TCS Daily

How to Save Medicare

By Laurence J. Kotlikoff - June 14, 2004 12:00 AM

Buried deep in the bowels of the recently released Medicare Trustees' Report is the first-ever official estimate of Medicare's true long-run costs. Previous reports have considered only short- and medium-term costs. The new "infinite horizon" estimate adds up all future costs, telling us the amount of money we'd need today to cover Medicare's commitments. This present value bill is unimaginably large -- $73.6 trillion to be precise! It's almost seven times GDP, twice the size of private net wealth, and 14 times official federal debt.

Can we pay this colossal sum? Medicare's trust fund is a paltry $256 billion. And the present value of its future payroll taxes is only $12.0 trillion. Historically, we've used general revenues to cover the gap between Medicare's expenditures and receipts. But continuing to do so will require a 50 percent immediate and permanent hike in federal income taxes! Alternatively, we can wait and raise taxes by an even larger percentage in the future. Tax hikes of this magnitude would severely damage our economy.

Simply printing money to pay Medicare's bills is another non-starter. It would trigger inflation, raising medical prices along with other prices, forcing us to print even more money. We'd end up in the same fiscal jam, but with hyperinflation to boot.

The only real option is limiting benefit growth. There are two sources of this growth. The first is population aging. By 2030, the entire country will be older than Florida. By 2050, we'll have enough centenarians to fill Washington, D.C.! The second is growth in benefits per beneficiary. Historically, per capita benefits have grown three times faster than real wages. In the last four years, they've grown 7 times faster! And just wait until the new prescription drug benefit kicks in.

We can't change the demographics. (And no, immigration won't help.) But limiting per capita benefit growth to that of wages per worker would lower costs by one third. Unfortunately, repeated attempts to contain expenditures under the current fee-for-service system have failed because it provides participants little or no incentive to limit their use of health services. Indeed, fee-for-service should be renamed freeĀ­-for-service.

Attempts to get HMOs to cover Medicare participants by paying them a fixed amount per participant have also failed. In a classic example of adverse selection, the HMOs enrolled the healthiest and least expensive participants. And when the government realized it was getting taken and cut back on the payments, the HMO's said forget it.

It's time for a new approach -- the Medical Security System (MSS). MSS eliminates fee-for-service. And it uses the private market to insure Medicare participants, but does so avoiding adverse selection.

All Medicare participants would receive individual-specific vouchers on October 1st of each year to purchase insurance coverage for the following calendar year. The size of the voucher would be based on the participant's current medical condition (an idea first suggested by Peter Ferrara of the Institute for Policy Innovation and John Goodman of the National Center for Policy Analysis). A healthy 67 year-old might get a voucher for $7,500, whereas an 85 year old with pancreatic cancer might get a voucher for $85,000. The vouchers would take account of the participant's age, region, sex, and other factors that affect health costs. Because those in the worst medical shape would get the largest vouchers, insurance carriers would be happy to sign them up.

All insurance carriers would have to cover a basic set of medical services and prescription drugs. But Medicare participants would be free to pay out of pocket for additional coverage. The government would keep up-to-date records about each participant's health status, release this information to insurance companies at the participant's request, and assign insurers for those who don't sign up on their own.

The government would cap total MSS voucher expenditures so that expenditures per beneficiary grow no faster than wages. Medicare participants would see their real medical benefits rise, just not as fast as in the past. And they'd realize that no matter how sick they got, they'd always receive a voucher large enough to purchase insurance coverage for the following year.

Some may worry about an invasion of privacy. But the government already knows about Medicare participants' health status via the claims it processes. And private health and life insurance providers routinely check their clients' medical status before signing them up.

Will this fly politically? Republicans will like the plan. And Democrats should go for it, given its protections against cherry picking. The current elderly will be nervous. But they could be given the option of remaining under the old system.

MSS is worth a try. The alternative is not pretty.

Laurence J. Kotlikoff is Chair of the Department of Economics, Boston University. He is Co-Author of The Coming Generational Storm.


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