Ethics & Public Policy Center

The Medicare Monster

Published in The Weekly Standard


Yuval Levin

Yuval Levin is the Hertog Fellow at the Ethics and Public Policy Center and the editor of National Affairs.


It is gradually dawning on Washington that a meaningful reform of the Medicare program will be unavoidable in the coming years. Medicare is at the center of both our health care dilemma and our fiscal crunch, and it will be very difficult to avoid a calamitous debt crisis without making changes to the program’s basic structure.

Medicare’s problem is not just overspending. In a sense, the program’s travails mirror (and severely exacerbate) those of our economy and welfare state more generally: The stifling of competition and innovation creates a crushing inefficiency that makes the system unsustainable​!!​giving off a strong whiff of institutional decline, and intimations of a terrible crash to come. Yet correcting the problem, in Medicare’s case as with our broader predicament, presents an enormous political challenge, because recipients of benefits are powerfully resistant to change.

Democrats have long used the prospect of changes to Medicare as a way to scare older voters, and Republicans have long responded by avoiding serious talk of reform. But this spring, Republicans in the House of Representatives broke with this pattern and passed a bold and promising reform as part of their annual budget resolution, produced by House Budget Committee chairman Paul Ryan. Democrats, however, have stuck to their pattern and sought to use the Republican proposal as election-year ammunition. When she was asked in May what the Democrats’ top three election issues would be in 2012, House Democratic leader Nancy Pelosi said they were “Medicare, Medicare, and Medicare.”

Polls this spring and summer suggested a surprising degree of openness among the public to Ryan’s kind of reform, but the Republican presidential candidates are clearly concerned that once the campaign really gets going, the Democrats’ scare tactics will again succeed. While a few GOP contenders have offered passing good words for the Ryan budget in general, they have largely steered clear of Medicare so far​—​neither endorsing nor rejecting a serious reform. They are surely aware that fixing Medicare is essential to the nation’s fiscal future, but they also know the issue can be politically explosive. They are thus badly in need of a Medicare reform proposal that could implement significant structural change while effectively assuring voters that seniors will not be put at risk​—​a proposal that would overcome the potential political challenges of the House Republican approach while retaining its substantive benefits.

The organizing principle of such a proposal should be not austerity, but innovation​—not the need to reduce costs as such but the need to unleash creativity and enterprise to find more efficient ways to provide higher quality care more affordably. That is what our health sector lacks above all. Focusing on innovation and dynamism can help us learn from both the strengths and the weaknesses of the Ryan proposal, and could provide a Republican presidential candidate with a politically appealing and substantively promising proposal of his own.

If it is properly conceived, such a proposal could also offer a model for reforming the welfare state more generally​—​unleashing the kind of innovation and efficiency that our entire economy so sorely lacks today.

The Disaster Ahead

The record deficits of the past few years have largely been a function of an explosion of discretionary spending. But the utterly unprecedented debt disaster we confront in the coming years​​—the projected ballooning of spending and borrowing that has our creditors nervous and will leave us with a national debt larger than our economy in just a decade and twice as large in the 2030s​​—​​is a function of an explosion of health-entitlement costs and especially Medicare costs. The Congressional Budget Office projects that the already immense cost of our health programs will double as a share of the economy by the early 2030s and nearly triple by 2050, while all other federal spending combined (except interest payments) will actuallydeclineas a share of the economy. Health-entitlement costs will thus account for essentially the entirety of our debt explosion, and Medicare will account for the bulk of those costs​—​as our population ages and the program’s grossly inefficient design pushes health inflation ever upward.

That design is at the heart of our health care crisis too. Today’s “fee-for-service” Medicare pays all doctors and hospitals the same price for a given service​—regardless of quality, efficiency, outcome, cost to the provider, or patient satisfaction. Medicare recipients play no part in determining who gets paid and how much, and have no sense of what their care costs. Health care providers have no financial incentive to deliver better care at lower cost since they get paid the same regardless. All this creates an enormous incentive for volume rather than efficiency​—which yields massive economic distortions and higher costs. And because Medicare is the largest payer for health care in most parts of the country, its structure defines the entire health care system: Hospitals and doctors shape their accounting and billing (and therefore also their practice of medicine) to suit Medicare’s demands; Medicaid and most private insurers often use Medicare’s payment codes and methods to make things easier on doctors. Medicare shapes how nearly everyone in the American health care system thinks about economics, and it does so in a way that makes very little economic sense​—spreading staggering inefficiency throughout the system, and inflating the costs that leave more and more people uninsured.

This calls for real structural reform of Medicare, not just tinkering at the edges or increasing taxes to pay for an unreformed program. President Obama has acknowledged as much​—saying in July that “if you look at the numbers, then Medicare in particular will run out of money and we will not be able to sustain that program no matter how much taxes go up”​—though he has yet to offer any solution.

The health care law he signed last year avoided structural reforms of Medicare, opting instead for still more price controls, which reduce the amount that Medicare pays per procedure. But such price controls, which have been tried for decades, only exacerbate the problem. By paying less for each service, they drive doctors to segment their work into more individual procedures and to perform more such procedures, undermining efficiency and further inflating costs.

Obamacare’s only nod toward addressing the problems of the fee-for-service system were small pilot programs to reward providers for organizing their work more efficiently (as determined by experts in Washington), rather than simply billing for volume. But such small experiments, which also have been attempted in Medicare for decades, have no hope of succeeding precisely because the structure of the larger program shapes the economics of the entire health sector. Pilot programs (and even the Medicare Advantage program, under which some seniors choose to have private insurers manage their benefits) are not significant enough to change how doctors and hospitals approach the business side of their work. They therefore often end up being less efficient than even the larger Medicare program, since they do not enjoy the advantages of command-and-control health care (like using Medicare’s muscle to force price reductions that shift costs elsewhere) but cannot change the providers’ incentives and so cannot draw on the far greater advantages of market economics either.

An effective reform would have to loosen the stranglehold of the fee-for-service system, which means it would have to fundamentally change the way Medicare works. If Medicare is going to shape the economics of health care, it should at least do so in a way that comports with modern economics​—creating efficiency through consumer pressure, competition, and innovation, not through central planning and price controls.

 

Premium Support

The basic outline of that kind of reform has been clear for decades. Rather than providing insurance directly to all American seniors​—setting payment rates, making coverage decisions, and directly paying doctors and hospitals​—Medicare would assign to each senior roughly the amount it would have spent on his coverage and allow him to spend that “premium-support” subsidy on a private health insurer of his choosing. The private insurers would have to provide at least the same minimum level of coverage as Medicare does, but they could organize their plans​—any coverage beyond the minimum, their payment rates, their arrangements with doctors, and so on​—as they liked. If a senior chose an insurer that charged less than the premium-support payment provided by Medicare, he could keep some or all of the difference, giving him a strong incentive to shop around and choose carefully (and giving insurers a strong reason to offer cheaper plans). If he chose a plan that cost more than the premium-support level, he would have to make up the difference out of his own pocket.

More efficient ways of organizing and providing health care have to come from physicians and hospitals, but those providers have to be motivated by the people who pay their bills​—that is, the insurers​—who in turn need a good reason to provide attractive comprehensive health coverage at the lowest possible cost. A premium-support system would use the leverage of Medicare’s enormous budget to make that happen​—essentially turning the problem into the solution. Seniors would still have a heavily subsidized and guaranteed health-insurance benefit, but it could be provided at a sustainable cost, and without badly distorting the economics of the broader health sector. This would not make Medicare cheap or keep health costs from rising, but it should dramatically constrain the rate of their growth, using consumer pressure to encourage the kind of business-model innovations that American medicine badly needs.

Different versions of the premium-support model have been proposed by various experts over the years. One was even championed by a bipartisan commission established by President Clinton and House speaker Newt Gingrich in the late 1990s, and headed by Democratic senator John Breaux and Republican congressman Bill Thomas. But in each case, the politics of Medicare and the fact that the program’s fiscal collapse was still some way off in the future meant that Congress and the president chose not to act​—preferring to buy more time with counterproductive price controls and empty rhetoric.

But the collapse of Medicare is no longer far off in the future, even by the myopic standards of Washington. According to the Congressional Budget Office and Medicare’s trustees, the program has a long-term unfunded liability of more than $30 trillionand is about a decade from insolvency. The trustees’ latest annual report, released in May, notes that the Medicare trust fund is now projected to run out of money five years sooner than was projected just last year. The program’s current trajectory would swallow up the federal budget, and taxes could not be raised high enough fast enough to keep up with its growth without crushing the economy.

These grim realities, combined with the results of the 2010 congressional elections, are what motivated House Republicans to offer the Ryan proposal in April​—the most significant step yet toward a meaningful reform of Medicare.

The Ryan reform would leave all current seniors and workers who will retire in the next decade in the existing Medicare system to avoid displacing those who have planned their retirements around that system, and to avoid the political fallout of changing the arrangements of today’s retirees and near-retirees. Everyone younger than 55, however, would eventually retire into a redesigned Medicare system in which, rather than be insured by the government directly, they would choose from a list of approved private coverage options. Their Medicare benefit would take the form of a government payment for the coverage they chose​—and if they opted for coverage more expensive than that payment, they would pay the difference. Poor seniors and those in the worst health would get significantly greater support, while the wealthiest would receive less and so need to use more of their own money to buy coverage.

The level of the base premium support payment would start at what Medicare spends per patient today and grow at the rate of inflation, so that the program’s future rate of growth would be far slower than it has been in recent decades, putting downward pressure on insurance costs and forcing providers to find more cost-effective ways to do their work.

The savings from such a reform would be immense. Ten years after implementation of the Ryan reform, according to the Congressional Budget Office, the federal government would spend $240 billion less per year on Medicare than it would under current law. Beyond that first decade, the cost of Medicare would actually decline as a share of GDP. By 2040, Medicare would account for about 4.75 percent of GDP each year, down from 7.75 percent if the program were not reformed​—a difference of some $900 billionper yearat that point. Such dramatic savings would rescue the Medicare program from collapse and allow the federal budget to ease back toward balance​—and thus help the country find a path toward prosperity again.

But of course Ryan’s proposed reform has been enormously controversial. Congressional Democrats and President Obama have vilified it as an assault on seniors, and seem intent on making the prospect of such an assault a centerpiece of their 2012 campaign strategy.

Most of their attacks on the Ryan proposal have been patently demagogic lies. Almost every Democrat in Washington has argued that the proposed reform would end Medicare, when in fact it would save the program (and increase spending on it each year, if less quickly than would otherwise happen). Rep. Debbie Wasserman Schultz, chairwoman of the Democratic National Committee, has said the reform would allow private insurers to deny coverage to seniors with preexisting conditions, when in fact the Ryan bill specifically prohibits such exclusions. Others, including Health and Human Services secretary Kathleen Sebelius, have suggested that Ryan’s reform would replace comprehensive insurance with a limited voucher for care, which is also flat false.

But the most politically potent critique of the plan has also been the most substantively serious. It has focused on the rate at which the premium-support payment would grow, and on seniors’ fears that their costs would rise. The concern, voiced by some congressional Democrats and by liberal health care experts like former Clinton budget director Alice Rivlin, has been that the competitive pressures unleashed by the Ryan plan would not be sufficient to cause health care costs to grow only at the rate of inflation​—which is far lower than their growth rate in recent years​—so that the premium-support payment would not keep up with the cost of insurance, and seniors would face a steady increase in out-of-pocket costs over time to cover the gap. It is hard to gauge exactly what the gap would be (and most Democrats voicing this concern have used figures that assume that competition would not bring down costs at all, which is ridiculous), but it is not unreasonable to worry that there would be some such gap, as even in a competitive marketplace health care costs are likely to continue rising faster than inflation, especially if inflation remains fairly low.

This concern about increasing out-of-pocket costs has been the most effective line of attack against the Ryan budget, and has even been voiced by some Republicans. Rep. Michele Bachmann, a Tea Party stalwart and Republican presidential candidate, has said that while she voted for the Ryan budget and supports its discretionary cuts, she would put “an asterisk” over its Medicare reform because she’s “concerned about shifting the cost burden to senior citizens.”

Ryan’s response to this critique has been that the critics underestimate the power of competition to bring down costs, and that the particular growth rate of the premium-support payment in his plan is in any case open to negotiation and could be adjusted over time if it proved inadequate. Other reformers have also sought to address this concern by adjusting that rate: The debt-reduction task force of the Bipartisan Policy Center, chaired by Rivlin and former Republican senator Pete Domenici, proposed a Medicare plan very similar to Ryan’s but with a premium-support payment that would grow at one percentage point above the rate of growth of the gross domestic product each year, rather than at the rate of inflation. This, they argue, might be a more realistic pace of growth given the savings likely to result from competition.

But of course, this last proposal might be subject to the same critique​—especially from those who simply deny that competition would lower prices. And at the same time, setting ever-higher growth rates risks undermining the potential of markets to bring down costs. Costs would not fallbelowthe preset growth rate, since insurers would have no incentive to push them below the level of payments already promised. Searching for the perfect growth rate thus sends reformers on a fool’s errand without neutralizing the political case against shifting the risk of higher costs onto seniors.

More important, searching for the perfect growth rate puts austerity​—and the need to cut the cost of Medicare​—at the heart of the reform proposal. If we instead put innovation itself, driven by competition, at the heart of our search for an effective Medicare reform, we will find our way to a version of the premium-support solution that is both politically and substantively superior​—a reform with tremendous potential to address our fiscal problems and our health care problems yet also with a very real chance of easing voters’ concerns and being enacted into law. The work of a series of conservative policy experts over the past two decades points the way to just such a solution.

The Confident Market Solution

If the promise of the premium-support model is its potential to unleash genuine competition in health insurance, then a preset rate of growth for the premium-support payment is not an essential feature of a meaningful reform. In fact, the goal of the reform would be better served by allowing market competition to set the growth rate, as well as to drive the cost of coverage downward.

How would that work? First, Medicare would define the minimum insurance benefit it would seek to provide to all covered seniors​—presumably at roughly the level of coverage it now provides. Then, in each region of the country (Medicare is already divided into geographic regions), there would be a competitive bidding process each year in which private insurers would offer bids proposing to provide that (or a greater) benefit at the lowest cost they could. The level of the premium-support payment in each region for that year would be set at, for instance, the level of the second-lowest of the bids. Seniors would then be able to apply that amount toward the purchase of any of the plans on offer in their area. Thus, in each region, there would be at least one option that would cost less than the Medicare benefit, and seniors choosing that option would get the difference back as cash in their pockets; there would be at least one plan that cost the same as the benefit, so that seniors could obtain it with only the same out-of-pocket costs they have today; and there would be other plans that cost more (perhaps because they offered more, or because they failed to find ways to drive greater efficiency in their networks of doctors and hospitals) and for which seniors would pay an additional premium if they chose.

Such a system could even allow a form of the traditional fee-for-service Medicare to be one of the bidders​—offering government-provided insurance, but on the same terms as the private insurers, and thus with its ability to throw its weight around suitably constrained. This would appease some on the left concerned about the disappearance of “Medicare as we know it,” but would not take much away from the effectiveness of the new system if the rules allowed for real competition.

In such a system, the premium-support benefit would grow exactly as quickly as required to provide a comprehensive insurance benefit, since the growth rate would be determined by a market process rather than a preset formula. Information about costs and prices would flow from those who had more direct on-the-ground knowledge (insurers, doctors, and hospitals) to those with less (Medicare administrators) rather than the other way around, as now happens. Insurers and providers would have a strong incentive to innovate, to improve efficiency, and to cut costs while offering high-quality services, and the broader health care system would be liberated from the stranglehold of the economically obtuse fee-for-service system. But seniors would not face the risk of greater out-of-pocket costs​—if markets failed to bring down costs, the federal budget would suffer, but Medicare recipients would not. The risk would be borne by the government, not the elderly.

Such a reform would be a way for advocates of market-friendly health care to show confidence in their own expectations of competition. If market forces did drive costs down, as conservative health care experts expect, the reform would save the government an enormous amount of money (perhaps no less than the Ryan or Rivlin-Domenici plans), leaving both our budget and our health care system in vastly better shape. If market forces did not drive costs down, then we would have to find another way to address our entitlement costs. We would be back where we started, which is where Democrats want to end up anyway. Whether the reform succeeded or failed, seniors would have a guaranteed benefit and essentially no added financial risk.

The Democrats’ case against Medicare reform would thus be reduced to nearly nothing​—especially if seniors could even opt for a public fee-for-service program if they were willing to pay the premium. And voters’ concerns about Medicare reform should be very greatly alleviated, since the pace of change under such a reform would be set by the market in a way that would minimize disruption for the elderly.

Some on the right might complain that this would leave in place a highly managed and administered Medicare program, and indeed one that resembles some elements of Obamacare​—perhaps even a kind of public insurance option. But this misses a crucial distinction: This reform, like the Ryan plan, would transform today’s lumbering single-payer fee-for-service Medicare program into a much more market-based and competitive system for providing a public benefit. If we believe that the government should heavily subsidize health insurance for the elderly, this is a far better way to do it. Obamacare, by contrast, will make our existing health care system evenlessmarket-oriented​—leaving in place today’s failing Medicare program for the elderly and turning our private health-insurance sector into a series of public utilities.

Indeed, a market-based reform of Medicare like the one proposed here would require the repeal of Obamacare, and would work best in tandem with a reform that moved the under-65 health care system in a more market-friendly direction​—eventually transforming the tax exclusion for employer-provided insurance into a universal tax credit for the purchase of private coverage by individuals and turning Medicaid into an income-based add-on to that credit.

Other conservatives might complain that such an approach would be less aggressive than Ryan’s, and thus save less money. But if competition could bring the growth of health care costs to roughly the level of general inflation, then a reform like this could work just as well if not better than the Ryan plan. If it couldn’t, then the growth rate of the benefit under Ryan’s plan would likely have to be adjusted over time in any case. In fact, a system that set the pace of benefit growth using competitive bidding would actually bemoremarket-based than Ryan’s proposal. It would, in a sense, be a more profound or radical reform, yet it would also (and in part for that very reason) be far less problematic politically. Indeed, Ryan himself has said he would welcome this approach, and would even be open to offering fee-for-service Medicare as an option​—since it is a version of precisely what he is trying to achieve.

Why, then, did Ryan not propose this form of the premium-support model himself? The reason seems largely to be that the “scoring” conventions of the Congressional Budget Office made it impossible. Put simply, CBO refuses to estimate the effects of competition on prices​—or indeed the effects of any policy on the behavior of consumers or providers. The agency scores only blunt changes in funding, but does not make economically informed projections about dynamic effects. So while CBO is perfectly happy to offer a (perfectly meaningless) projection of what the unemployment rate will be in the year 2083 (5 percent, by the way), it declines to assume that having insurers compete for customers will result in lower costs than having the government pay a universal preset rate for every medical procedure. The agency has acknowledged that its failure to account for such market effects is, as its director has put it, “a gap in our toolkit,” but it has so far not sought to fill that gap.

Other government analysts, like the actuary of the Medicare program, do model market effects, and have found that a premium-support reform would significantly reduce costs and improve efficiency. “It can get you to the lowest cost consistent with good quality of care,” the program’s chief actuary, Richard Foster, said at a congressional hearing in July. But because CBO does not score market effects, it cannot score a version of premium support based on competitive bidding. Because budget resolutions in the House of Representatives need to be scored by CBO, Ryan had to employ a preset spending level. The Rivlin-Domenici panel also wanted a plan that CBO could score, and so proceeded along the same lines.

But other reformers over the years have seen the appeal of a system that sets premium-support levels through competitive bidding. The Breaux-Thomas commission of the late 1990s proposed a version of this approach. The Medicare prescription-drug benefit, designed by the Bush administration and enacted in 2003, works along these general lines and has achieved impressive savings. Scholars Robert Coulam, Roger Feldman, and Bryan Dowd proposed a more limited application of the idea in a 2009 book. And last year, Thomas Miller of the American Enterprise Institute and James Capretta of the Ethics and Public Policy Center proposed a form of this approach as part of a broader transformation of the health care system. Some on the left, including Alice Rivlin, have praised the idea too.

In Search of a Champion

The appeal of the Ryan proposal, and the lessons to be drawn from the political response to that proposal, suggest the time has come for a candidate or officeholder to propose in detail the transformation of Medicare into a truly market-based guaranteed insurance benefit.

Such a proposal would be ideal for the platform of a Republican presidential candidate. A candidate would not have to worry about a CBO score, and his campaign could explain the potential of this approach with the help of academic economists and modelers. Because such a reform would be inherently gradual and might retain the current system as an option, the candidate could also propose to implement it sooner than 10 years from now, and so have it begin bearing fruit far more quickly.

Most important, a candidate could champion this approach as a safe and reasonable attempt to lower costs and address the country’s monumental fiscal crisis without shifting risk onto seniors. Such a proposal could serve as a way to educate voters about just how central our entitlement crisis is to our coming debt crisis, while showing them that​—if we set clear goals and rules and then allow the market economy to work​—solutions are possible without causing undue disruptions in the lives of the most vulnerable Americans. It would thus also function as a model for other reforms of our moribund welfare state​—pressing the point that what our economy badly needs today is innovation and enterprise, and that these must be at the core of every facet of our domestic policy.

Much of the left would certainly oppose a market-based reform, which would after all strike at the conceptual core of the liberal welfare state. But on what grounds would liberals base their opposition and seek to scare the elderly? This reform would retain Medicare’s guaranteed benefit, and would simply test whether market competition could dramatically lower the cost of providing that benefit while freeing our health care system from the shackles of command-and-control economics. If it worked, our fiscal prospects would improve dramatically and liberals would have to acknowledge the case for transforming the rest of our welfare state along similar lines. If it failed, we would need to find other means of addressing our fiscal problems, and conservatives would have to acknowledge that their vision of American government beyond the welfare state requires a profound rethinking. Either way, seniors would have their comprehensive health insurance subsidized by Medicare, just as they have for decades.

Our disastrous debt projections mean that there is really no alternative to a market-based Medicare reform. It is the only solution conservative experts have come up with, and liberals have offered essentially nothing at all​—burying their heads in the sand and insisting all is well. For the moment, voters might still be inclined to do the same. But, like so much else in our politics, that appears to be changing in light of economic realities.

The need for Medicare reform has never been more urgent, or more clear. We simply cannot avert a debt crisis without it. But the case can be made most easily and effectively if it is made in the service of a politically palatable reform idea focused on innovation rather than austerity.

Years of work by conservative health care experts have produced such an idea. All we need now is a conservative presidential candidate who can see beyond the political peril of Medicare politics to the political promise of offering the country a solution to its mounting woes that is both appealing and achievable.

Yuval Levin is the Hertog fellow at the Ethics and Public Policy Center and the editor of National Affairs.

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