This is the second in a series of posts about Medicare funding and how to prevent depletion of the Medicare trust fund. In the previous post, we saw how the COVID pandemic extended the date of Medicare insolvency from 2031 to 2036 by preferentially killing Medicare beneficiaries and thus reducing future Medicare expenditures for all of those Americans who died. But the Medicare trust fund is still going to run out in 2036. To understand why, it is necessary to first understand how Medicare is funded.
Medicare consists of four components: Parts A, B, C, & D. Each of these is funded differently. Medicare Part A is funded by the Hospital Insurance trust fund (HI). Medicare Parts B & D are funded through the Supplementary Medical Insurance trust fund (SMI). Medicare Part C (Medicare Advantage Plans) is funded through both the HI and SMI trust funds.
Every year, the Board of Trustees of the Medicare trust funds publishes a report on the status of the trust funds. The most recent report was released in May 2024. In 2023, Medicare covered 66.7 million Americans (59.1 million over age 65 and 7.6 million who were disabled). Medicare total expenditures were $1,037.0 billion and Medicare income was $1,024.6 billion. This gave Medicare a $12.4 billion surplus in 2023 that is carried forward to 2024 in the Medicare trust funds.
The average benefit paid per Medicare enrollee in 2023 was $16,710. Of that, Part A accounted for $5,992 (36%), Part B accounted for $8,177 (49%), and Part D accounted for $2,541 (15%).
Overall Medicare funding
When the HI and SMI trust funds are lumped together, Medicare as a whole derives its funds from six sources: (1) payroll taxes, (2) federal government contributions, (3) premiums, (4) taxes on Social Security, (5) payments from states, and (6) interest.
- Government contributions (43%). From the graph above, it is clear that the largest funding source for Medicare is from the federal government. Specifically, this is from the general funds that are primarily derived from personal and corporate income taxes. The general fund transfers into Medicare are reset each year by Congressional budgetary legislation. A common misconception of Americans is that Medicare is mostly funded by Medicare payroll taxes whereas in reality, income taxes are ultimately the largest source of Medicare funding.
- Payroll taxes (36%). These are taxes paid by working Americans and their employers on earned income. The total payroll tax rate for most workers is a flat 12.4% of income with half (6.2%) paid by the employee and half (6.2%) paid by the employer. Payroll tax covers Social Security and Medicare. The portion allocated to Medicare is 2.90% with 1.45% paid by the employee and 1.45% paid by the employer. In addition, single workers earning more than $200,000 per year (or married workers jointly earning more than $250,000 per year) pay an additional 0.9% Medicare payroll tax for a total payroll tax of 3. 8% allocated to Medicare. Unlike the Social Security portion of the payroll tax that is limited to the first $168,000 of earnings, there is no limit on the amount of earnings subject to the Medicare portion of the payroll tax.
- Premiums (15%). Medicare part A is free to most Americans but Medicare Part B and Part D require monthly premiums charged to each Medicare beneficiary. The amount of the premium depends on a person’s modified adjusted gross income in any given year. The lowest premium (paid by most Medicare beneficiaries) is $174.70 per month. The highest premium is $594.00 per month, paid by beneficiaries with a modified adjusted gross annual income of more than $500,000 per year ($750,000 per year if married filing jointly). For determination of an individual’s monthly premium rate, there is a hold-harmless provision in the law that limits the dollar increase in the premium to the dollar increase in an individual’s Social Security benefit. Thus, by law, Part B premiums cannot rise faster than Social Security benefits.
- Taxation of benefits (3%). When a person receives Social Security and their total income is high enough, their Social Security benefit is subject to federal income tax. A portion of that income tax is directly allocated to Medicare part A.
- Payment from states (2%). For those people who are dually eligible for both Medicare and Medicaid, a portion of the money to cover Part D medication costs is covered by the states.
- Interest (1%). Money held in the Medicare trust funds that is not immediately needed to pay for healthcare costs is invested in U.S. Treasury securities and the interest from those investments is included as income to the trust funds. Currently, the Medicare trust funds have $396.7 billion held in U.S. Treasury securities giving $10 billion in annual interest.
Funding for the hospital insurance (HI) trust fund
The HI trust fund covers Medicare Part A. The HI is funded differently than the SMI trust fund that covers Medicare Parts B and D. Medicare Part A covers inpatient hospitalization, skilled nursing facilities, some home health care, and hospice care.
The overwhelming majority of funding for Medicare Part A comes from payroll taxes (88%) with a smaller amount from taxation of Social Security benefits (8%) and less than 2% each from interest income and premiums for those with insufficient work history to qualify for free Part A benefits.
Funding for the Supplementary Medical Insurance (SMI) trust fund
The SMI trust fund covers Medicare Parts B and D. In turn, Medicare Part B is funded differently than Medicare Part D. Medicare Part B covers outpatient hospital care, physician professional fees, some home health care, durable medical equipment, physician-administered outpatient drugs, outpatient labs, outpatient radiology, and other outpatient services.
The overwhelming majority of Medicare Part B is covered by federal government general fund contributions (71%). These government contributions are derived primarily from personal and corporate income taxes. Medicare Part B premiums account for most of the rest of Part B funding (27%). Less than 1% is derived from interest income. Importantly, payroll taxes do not contribute at all to Medicare Part B funding.
Medicare Part D covers outpatient medications and falls under the SMI trust fund.
Part D is mainly funded by government general fund contributions from personal and corporate income taxes (73%). Part D premiums paid by Medicare beneficiaries account for 14%. Payment from states (to cover medications for people dually eligible for both Medicare and Medicaid) accounts for 12%. Interest income accounts for < 1%.
Key differences between the HI and SMI trust funds
As shown above, the SMI trust fund that covers Medicare Parts B and D is funded primarily from federal government general funds (personal and corporate income tax) and premiums paid by Medicare beneficiaries. The amount of general fund contributions and premiums are reset each year by congress to insure that the SMI trust fund never runs out. For this reason, the SMI trust fund is in no danger of becoming depleted. As noted above, Medicare Part B premiums cannot be increased any more than the cost of living increase in Social Security benefits so if Medicare costs rise faster than the overall inflation rate, Part B premiums will be insufficient to keep up with Part B expenditures. Therefore, as Medicare Part B and Part D costs increase in the future, the federal government will be required to use a greater percentage of its income tax revenue to cover the higher costs.
On the other hand, the HI trust fund that covers Medicare Part A is permanently tied to payroll taxes. Under current law, the HI trust fund is not able to get additional money from the federal government general fund and thus cannot make up any shortfalls from income taxes. If Medicare Part A costs increase faster than money coming into Medicare from payroll taxes, then the HI trust fund will be depleted. There is currently $209 billion in the HI trust fund. Under current projections, HI trust fund expenditures will begin to exceed HI income from payroll taxes in 2030, requiring Medicare Part A to begin to deplete the HI trust fund reserves. The HI trust fund is projected to be fully depleted in 2036. At that time, Medicare Part A can only pay out as much as it receives in payroll taxes each year – this is projected to reduce beneficiary payments for hospital and nursing home care by 11%.
In the next post, we will see how several different factors have contributed to the HI trust fund’s impending depletion.
July 23, 2024
