed online June 16, 2008)
  3. Andrew J. Rettenmaier and Thomas R. Saving, The Diagnosis and Treatment of Medicare, The AEI Press, Washington DC, 2007.
  4. 2004 State Expenditure Report, National Association of State Budget Officers. Accessed online 2007: http://www.nasbo.org/Publications/PDFs/2004ExpendReport.pdf