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Medicare Financing: Let’s Get the Basics Right

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27 Feb 2013 12:57 PM

By Blase Polite, MD, MPP

In a previous life, I spent several years in the budget office of the Secretary of Health and Human Services, working on Medicare budgets. My experience in medicine is that very few of my colleagues understand how Medicare is actually financed. We, as health care professionals, are typically pretty savvy about how Medicare spends its money, but not quite as clear on where it gets its money. We hear over and over that Medicare is going “bankrupt” but what does that really mean? I share this blog now because Medicare reform, like Medicaid reform mentioned in my previous blog, is almost certainly going to happen or at least be seriously discussed in the 113th Congress. We obviously have a vested interest in this debate not just because our own livelihoods are tied to Medicare, but more importantly because it will impact our patients with cancer who depend on this program.

Let’s start with the basics. Medicare, from the actuaries’ standpoint, has two parts. Part A (Hospital Insurance), which covers primarily in-patient care but also some home health, hospice, and limited-skilled nursing facility care; and Parts B and D (Supplementary Medical Insurance program). Part B covers mainly physician services, but also home health, durable medical equipment, ambulatory surgical services and laboratory services. Part D is the relatively new prescription drug benefit. Medicare enrolled 48.7 million beneficiaries in 2011 (40.4 million elderly and 8.3 million disabled) and cost a total of $530 billion (Part A: $229 B, Part B 233.6 B, and Part D 67.4 B). This represents 4% of our GDP. Where this money comes from differs significantly between Part A versus Parts B and D.

When one hears about the Medicare trust fund or about Medicare going bankrupt; it is about the Part A trust fund that they are talking about. Part A is funded primarily by payroll taxes: 2.9% of income divided equally between employees and employers or paid totally by the self-employed. The Affordable Care Act added an additional 0.9% tax for individuals making more than $200K per year. Since 2008, money going out has exceeded money coming in and without changes, the fund will go broke in 2024. A logical question is what do payroll taxes have to do with health care costs? That is, why is the efficiency or solvency of Medicare held to an arbitrary payroll tax rate? There is no answer to that other than, that is just the way it is. Finally, it should be stated that even the use of the word “trust fund” strains common English language usage. It is an accounting gimmick at best as all of the “surplus” in this trust fund has long been borrowed by the Treasury and what remains are IOUs from the Treasury.

The Supplementary Medical Insurance (SMI) trust fund is a much different concept. There are no payroll taxes funding this on a yearly basis. Instead, the treasury deposits in to it the amount needed to cover the costs minus the premiums it collects. By definition, it can never go bankrupt unless the treasury goes bankrupt. Because it has not been funded by payroll taxes, Parts B and D require beneficiaries to pay premiums each year. These premiums are set such that beneficiaries pay 25% of the expected costs and the Federal Government through general revenue and borrowing, subsidies the remaining 75%. For high-income beneficiaries, the subsidies are lower and range from 65% to 20%. What is the financial burden of this to the Federal Government? In 2000, Part B took up 5.4% of income tax revenue. In 2011, that rose to 17.2% of income tax revenue and is expected to rise to 26% by 2080.

How you think through Medicare reform (the subject of a future blog) comes down to whether you primarily think Medicare is underfinanced given what it is asked to do (provide comprehensive health care to the oldest and sickest in the population) or whether it is inefficient and should be able to make do with lower expenditures and still provide quality care. If you fall in the former category, then you want more revenue going into the program. That revenue either comes from the Federal Treasury (through taxes, borrowing etc.) or from beneficiaries in the form of new or increased premiums, cost-sharing, etc. If you fall in the latter category, then reforms take the shape of changes to how payments are made to providers either through cuts in fee-for-service payment rates or more dramatic reform of how Medicare pays for services (bundling, competitive bidding). The end solution will need both approaches, but one of these two themes will dominate. 

My major take home point for readers is that debating Medicare reform by using terms like, “Medicare is going bankrupt,” undermines our ability to have a serious debate about Medicare policy. We need to step back and ask ourselves three questions as a Nation: What do we want the Medicare program to be able to do? How can it do that in the most efficient manner possible? How do we then pay for it? For those playing the chess match out at home, where you ultimately end up is in a tension between question 1 and question 3, which can only be worked out through the byproduct of our collective soul searching called the United States Congress. God help us all.

Visit ASCO in Action’s Physician Payment Reform page for more information.

Blase N. Polite, MD, MPP, is an Assistant Professor of Medicine at the University of Chicago and is Chair of the ASCO Health Disparities Advisory Group. Dr. Polite’s research has focused on understanding stage specific racial and ethnic differences in colon and breast cancer outcomes, and better understanding reasons for and finding solutions to the under representation of minority patients in therapeutic cancer clinical trials. Dr. Polite earned his Bachelor and Master’s degree in Public Policy Studies from the University of Chicago and then spent four years working on Health Care and Medicare reform policy in Washington, DC, with the Department of Health and Human Services and with the Office of Senator Bill Bradley.

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