SOLVENCY OR AFFORDABILITY? WAYS TO MEASURE MEDICARE S FINANCIAL HEALTH

Transcription

1 The Henry J. Kaiser Family Foundation SOLVENCY OR AFFORDABILITY? WAYS TO MEASURE MEDICARE S FINANCIAL HEALTH by Marilyn Moon and Matthew Storeygard The Urban Institute Prepared for The Kaiser Family Foundation March 2002

2 The Kaiser Family Foundation is an independent, national health philanthropy dedicated to providing information and analysis on health issues to policymakers, the media, and the general public. The Foundation is not associated with Kaiser Permanente or Kaiser Industries.

3 The Henry J. Kaiser Family Foundation SOLVENCY OR AFFORDABILITY? WAYS TO MEASURE MEDICARE S FINANCIAL HEALTH by Marilyn Moon and Matthew Storeygard The Urban Institute Prepared for The Kaiser Family Foundation March 2002 The authors wish to thank Krista Dowling for her research assistance on this paper, and to acknowledge the helpful comments of Robert Reischauer, Lisa Potetz, and Wendell Primus.

4 INTRODUCTION The question of the financial health of the Medicare program is important to the debate over how the program should change in the future. Are dramatic measures to save costs necessary? Can resources be found to support a prescription drug benefit? These policy issues are intimately tied to how we view the program and its financial situation. But there are many possible ways of examining Medicare s financial issues, and the choice of which to use is often made on the basis of politics and spin that a particular measure can create. This paper examines different ways to look at Medicare s financial status and the implications each may hold for the future. A measure can be created that, by definition, will demonstrate that a major problem exists or that we need not worry about the future. And while alternative views can emerge on the best or most appropriate measure, some approaches are misleading and do not contribute constructively to the debate. Moreover, even using the same measures can result in different characterizations of Medicare. In response to the release of the 2002 Trustees Reports (Board of Trustees, 2002), for example, Medicare was variously called unsustainable and at the same time referred to as a program in strong financial health. The differences arise from attitudes that extend well beyond the choice of measure to what the role of government should be and to how resources should be shared across generations. Rather than identifying just one measure, this paper offers a number of alternatives, distinguishing between issues of solvency and affordability, offering a broader perspective on the issue of Medicare s future. 1

5 How Medicare is Financed Before turning to these measures, it is useful to review how the Medicare program is funded. The two parts of the program have totally different revenue streams. Part A, Hospital Insurance, is supported mainly by payroll taxes currently set at 1.45 percent each on employers and employees. Additional revenues come from taxation of Social Security benefits and some small general revenue transfers. Revenues are held in a trust fund that grows over time and pays out Part A expenditures on behalf of current beneficiaries. Surplus trust fund dollars are exchanged for Treasury securities and held as promises to pay benefits for future beneficiaries. The build up in the Trust Fund is intended to assure individuals that the promises of future benefits will be kept. Moreover, it is effectively a way to ask current taxpayers (including the Baby Boom generation which will benefit in the future) to pay more in taxes now than is necessary to fund current Part A Medicare benefits. Part B, Supplementary Medical Insurance, is supported by premiums from enrollees (equal to 25 percent of the costs for elderly beneficiaries) and from general revenues. The law, in place since Medicare began, requires that general revenues be devoted to Part B in whatever amounts are needed to pay benefits. Thus, although there is also a Part B trust fund, it is, by law, kept in balance and hence is usually ignored in solvency discussions. TRADITIONAL MEASURES OF FINANCIAL HEALTH A number of basic measures have traditionally been used to provide information on Medicare s future financial health. The Medicare Board of Trustees releases three of the most commonly cited measures each year as part of their annual reports (Board of Trustees, 2002). 2

6 The first, and most commonly cited, is the date of exhaustion of the Part A Trust Fund. 1 A second popular measure is the ratio of workers to beneficiaries over time. Finally, projected costs of both Parts A and B as a share of Gross Domestic Product (GDP) are also reported each year. Part A Trust Fund Solvency The Part A Trust Fund was established to ensure that revenues raised for Part A (Hospital Insurance) were dedicated to expenses of that program. As dedicated revenues, payroll and other revenue sources that exceed the amount necessary to cover Part A benefits go into the Trust Fund and collect interest. Projections of the Medicare Part A trust fund indicate that it will maintain a positive balance through 2030 (Board of Trustees, 2002). Considered in historical context, the date of projected insolvency is further into the future than ever before (Figure 1). The trust fund is expected to grow from its level of $141 billion at the end of 2000 to about $900 billion or 283 percent of annual Part A expenditures in 2015 after which the trust fund s balances will begin to decline when payroll tax and other receipts are insufficient to cover expenditures. Like the Social Security Trust Fund, the Part A Trust Fund was designed to assure that the specified payroll tax contribution would be used specifically for Part A spending, and not, as some have suggested, to establish a limit on financing over time. Moreover, at the least, the Part A Trust Fund allows variations in spending to be smoothed out over time, reducing the need to 1 Although there is also a Part B Trust Fund, it serves a much different purpose and is intentionally kept at a small positive level. 3

7 revisit the operations of the program each year. In 1983, additional revenues were added to Social Security to create a substantial trust fund balance and hence pre-fund some of its benefits, but Medicare s Part A Trust Fund was not adjusted to take on such a role. As a consequence, this measure of solvency tells us less about the financial health of the program than many believe. Critics of Medicare focused much more on this trust fund balance in the mid-1990s when the date of exhaustion was much closer ~ ~ Number of Years Before HI Trust Fund Projected to be Exhausted ~ Missing Data for Years and 1989 Source: CRS 1995 and Medicare Trustees Reports. Figure (Figure 1), as an early warning of the need for changes in the program. Today, several criticisms are often leveled at this measure. First, critics have pointed out that it ignores Part B issues. Hence, there have been efforts to create a combined trust fund measure (as will be described below). But an even more important issue is whether this measure of Part A solvency captures the ability to support Part A spending over time. Basing the health of the program solely on the solvency of the Part A Trust Fund is analogous to individuals arguing that they cannot pay all their bills because the balance in one of their checking accounts is too low. The affordability of Medicare is actually a much broader issue than Part A solvency and should encompass other measures as well. 4

8 Critics of the Part A Trust Fund solvency measure also argue that it is merely an accounting fiction and that the assets now reported are not real. This is because the actual dollars that have come in to the Treasury are used for other purposes while the Fund holds Treasury securities and earns interest on them. But if these dollars are used to pay cash to the holders of other Treasury securities (that is, to individuals, state, local and foreign governments, businesses and institutions outside of the federal government) as they come due, the outstanding debt held by the public will go down and the government s ability to honor Medicare s Treasury Bill holdings when they need to be cashed in will be improved. When Medicare begins to redeem its securities (because benefit costs begin to exceed trust fund receipts), the burdens of meeting these obligations will fall on citizens. At that point in time, general revenue taxes can be raised, spending on other services can be reduced, or the Treasury can redeem Medicare s securities by issuing new debt to the public. If the debt owed to the public is reduced through 2015 using Medicare s surpluses, then it will be less of a problem to increase borrowing at a later point in time representing yet another benefit of paying down the public debt. But using the surplus to finance current spending (even on Part B) or to cut other taxes eliminates this advantage. 5

9 The Worker-to-Beneficiary Ratio Another measure provided each year in the Trustees Report is the ratio of workers contributing to Medicare at any point in time compared to the number of beneficiaries in the program. This measure shows that the ratio of younger persons to older ones will decline in the future given the aging of society. This declining ratio of workers to retirees implies that each worker will have to bear a larger share of the cost of providing Medicare benefits that are financed by payroll taxes, if the present pay-as-you-go system in which current taxes mainly go to pay for current benefits) is not changed. The numbers as 4.5 Figure 2 Ratio of Workers to Medicare Beneficiaries ( ) usually presented are quite dramatic (Figure 2) Between 2000 and (several years beyond when most Baby 1.0 Boomers will have become eligible for Source: Urban Institute Analysis of 2002 OASDI and Medicare Trustees Reports. Medicare), the ratio of workers to beneficiaries will fall from 3.90 to 2.22, and to 2.0 by This change represents a 43 percent decline in the ratio a fact that is sometimes treated as a 43 percent increase in burdens on workers. Indeed, this is one of the statistics commonly miscited 2 We use 2035 since it will capture much of the dramatic growth in Medicare spending. The uncertainty of estimates beyond 2035 is such that it may be very misleading to look out until 2075 as is required of the Trustees Report. 6

10 by those who fear the program is unsustainable. This measure signals the need for more revenues per worker a legitimate concern over time. However, it can be faulted for failing to assess the level of burden relative to ability to pay from each future worker. This measure thus ignores any improvement in the economic circumstances of workers over time due to per capita economic growth. Medicare Spending as a Share of GDP A third measure, which has long been included in the annual reports but is just now getting more attention, is the sum of Part A and B spending as a share of GDP. In 2001, Medicare s total share was 2.4 percent and is projected to rise to 5.0 percent in This represents a doubling of the GDP share. But such an increase should not be a surprise since health care costs per capita are expected to continue rising, and the number of people covered will double over the same period. In fact, the share of the population on Medicare is projected to rise by more than 60 percent. This measure puts potential costs into the context of the income of the country and in that sense offers more information than the worker-to-retiree ratio. Moreover, since both Parts A and B are included, it also provides a broader look into the future than a focus only on Part A solvency. It is not a very intuitive measure, however, as there is no natural benchmark for what an appropriate share would be, particularly as the share of the population covered by Medicare rises over time. In addition, it may not be as helpful in the debate on Medicare s future because it does not consider how well off we will be as a society as the level of GDP grows. Some goods and services, like health care, may appropriately grow as a share of GDP in response to higher 7

11 living standards. NEW MEASURES THAT HAVE BEEN PROPOSED A number of new measures of financial health have been proposed in recent years that tend to paint a relatively dire picture of Medicare s future. For example, the co-chairs of the National Bipartisan Commission on Medicare s Future suggested a new measure of solvency, attempting to combine Parts A and B. They proposed to freeze general revenue contributions at a particular level for purposes of assessing the adequacy of financing for Part B. And more recently, the Congressional Budget Office (CBO) and the Bush administration have both implicitly offered measures of financial health that compare spending needs showing only the revenues specifically earmarked for the program (CBO, 2001 and 2002; Office of the President, 2001 and 2002). In both cases, these alternative measures proposed to handle revenues into Medicare in a manner at variance with current law. Limiting General Revenue Contributions In 1999, some members of the Bipartisan Medicare Commission expressed concern that the general revenue contribution requirement under Part B represented an open-ended commitment to Medicare that should be limited. Under current law, general revenues rise as needed to pay for Part B spending, supplementing beneficiary premiums. The co-chairs of the Bipartisan Medicare Commission argued, however, that the current approach masks the increased burden that Part B places on society. Therefore, they sought to establish a limit on general revenue contributions, analogous to the payroll tax contribution rate that is set by law. The 8

12 Commission therefore proposed, as part of its recommendations, 3 that when general revenues reached 40 percent of the costs of all Medicare benefits, the contribution would be frozen at that share unless Congress voted to increase it. the Medicare The proposal of Medicare Solvency Issues Raised by Freezing General Revenues at 40% of All Revenues 9.0% Figure 3 Commission would have combined Parts A and B to create a unified measure of solvency, but would have constrained revenues that could be Percentage of GDP 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2001 Date at Which General Revenues = 40% Total Expenditures Year Revenue Under Current Law Revenue if General Revenue used to meet future needs. Source: Urban Institute Analysis of 2001 OASDI and Medicare Trustees Reports. Under this approach, if Congress failed to lift the cap, there would be insufficient funds to pay for current level of benefits beginning in about Further, as Figure 3 illustrates, the gap between expenditures and revenues would widen even more in subsequent years and there would be fewer resources available to fund Medicare benefits in the future. 4 Thus, the Medicare Commission proposed both a new measure of solvency and new constraints on revenues. While a unified measure of solvency could be advantageous in taking 3 A majority of commission members agreed to a set of recommendations, but the number fell short of the level established in legislation to formally transmit their recommendations to the President and Congress. Thus, while there was no formal final report, this solvency measure was broadly discussed. 4 Moreover, critics of this approach have expressed concern that this would change the entitlement nature of the program by making it subject to annual appropriations. 9

13 into account both portions of Medicare spending, it is unclear how or why the limit on general revenues was set at 40 percent, rather than a higher or lower share. This apparently arbitrary restriction obscures an important policy debate about the affordability of Medicare. 5 This approach puts the cart before the horse by locking in general revenue s share of contribution to Medicare in the guise of a measurement change. It also shortchanges the debate on what revenue sources to use for Medicare in the future. Each source has its own advantages and disadvantages. For example, the payroll tax, which still represents the largest share of funding for Medicare, is a simple tax to administer and easy for individuals to understand. It is also directly tied to the Medicare program, stressing that this is a social insurance program. But, payroll taxes tend to be regressive, meaning that their burdens fall heavily on low-wage workers. And critics often argue that such taxes discourage employers from expanding their workforce. On the other hand, general revenue contributions tend to be more progressive than other taxes, reducing low-income burdens. They grow faster than payroll taxes over time, doing a better job of keeping up with the costs of care. Further, retirees as well as workers pay income taxes which help to spread the burden of Medicare across workers and beneficiaries. However, this revenue source is often criticized because of the complexity of the income tax and individuals concerns about its fairness. 5 Other attempts at finding a way to combine Medicare A and B spending using a virtual trust fund approach have used other potential measures such as freezing the share of GDP that now comes from general revenues. This is essentially a way to argue that increases in general revenues beyond what could come from economic growth need to be considered in policy debates. (See for example, Moon, Segal and Weiss, 2000; and Gluck and Moon, 2000). 10

14 Beneficiary premiums represent the third major source of funding for the program, thus if limits are set on general revenues, there would be implications for beneficiaries as well. Future financing through increased premiums offers a means for asking individuals who benefit to pay some of the costs of their own care. But, burdens on Medicare beneficiaries for the costs of health care are already high and will grow over time if, as expected, health care costs rise faster than their incomes (Maxwell, Moon and Segal, 2001). Using an explicit limit on general revenue contributions makes the future financial health of Medicare less secure and fails to reconcile differences between commitments and revenues. All of these issues need to be addressed when considering the desired balance across revenue sources; but this discussion should not be confused with decisions about how to measure solvency or affordability. Omitting General Revenue Obligations An even more stringent view of Medicare finances has been put forth by both the Bush administration in its FY 2003 Budget and by the Congressional Budget Office in its January 2002 Medicare baseline. This relatively new approach to describing Medicare s financial outlook omits general revenue sources from the presentation of Medicare revenues and includes only dedicated revenues (payroll taxes and premiums) in comparisons of revenues and costs over time. As shown in Figure 4, this gives the appearance of a substantially lower revenue stream for Medicare over time. In its FY 2003 Budget, the Administration refers to the program as being in deficit because dedicated taxes (mainly payroll tax revenues and premiums) are insufficient to cover current spending. But this is a misrepresentation because general revenue contributions 11

15 (an explicitly designated source of funding under current law) are ignored. The Bush administration also argues that revenues from Part A over and above current spending on Part A should be used to finance Part B Percentage of GDP Medicare Solvency Issues Raised by Counting Only Dedicated Revenues 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Figure Year Current Law Revenues 2053 Total Expenditures Dedicated Revenues Note: The difference between Current Law Revenues and Dedicated Revenues (premiums and payroll taxes) is General Revenue. Source: 2001 OASDI and Medicare Trustees Reports spending in place of general revenues. The major weakness of omitting general revenues from an overall view of Medicare s fiscal health is that it omits a critical funding source to which Medicare is entitled under current law. It makes Medicare s situation appear to be much worse than it is both now and in the future. Since general revenues have been a major source of support for the program from the beginning, it is misleading to simply zero out this component. This may be a legitimate option to debate, but it is not consistent with current law and skirts the need for a broader discussion of how funding should be set in the future. Figure 5 considers the implications of restrictions on general revenue financing by comparing the amount of revenues that would need to be raised to finance benefits in selected years through 2035 if general revenues were capped at 40 percent of total spending, or omitted altogether. This measure effectively examines revenues and spending only in a current year context, ignoring the Part A Trust Fund and excluding as revenue both interest and principal on 12

16 the balance in that Trust Fund. Figure 5 shows that, under current law, Additional Revenues Needed to Cover Medicare Spending Under Alternative Restrictions on Current Revenues 3.0% 2.5% Figure 5 Additional Revenues as a Percent of GDP 2.8% which includes income 2.0% 1.9% from general revenues, Medicare financing 1.5% 1.0% 0.5% 0.5% 1.0% 0.5% 0.6% 1.1% 1.4% remains strong until % 0.0% 0.0% even when viewed on this pay-as-you go basis. The -0.2% -0.2% -0.5% Current Law Funding Freezing General Revenue at 40% of Total Dedicated Revenues Only Source: Urban Institute Analysis of 2002 OASDI and Medicare Trustees Reports. second bar on the chart for each year indicates the gap that remains if the Medicare Commission s approach were used; it looks bleaker than current law. If general revenues are not counted at all (the third bar), by 2035, the program would be substantially out of balance. ANOTHER WAY TO LOOK AT AFFORDABILITY Issues of the future affordability of Medicare benefits go well beyond technical definitions of solvency and even of government spending in general. As our population ages and the numbers of persons eligible for Medicare swell, these older and disabled persons must get care somewhere. If no public program provides health care, then individuals and their families will be responsible for the costs. In such a case, it is likely that the equal access to care that most older and disabled persons receive under Medicare would deteriorate as those who cannot afford the best care will be left behind. If such care remains a high priority, the key question is whether as a society we can 13

17 afford that care and, if so, how it will be financed. Many of those who question the sustainability of the Medicare program are implicitly arguing that as a society we will not be able to afford to care for our elderly and disabled or at least not through a public program. In support of this argument, skeptics usually point to the share of GDP that Medicare will require and/or the worker-to-beneficiary ratio. The Bush administration s approach represents more of a public sector view of affordability, showing big gaps in funding that would be needed to keep the program going. Another way to look at affordability is to focus not just on the number of workers but also on what they will produce. Further, while the share of the pie (GDP) going to Medicare is likely to rise, if the pie (on a per capita basis) is also much larger, then an increasing share is less of a burden. Indeed, this has been the justification over the years for increasing Social Security benefit generosity and adding Medicare to the system. In that way, the higher standards of living enjoyed by Americans since the end of World War II have been shared with retirees. If the future also leads to increased national well-being, such a sharing of resources may prove to be affordable. Hence, we offer a new way to examine affordability by focusing on whether taxpayers of the future will be better off even after they pay higher amounts for Medicare. This measure seeks to examine whether, as a society, we can afford such care for this population. First, we compute per worker GDP amounts over time. Per worker GDP is a measure of the nation s output of goods and services divided across the working population. While these resources will be shared with others as well, this ties Medicare s burden to workers since they pay for the bulk of support for the program. Second, we subtract the Medicare burden that each worker will be expected to bear under current law. Per worker GDP even after adjusting for 14

18 inflation rises substantially, from $67,000 per worker in 2000 to over $105,000 in 2035 (in 2002 dollars). 6 This is an increase of 56.7 percent in per worker output. The burdens from Medicare spending are projected to rise at a faster rate because both numbers of beneficiaries and their inflation-adjusted spending will rise over time. Indeed, as discussed earlier, the share of GDP going toward Medicare will rise. But because per worker GDP is a much larger dollar amount than Medicare burdens, the reduction in well-being that this entails for workers is modest. To calculate this per worker burden from Medicare, several adjustments are necessary. First, each worker will bear an increasing share of Medicare over time because of the change in the ratio of workers to retirees. Further, per capita Medicare costs are expected to rise by 102 percent in real terms by 2035, also increasing the real dollar burden on workers. But not all of Medicare s costs are borne by workers. Thus, we adjust these costs downward by the contributions that will be made by beneficiaries themselves. The Part B premium accounts for about 10 percent of Medicare s costs. In addition, beneficiaries make further contributions because some of the taxation of Social Security benefits goes into Part A and older and disabled persons also pay income taxes that help support Part B. Thus, we net out those costs. The resulting real per worker burden is estimated to rise from $1,315 in 2000 to $4,219 in 2035 (in 2002 dollars). As shown in Figure 6, the bar graph indicates per worker GDP in inflation-adjusted dollars, and the line graph indicates how much would be left for workers after accounting for the Medicare burden. From 2000 to 2035, the increase in net (after subtracting 6 We use the intermediate projections from the 2002 Trustees Report, which assumes a 1.1 percent real growth in per worker wages each year. Over the past 50 years, productivity has been higher than this amount, averaging over 1.5 percent per year. 15

19 Medicare) per worker resources would be 53.8 percent as compared to the 57.0 percent increase in per worker GDP. $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 Impact of Medicare Burden on Workers, (in 2002 dollars) $0 $67,473 $66,158 $72,313 $70,870 $77,348 $75,762 $82,528 $80,577 $87,460 $85,071 $93,147 $90,205 $99,318 $95,728 $105,982 $101, Per Worker GDP Figure 6 Source: Urban Institute Analysis of 2002 OASDI and Medicare Trustees Reports. Per Worker GDP - Adjusted Medicare Burden That is, workers would still be substantially better off than today, even after paying the full projected costs of Medicare. 7 The pie will indeed have gotten larger. There will, of course, be other demands on these resources as well, but this approach puts demands from Medicare into a broader perspective. We prefer this measure for examining affordability because it takes into account Parts A and B of Medicare, and it puts the issue of the burdens of the program into a per worker context that is likely to be more meaningful to individuals looking into the future. CONCLUSIONS Policy debate on an issue as important as Medicare s future will always offer a confusing array of numbers to prove various points. And most of the measures described above can appropriately be used at various times. But it is important to match the measure with the 7 This trend has been in place since 1975 as well, with Medicare burdens growing but not by enough to slow the growth in per worker resources by very much. In addition, the results would be similar if we were to add Social Security to this calculation as well. 16

20 question. Part A solvency issues are important, but only speak to a part of the issues affecting Medicare s future. If the issue is Medicare s current financial health, it is inappropriate to exclude general revenues from the assessment since these revenues represent a legitimate source of Medicare funding as established in statute. Moreover, by making the program appear to be in worse shape than it really is, Medicare is vulnerable to radical restructuring that could leave future beneficiaries out in the cold. Changes in Medicare will be needed over time to meet higher costs, but both the needs and our ability to pay should be examined carefully. The appropriate question to ask is whether, as a society, we will be able to afford Medicare without an inordinate burden on workers or taxpayers. A new and more comprehensive measure of net per worker wealth offered here suggests that the answer is certainly yes once even modest estimates of productivity growth over time are taken into account. The greatest challenge will be for society to decide whether it is willing to share these costs. 17

21 BIBLIOGRAPHY Board of Trustees, Federal Hospital Insurance Trust Fund Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund. Washington, DC: US Government Printing Office. Board of Trustees, Federal Hospital Insurance Trust Fund Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund. Washington, DC: US Government Printing Office. Congressional Budget Office CBO January 2002 Baseline: Medicare. Washington, DC: January. Crippen, Dan Medicare Solvency. Testimony before the Committee on Ways and Means, U.S. Senate 107th Congress 1st Session, March. Maxwell, Stephanie, Marilyn Moon and Misha Segal Growth in Medicare Out-of-Pocket Spending: Impact on Vulnerable Beneficiaries. New York, NY: The Commonwealth Fund. Moon, Marilyn, and Michael Gluck Financing Medicare s Future. Washington D.C.: National Academy of Social Insurance, September. Moon, Marilyn, Misha Segal and Randall Weiss. 2000/2001. A Moving Target: Financing Medicare for the Future. Inquiry, vol. 37, no. 4. Office of the President Fiscal Year 2003 Budget of the U.S. Government. Washington, DC: U.S. Government Printing Office, February. Office of the President A Blueprint for New Beginnings: A Responsible Budget for America s Priorities. Washington, DC: U.S. Government Printing Office, February.

22 The Henry J. Kaiser Family Foundation 2400 Sand Hill Road Menlo Park, CA (650) Fax: (650) Washington Office: 1450 G Street NW, Suite 250 Washington, DC (202) Fax: (202) Additional free copies of this publication (#6034) are available on the Kaiser Family Foundation s website at or by calling the Foundation s Publication Request line at