A Closer Look at Medicare

Published August 22, 2014


The Medicare Trustees issued their annual report on the program’s long-term financing outlook last month, and their findings were greeted by the Obama administration as evidence that the Affordable Care Act is working. This is nonsense.

The general slowdown in health spending remains largely a phenomenon of economic conditions related to the deep recession of 2007-2009 and factors outside the realm of the ACA. Among other things, it is noteworthy that health spending growth rates have moderated across the developed world in recent years, as measured by the OECD. Even Obamacare’s most enthusiastic apologists might be sheepish about claiming the law somehow caused a global health transformation.

A close examination of the ACA’s provisions, especially those related to Medicare, also produces nothing that would lead one to expect large-scale spending moderation. The main provisions of the ACA provide substantial new subsidies for health insurance, through Medicaid and the federal and state exchanges. The Congressional Budget Office (CBO) estimates that these provisions will cost about $1.8 trillion over the period 2015 to 2024. The main effect of this massive increase in subsidization of insurance will be to increase demand for services and thus put upward pressure on prices and costs. This is simple economics. It may take some time for these pressures to emerge, but they will eventually emerge.

Within Medicare, the ACA cut program spending substantially–by more than $700 billion over a decade,from CBO’s last assessment of them. But these cuts inspire no confidence. The largest cut is an indiscriminate, across-the-board reduction in payments to all hospitals and other institutions serving Medicare patients, totaling $415 billion over 10 years. Called the “productivity adjustment factor,” the cut reduces the inflation updates for these institutions on the presumption that they will achieve a certain level of productivity improvement each year. But the actuaries who produce Medicare’s spending forecast have been dubious from the beginning that these cuts can be sustained because they would wipe out the positive revenue margins of many facilities around the country, and thus jeopardize access to care for seniors. The actuaries have been so skeptical of this cut that they have produced an alternative projection to the official trustees’ report forecast each year since 2010. The alternative scenario shows what Medicare’s spending trajectory would be if the cuts were overturned. In effect, without this simplistic cut, Medicare spending would closely resemble the projections that were made before the ACA was enacted.

The other significant cut in Medicare spending is a reduction in the payments made to the private insurers providing coverage for Medicare beneficiaries, called Medicare Advantage (MA) plans. In 2012, CBO estimated these cuts would total $156 billion over ten years. The effect of these cuts will be to lower MA enrollment and force more program enrollees back into the traditional, government-run fee-for-service (FFS) part of Medicare. Despite what many critics of MA plans contend, these private insurance options are more efficient than FFS, according to official government data. The average MA HMO can provide standard Medicare benefits for 95 percent of what it costs FFS to provide these benefits. The plans get paid more than FFS, but the extra payments go toward more expansive benefits for MA enrollees. Cutting payments to MA plans does not increase the efficiency of the overall health system.

The changes in Medicare that ACA advocates like to tout–the so-called “delivery system reforms” such as “Accountable Care Organizations” (ACOs) and reducing payments for hospital readmissions–are very minor relative to the size of Medicare and national health expenditures. At the time the ACA was enacted, CBO estimated Medicare ACOs would save about $4.9 billion over 10 years, and the readmission provision would save another $7.1 billion. These amounts are barely noticeable in Medicare, which will spend $6.9 trillion over the coming decade. The ACO program is already widely viewed as a disappointment anyway, with fundamental design flaws. The suggestion that these provisions are somehow responsible for the slowdown in health spending in the United States is ludicrous.

The long-term outlook for Medicare is also clouded by the ACA’s double-count of the Medicare cuts aimed at the hospital, or part A, side of the program. The 2014 trustees report says these Medicare cuts have added several additional years to the solvency of the Hospital Insurance (HI) trust fund. But the same cuts were also used to partially finance the Medicaid expansion and the new subsidies paid to lower income households getting insurance through the exchanges. So the same Medicare spending cuts are being used to both create new entitlement spending outside of Medicare and to pay future Medicare benefit claims out of the HI trust fund. That may make the HI trust fund look better on paper, but the federal budget outlook has certainly not improved.

Even with this double-count, Medicare’s outlook remains grim. According to the trustees, the program has $28.1 trillion in unfunded liabilities over the next 75 years. Together with Social Security’s $13.3 trillion shortfall, it is clear the federal government has accumulated entitlement spending commitments that far exceed our capacity to pay for them.

Medicare’s problem is twofold. The program remains highly inefficient because the default FFS option has very little cost control within it. The government attempts to hold down costs with payment regulations, but price-setting does not directly limit volume, or the use of services. In addition, the retirement of the baby boom generation will send enrollment in the program soaring, from 52 million enrollees in 2013 to nearly 82 million in 2030.

Competition and consumer choice, of the kind Congressman Paul Ryan has proposed in the form of premium support, can slow Medicare’s per capita cost growth by rewarding more efficient care and providing incentives for finding new and less expensive ways of deliver high quality services.

The demographic problem, however, requires an entirely different set of considerations. As Americans live longer lives, and have fewer children, it will not be possible to sustain indefinitely the current policy of fully subsidized Medicare benefits for everyone over the age of 65.

Addressing this demographic problem may require asking future retirees to pay more for their Medicare coverage. This can be done without undermining the significant value the program provides for these retirees. Medicare’s main benefit is that it ensures access to insurance for everyone over the age of 65. Regardless of their health status, the same implied premium applies to all Medicare beneficiaries. This is a significant benefit that a fully private market would not be able to provide.

Medicare could be reformed so that it continues to offer insurance to all Americans over the age of 65 at a premium that is the same for every enrollee. What would change are the tax-and-transfer features of the program that are the source the looming financial shortfall. Workers would be asked to save more during their pre-retirement years so that they could pay for more of their Medicare premium when they retired. That is a logical response to the massive demographic changes already underway, and a response that would ensure Medicare is able to provide secure insurance for seniors for many decades to come.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute.

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