Time is running out but there is still an opportunity to save the Medicare trust fund and prevent it from running out of money in 2036. This is the 4th in a series of posts about Medicare funding. The first post demonstrated why the COVID pandemic extended the Medicare trust fund depletion date from 2031 to 2036. The second post provided an overview of the complex way Medicare is funded. The third post outlined the reasons why the Medicare trust fund will become insolvent in 2036. To summarize, the Medicare Hospital Insurance (HI) trust fund that covers Medicare Part A will become depleted due to a combination of health care inflation and a reduced ratio of current American workers to Medicare beneficiaries. The Medicare Supplementary Medical Insurance (SMI) trust fund that covers Medicare Parts B and D is not in danger of depletion.
Unlike the SMI trust fund, the HI trust fund (Medicare Part A) is mainly funded by payroll taxes that are paid by Americans who are currently employed. The SMI trust fund is mainly funded by income taxes and Medicare premiums. Here are the options that policy makers must choose from to address the impending depletion of the Medicare HI trust fund.
Let it become insolvent
If the HI trust fund becomes depleted, it will only be able to cover 89% of inpatient hospital care, nursing home care, and hospice care. It would then up to Medicare beneficiaries to pay for 11% of that care themselves, either out of pocket or by purchasing supplemental health insurance. This would increase costs to Medicare beneficiaries and would be a particular hardship on the elderly who depend on relatively low fixed incomes.
Change what Medicare Part A covers (the politician’s choice)
Currently, Medicare Part A pays for inpatient hospitalization, skilled nursing facilities, some home health care, and hospice care. Medicare Part C (Medicare Advantage plans) covers health care services from both Part A and Part B. The current expenditures from Medicare Parts A, B, and D are shown in the table below.
One of the simplest solutions to prevent the HI trust fund from becoming depleted is to simply move all home health care that is currently under Part A ($6 billion) into Part B in 2025. This will briefly delay the trust fund’s depletion. By then moving hospice care ($26 billion) from Part A into Part B in 2033, Part A should remain solvent for the foreseeable future.
Of course, this does nothing to reduce overall Medicare expenditures, it is just a sleight of hand movement to a different funding mechanism. The result is that all home health care and hospice care would be funded by income taxes rather than payroll taxes. Ultimately, congress would need to increase income taxes to cover the increased federal general funds used to cover home health and hospice care in Medicare Part B.
There is some precedent for this option. When Medicare created the “2-midnight rule”, it decreed that any patient requiring a hospitalization of less than 2 midnights would be declared an outpatient hospitalization rather than an inpatient hospitalization. This moved all of these so-called observation hospital stays from Medicare Part A into Medicare Part B, thus improving the financial status of the Medicare HI trust fund.
Increase the Medicare age
Since Medicare’s inception in 1965, the age of Medicare eligibility has remained unchanged at 65 years old. However, by 2019, life expectancy from age 65 has increased by 5.3 years for men and 4.5 years for women compared to life expectancy from age 65 in 1965 (these numbers fell in 2021 and 2022 due to COVID). But Americans are not working more years, instead these extra years of life expectancy are being spent in retirement. It can be argued that the price of living a lot longer should be working a little longer.
There is some precedent for this option, also, In the 1950’s the Social Security retirement age was 65. Today, the Social Security full retirement age is 67, although people can opt to retire as early as 62 with reduced benefits. Increasing the Medicare age to 67 would seem to be logical and keep it in line with the Social Security full retirement age.
This would undoubtedly anger Americans who are close to retirement who would be faced with having to work 2 years longer than they had planned. A compromise could be offered to allow those between age 65 and 67 to purchase Medicare Part A by paying premiums for it.
Increase payroll taxes
Currently, Medicare’s portion of the payroll tax is 2.9% for most Americans and 3.8% for those making more than $200,000 ($250,000 if married). Health care costs have risen much faster than worker wages over the past 40 years and thus health care inflation has risen faster than payroll tax contributions to Medicare Part A. It can be argued that the cost of Americans having better health and living longer should be paying for the health care that they are using and this would require increasing the Medicare payroll tax to keep up with health care inflation.
There is precedent for this option. When Medicare was rolled out in 1966, the Medicare payroll tax was only 0.35%. This was gradually increased until 1986 when it reached the current value of 2.9%. The higher payroll tax rate of 3.8% on high income earners went into effect in 2013.
Charge Medicare Part A premiums
Another way of making up the shortfall in payroll taxes to cover Medicare Part A costs would be to charge Medicare beneficiaries premiums for Part A coverage. Currently, Medicare Part A is free to all Americans over age 65 who have worked and paid payroll tax for at least 10 years.
Medicare beneficiaries already pay monthly premiums for Medicare Part B and Part D. The problem with charging all beneficiaries premiums for Part A is that many elderly who are living on fixed incomes from Social Security benefits would not be able to afford to pay more in Medicare premiums than they had originally budgeted when they retired. One option to address this would be to charge Part A premiums based on income. For example, leaving Medicare Part A as being free for those with a modified gross income less than $25,000 and then charging premiums that increase with higher incomes.
Increase immigration
The U.S. fertility rate has fallen from 3 live births per woman in 1960 to 1.62 live births per woman today. Without immigration, this would result in negative population growth with a shrinking population. For Medicare Part A to remain solvent, there must be more workers paying payroll tax than there are Medicare beneficiaries in any given year. Historically, that ratio was 4 workers per Medicare beneficiary but the ratio has fallen since 2000 and is currently only 2.8 workers per Medicare beneficiary. The falling U.S. fertility rate means that the U.S. cannot rely on children born to U.S. citizens to provide a sufficiently large workforce to support Medicare Part A from payroll taxes. Ideally, immigration should prioritized to children and young adults. Because payroll taxes are a fixed percentage of modified adjusted gross income, regardless of how high that income is, immigrants who will contribute the most in payroll taxes are those who would be expected to have the highest incomes in the United States. In other words, those immigrants with college or graduate degrees.
There are currently about 11 million undocumented immigrants living in the United States and 95% of those are over age 16. As undocumented immigrants, they cannot get Social Security numbers and consequently they do not pay any payroll taxes since payroll taxes are linked to Social Security numbers. Neither are they eligible to get Medicare when they turn 65. However, our nation’s hospitals are legally required to provide emergency medical care in the ER or in the hospital to everyone so undocumented immigrants are already getting medical treatment that is ultimately paid for by American taxpayers. We would be far better off if we converted undocumented immigrants to immigrants with work visas or citizens so that we can start collecting payroll taxes on the work that they are already doing but just getting paid under the table.
Change how Medicare Part A is funded
The fundamental problem with the Medicare HI trust fund is that it depends almost entirely on payroll taxes whereas the Medicare SMI trust fund derives its money from income taxes and Medicare premiums. Congress could change the law to use federal general funds to cover the Medicare HI trust fund shortfall. However, since general funds are derived from income taxes, this option would have the downstream effect of requiring congress to increase income taxes.
The problem with taxes is that nobody wants to pay them. Consequently, the U.S. has created an incredibly complex tax system that taxes different things in different ways. There is payroll tax that taxes wage-earning workers. Consumption taxes, such as sales tax and gasoline tax, are paid by consumers. There is capital gains tax that taxes investors. There is income tax that taxes wages, some investments, pensions, and tax-deferred retirement plan withdrawals. There is property tax that taxes homeowners. And that brings up the philosophical question of who should pay for the health care of today’s seniors? By funding Medicare Part A with payroll taxes, it is current wage-earning workers. But should it instead be paid by investors? pensioners? land owners? consumers? Someone ultimately has to pay for Medicare Part A through taxes, the questions is just exactly who should have to pay those taxes?
Reduce U.S. health care costs
This is the ultimate solution the problem of depletion of the Medicare trust fund. The reasons why Americans pay so much more for their health care than people in any other country are complex. There is not a single, simple solution to fixing this problem. Americans pay way more than anyone else for medications. The Inflation Reduction Act of 2022 will help lower Medicare costs by lowering the costs of many expensive drugs. But to really control health care costs would require a major overhaul of the U.S. health care delivery system and in the current political climate, the chances of that happening the near future are nil.
If it was up to me…
So, if I was a government policy maker, how would I fix the Medicare HI trust fund? The fundamental problem is that Medicare Part A is spending more than it brings in from payroll taxes. Here are the measures that I would take:
- Move all home health into Medicare Part B in 2025 and hospice care into Medicare Part B in 2030. This would reduce the amount of money that Part A would have to spend and prevent the HI trust fund from becoming depleted (at least temporarily). However, this will just mean that those costs will have to be covered by income taxes or government borrowing. it is like “rearranging the deck chairs on the Titanic” but it does at least buy a few years for other policy changes to go into effect.
- Raise the Medicare full benefit age to 67. This would align with the Social Security full retirement age of 67. It would also decrease the number of Medicare beneficiaries while increasing the number of wage-earning workers since they would likely postpone retirement. The net effect would be to improve the ratio of current workers to current Medicare beneficiaries. Since Americans are living 5 years longer from age 65 than they were when Medicare was enacted in 1965, it can be justified that Americans work 2 years longer than they did in 1965 – 2 years of extra work is the price for 5 years of extra life. This would cause an uproar among those over age 50 since their retirement would be unexpectedly pushed back 2 years, but a compromise would be to offer those between ages 65 and 67 the option to buy Medicare by paying monthly premiums for both Parts A and B. This would be similar to the option to take Social Security early at age 62 with a reduced monthly benefit. So, if a person wants to retire at 65 they can but they have to pay for their own Medicare Part A coverage until they are 67.
- Increase immigration. This will be solve the problem of the United States’ declining fertility rate and increase the number of wage-earning workers. Ideally, those immigrants would be young enough to have at least 25-30 future working years and skilled enough to have high incomes (and thus more payroll tax contributions). Therefore, the “best” immigrants from a Medicare trust fund standpoint would be those who are under age 40 with a college degree. Immigrant children would also be beneficial to the Medicare HI trust fund since they will become wage-earning workers in the future.
There are no easy solutions
The Medicare Part A funding strategy when Medicare was enacted worked fine in the 1960s but a combination of an increased U.S. life expectancy, health care inflation, more Americans going to college and entering the workforce later in life, and a declining U.S. fertility rate have now made the original funding strategy insufficient. The question presently faced by the United States is who will pay for Medicare Part A now that payroll taxes alone will not suffice? Every option will make someone unhappy.
July 25, 2024
