Medicare Can Be Fixed But Do Any Politicians Have The Courage To Do It?

Medicare is running out of money. This is nothing new, we’ve known this for years. The basic reason why is simple: there is less money going into the Medicare Trust Fund than is going out of the Medicare Trust Fund. Many Americans incorrectly believe that when they pay payroll taxes during their working years, the federal government puts that money into some kind of savings account so that they can draw from it for their Medicare bills. The reality is that those Americans’ payroll taxes went to pay for the Medicare benefits of the people who were on Medicare back then. Similarly, when an American retires, their Medicare benefits are paid by the people who are currently working and paying payroll taxes.

When Medicare was introduced in 1965, this set up worked well because there were 4 American workers paying payroll taxes for every 1 American receiving Medicare benefits. Over the past 60 years, the U.S. birth rate has been dropping and the U.S. life expectancy has been increasing. As a result, there are now only 2.7 American workers for every 1 American Medicare beneficiary. This ratio of workers to Medicare beneficiaries is not sustainable and the Medicare Trust Fund is expected to be depleted in 2036. To understand why, it is first necessary to understand how Medicare is funded.

How is Medicare funded?

Medicare Part A is funded by the Hospital Insurance Trust Fund. This fund has four sources:

1. Payroll taxes. This is the overwhelmingly largest source of funds for Part A, accounting for 88% of funding.
2. Interest earned on money held in the Hospital Insurance Trust Fund. Most of this is in the form of U.S. Treasury bonds and accounts for 8% of Part A funding.
3. Income tax on Social Security benefits. Currently, Americans have to pay income tax on the money they receive from Social Security. Unlike income tax paid on all other sources of income, Social Security income tax goes to Medicare Part A. This is a minor source of Part A funding.
4. Part A premiums. Most Americans get Medicare Part A for free, as long as they (or their spouse) have worked and paid payroll taxes for at least 10 years. Americans who do not have a 10-year work history can buy Medicare Part A by paying premiums, just like you would for any other insurance plan. This is a relatively minor source of Part A funds.

Medicare Part B is funded by a totally different fund called the Supplementary Medical Insurance Trust Fund. This fund has three sources:

1. U.S. Government general funds. This is the largest component of Part B funding, accounting for 71%. These are authorized by Congress and generally derived from regular federal income taxes. Because Part B is partially derived from income taxes, Congress can adjust the income tax contribution to the trust fund each year, preventing it from being depleted.
2. Medicare Part B Premiums. This is the second largest source of Part B funding, accounting for 27%. Unlike Medicare Part A, Americans have to pay monthly premiums for Medicare Part B. These premiums are income-based and range from $185/month to $629/month, depending on one’s annual income.
3. Interest earned on money held in the Supplementary Medical Insurance Trust Fund. Similar to Part A, this is usually in the form of interest from U.S. Treasury bonds held by the trust fund. This is a minor source of Part B funding.

Because of the different sources of funds for the Part A and Part B trust funds, only Part A is in danger of being depleted. There are only two basic ways of preventing Part A from becoming depleted: increase money coming into the Part A Hospital Insurance Trust Fund or decrease the money being paid out in Part A benefits.

Increase money coming into Part A

Politicians have several options to increase annual contributions to the Part A Hospital Insurance Trust Fund:

1. Increase the payroll tax rate. Currently, payroll taxes are set at 12.4% of annual income (6.2% paid by the employer and 6.2% paid by the employee). By increasing this tax rate, money going into the Part A trust fund will increase. Who would get hurt? All employers who have to pay more in payroll taxes and all workers who also have to pay more in payroll taxes.
2. Increase the maximum taxable income for payroll taxes. For 2025, payroll taxes are only paid on the first $176,100 of income each year. By increasing this threshold, the annual amount of payroll taxes going into the Part A trust fund will increase. Who would get hurt? Wealthy Americans who have incomes above $176,100/year.
3. Charge premiums for Medicare Part A. This would provide an additional source of revenue for the Part A trust fund other than payroll taxes. Who would get hurt? Seniors over age 65 who will have their monthly Medicare premiums increase.
4. Change the law regarding Part A funding sources. Currently, Congress can use federal general funds that are derived from income taxes to pay any shortfall in Medicare Part B but cannot use income tax revenue for Medicare Part A. Congress could pass a law permitting general funds (i.e., federal income taxes) to be used for Part A. However, this would require Congress to increase the federal income tax rate. Who would get hurt? Any American who pays federal income tax.
5. Increase the number of legal immigrants. Since the fundamental reason that Medicare Part A is running out of money is the drop in the ratio of workers:Medicare beneficiaries from 4:1 in the 1960’s to 2.7:1 today, we can increase that ratio by bringing immigrants into the U.S. who are here legally and pay payroll taxes. The other option is to significantly increase the American birth rate but this would not increase the ratio of workers:Medicare beneficiaries for at least 20-30 years. Who would get hurt? Anyone who dislikes immigrants.
6. Raise the Medicare eligibility age above the current age of 65-years-old. This would result in Americans retiring later in life so that the ratio of workers:Medicare beneficiaries would increase. An argument often used for this approach is that Americans are living longer and the price of a longer life should be a longer working career. Who would get hurt? Americans younger than 65 who are going to have to work more years before they can retire (or have to buy commercial health insurance if they choose to to retire before the Medicare eligibility age.

Decrease the amount of money paid out of Part A

Once again, there are several ways of reducing Medicare Part A expenditures:

1. Raise the Medicare eligibility age above the current age of 65-years-old. This is also listed as a way of increasing money coming into Part A by increasing the working Americans and thus increasing the retirement age. But it also would reduce Medicare expenditures because when the Medicare eligibility age increases, the number of Americans receiving Medicare benefits decreases. In other words, there is a double benefit to increasing the eligibility age by both increasing money going into Medicare via payroll taxes and decreasing money spent by Medicare by decreasing the number of Medicare beneficiaries. Raising the eligibility age can be justified because Americans are living longer. Medicare began in 1965 at which time the U.S. life expectancy at age 65 was 12.9 years for men and 16.3 years for women. Today, the life expectancy at age 65 has increased to 17.0 years for men and 19.8 years for women. In other words, men live 4.1 years longer and women live 3.5 years longer than they did when Medicare first rolled out. Who would get hurt? Americans younger than 65 who are going to have to wait until later in life before they are eligible for Medicare.
2. Increase deductibles on Part A charges. Currently, there is a Part A deductible limit of $1,676 per hospital stay. People with original Medicare often purchase Medicare Supplemental Insurance (Medigap policies) from commercial insurance companies that pay for deductibles. By increasing the deductible limit, Medicare Part A expenditures would decrease. Who would get hurt? Medicare beneficiaries.
3. Increase co-pays on Part A charges. Currently, there is no co-pay for the first 60 days of hospitalization and 20 days of skilled nursing facility (SNF) care. After those numbers of days, there are daily co-pay charges. After 150 days of hospitalization or 100 days of skilled nursing facility care, you are responsible for all daily charges. By adding co-pays for all hospital or SNF days, Medicare Part A expenditures would decrease. Alternatively, the number of hospital or SNF days without a co-pay could be reduced from their current numbers. Who would get hurt? Medicare beneficiaries.
4. Move some Part A services to Part B. This is the sleight of hand approach. By moving services such as home health care or hospice care from Medicare Part A to Medicare Part B, there will be fewer Part A expenditures that have to be covered by payroll tax receipts. Instead, they would be covered by federal government general funds, derived from regular income tax. Who would get hurt? Everyone who pays federal income tax.
5. Change funding for Medicare Part C. Currently, Medicare Advantage Plans (Medicare Part C) is funded from three sources: Part A funds, Part B funds, and monthly premiums paid by covered individuals. The result is that the commercial insurance company offering a Medicare Advantage Plan then becomes responsible for any Medicare charges that would have otherwise been covered by Part A or Part B in traditional Medicare. Most Medicare Advantage Plans also cover prescription medications (Part D). Medicare Advantage Plans are popular and currently, more than half of Medicare beneficiaries are in a Medicare Advantage Plan instead of traditional Medicare Parts A & B. Congress could change the funding mechanism for Medicare Advantage Plans by making Medicare Part C funded entirely through federal general funds rather than the current mechanism of through both payroll taxes (the Part A component) and general funds (the Part B component). Who would get hurt? Anyone who pays federal income tax since ultimately federal general funds come from income tax revenue.
6. Change the definition of inpatient hospitalization. “Observation” hospital stays are considered to be outpatient care and thus paid for by Medicare Part B. In 2013, Medicare introduced the “2-midnight rule” that defined an observation stay as any hospitalized patient who was in a hospital bed for a period of time less than 2 midnights. This was a clever way of shifting those short hospital stays from Medicare Part A to Medicare Part B while reducing overall Medicare expenditures by requiring patient co-pays attendant to Part B services. By increasing the 2-midnight rule to 3 or 4 midnights, more hospitalizations would be reclassified as observation stays and thus moved to Medicare Part B. Alternatively, all elective surgical admissions could be redefined as observation stays (currently hospital stays for some surgical procedures are classified as observation stays covered by Part B and others are classified as inpatient stays covered by Part A). Who would get hurt? Medicare beneficiaries who would now be responsible for Part B co-pays and hospitals that are paid less for observation stays than for inpatient hospitalizations.
7. Reduce DRG payment amounts and SNF daily rates. Hospitals are paid a fixed amount from Medicare Part A based on a patient’s diagnosis, regardless of how many days that patient is in the hospital; this is know a the diagnosis related group (DRG). Skilled nursing facilities are paid based on Medicare’s SNF daily rate that is adjusted based on the types of therapy the patient receives in the SNF. By reducing the amount that Medicare pays hospitals per DRG and the daily rate amount that Medicare pays SNFs, Part A expenditures will drop. Who would get hurt? Hospitals and skilled nursing facilities. Hospitals and SNFs would have to make up the financial loss by charging more to commercial insurance companies, thus raising commercial heath insurance premiums to working Americans. Many skilled nursing facilities would likely go out of business.
8. Eliminate Medicare coverage for certain medical conditions. Medicare covers just about any medical illness that a person over age 65 has. Part A expenditures could be reduced by eliminating hospitalization coverage for preventable diseases such as COVID in a person who is unvaccinated or smoking-related disease in a person who is an active smoker. This would require controversial social judgements and undoubtedly result in lots of lawsuits from the ACLU and other patient advocacy groups. Who would get hurt? Smokers and anti-vaxxers who would have to pay the cost of treating preventable diseases.
9. Get rid of Medicare. Possibly one of the most draconian ways to reduce Medicare expenditures is to eliminate it completely. The result would be that lower income retirees would be eligible for Medicaid and wealthier retirees would have to purchase commercial health insurance. This would get the government out of the healthcare entitlement business but still keep Medicaid there as a safety net for the poorest retired Americans. Who would get hurt? Middle class and upper class Americans making more than the Medicaid income threshold. Each state has different Medicaid income requirements but they are typically for individuals making less than about $16,000/year or couples making less than $21,000/year.
10. Medicare for all. The opposite approach to eliminating Medicare is to make it available to all Americans of all ages. One of the problems with Medicare compared to commercial health insurance plans is that Medicare covers the elderly whereas commercial insurance plans cover Americans younger than 65. Younger people incur less healthcare expenses than older people and consequently, commercial health insurance companies cover the healthiest Americans with the lowest annual healthcare costs whereas Medicare covers the least healthy Americans with the greatest annual healthcare costs. Currently, working Americans and their employers together pay both 12.4% of income for payroll taxes (for Social Security plus Medicare) and an average of $8,500/individual/year for commercial health insurance premiums. For family coverage, those premiums increase to $24,000/year. Since the average annual income in the U.S. is $40,000, the average American worker and their employer is already paying $12,500 per year just for individual healthcare coverage (plus Social Security coverage) and that goes up to $29,000 for family coverage. Medicare for all would be overall less expensive because it would eliminate several costly layers of health insurance bureaucracy. Who would get hurt? Commercial insurance companies that would all go out of business except for those that sell Medigap policies and Medicare Advantage plans. Pharmacy benefits management companies would go out of business. Pharmaceutical companies would have to reduce drug prices.

So, what would I do?

If I was a politician and was worried about re-election, I would choose a sleight of hand approach and move some services currently covered by Medicare Part A into Medicare Part B. That immediately reduces Part A expenditures and transfers them to Part B where they would be funded by federal government general funds. Eventually, those general fund expenditures would require increasing federal income tax rates, however.

If I was a politician and was not running for re-election, I would gradually increase the Medicare eligibility age from 65 to 67. This has the double effect of (1) increasing the U.S. worker:Medicare beneficiary ratio with an attendant increase in payroll tax revenue while also (2) decreasing Part A expenditures by reducing the total number of Medicare beneficiaries. The justification would be that the Medicare eligibility age has remained at 65-years-old since the inception of Medicare in 1965 whereas the U.S. life expectancy has increased by about 4 years since that time. The cost of being able to live 4 more years is that you have to work a another 2 more years (or at least have buy your own health insurance for a few years if you retire before that age).

There are solutions to the impending Medicare funding crisis, it is just that there are no easy solutions.

March 13, 2025