Currently the Medicare Hospital Insurance (HI) trust fund is projected to be depleted in 2036. At that time, Medicare will only be able to pay for 89% of the cost of inpatient hospital and nursing home care. The previous post outlined the sources of funding for Medicare Part A, Part B, and Part D. Because each of these Medicare components are funded differently, only Medicare Part A is in danger of insolvency. But how did we get here? The simple answer is that health care costs are increasing faster than Medicare payroll taxes. But an in-depth look indicates that the causes of Medicare’s impending insolvency are much more complex. In order to develop solutions to the depletion of the Medicare trust fund, we must first understand the complex reasons causing the trust fund to run out of money. We can group these reasons into two broad categories: (1) health care cost inflation and (2) a falling ratio of currently working Americans to Medicare beneficiaries.
Health care cost inflation
Inflation is the increase in the cost of goods and services. It is commonly measured by changes in the consumer price index, as determined by the U.S. Department of Labor Statistics. The country’s overall average inflation rate is the sum of the individual inflation rates of all goods and services but each of these individual inflation rates vary considerably. The inflation rate for health care has consistently been higher than the overall average inflation rate. Since 2000, the increase in the consumer price index for all goods and services is up by 85% but the increase in the cost of health care is up by 119% as shown in the graph below.
Inflation is not necessarily bad because the cost of goods and services generally rises in tandem with worker wages. Only if inflation rises faster than worker wages is there a problem for the average American. Since 2000, wages have increased by an average of 82%, fairly close to the overall inflation rate but far less than the inflation rate for health care.
Because of health care inflation, Medicare expenditures are projected to increase at a faster pace than either worker’s earnings or the economy overall and as a result, money coming into Medicare Part A cannot keep up with money going out of Medicare Part A. Currently, Medicare expenditures are 3.8% of the nation’s overall GDP (gross domestic product) but this will increase to 5.8% by 2048.
Americans already pay more for health care than citizens in any other country. The OECD reports that in 2022, the cost of health care in the U.S. averaged $12,500 per person.
Because Medicare beneficiaries are by definition older or disabled, they generate higher health care costs than the average American. In 2023, the cost of health care for the average Medicare beneficiary was $16,710 per year. The net result of health care inflation is that each year, Medicare must spend increasingly more to pay for medical services for any one Medicare beneficiary.
The ratio of current U.S. workers to Medicare beneficiaries has fallen
Many Americans have the misconception that their Medicare benefits are funded by the money from the payroll taxes that they paid themselves when they were working. This is completely inaccurate – Medicare does not save the money that we individually pay in the way of payroll taxes in some kind of personal account. Medicare beneficiaries are supported by those people who are paying payroll taxes today. In order to maintain Medicare solvency, there must be a constant ratio of current workers to current Medicare beneficiaries. Historically, that ratio was 4:1, that is 4 Americans currently working and paying payroll taxes for every 1 Medicare beneficiary. That ratio started to fall in 2000 and is now down to 2.8:1. It is projected to fall even further over the next several decades as shown in the graph below from the most recent Annual Report by the Board of Trustees of the Medicare Trust Funds.
Medicare Part A is funded through the Medicare Hospital Insurance trust fund (HI). As the ratio of currently working Americans to Medicare beneficiaries falls, payroll taxes become insufficient to fully fund Medicare Part A expenses, eventually resulting in depletion of the Medicare HI trust fund.
There are several reasons for the reduced ratio of current workers to Medicare beneficiaries including (1) improved life expectancy, (2) reduced American birth rate, (3) the baby boomer population surge enrolling in Medicare, and (4) Americans working for fewer years than in the past. Let’s now look at each of these.
1. Medicare beneficiaries are living longer
Over the past 120 years, medical science has allowed Americans to live longer. In 1900, the life expectancy from birth was 47 years and today it is 77.5 years, a 30 year longer life expectancy.
Much of the increase in life expectancy from birth has been due to improvements in infant and maternal mortality rates. For Medicare financing purposes, a better measure is life expectancy from age 65. In 1965, when Medicare was enacted, U.S. life expectancy from age 65 was 12.9 years for men and 16.3 years for women. In 2022, those numbers grew to 17.5 years for men and 20.1 years for women. In other words, American men are on Medicare 4.6 years longer (26%) than in 1965 and American women are on Medicare for 3.8 years longer (19%) than they were in 1965.
This striking improvement in life expectancy could not have been anticipated back when Medicare was first created. It is due in part to improvements in medical science and in part due to the reduction in cigarette smoking. In 1965, 52% of men and 34% of women smoked; today, only 13.1% of men and 10.1% of women smoke. The cost of our better health and improved life expectancy is being paid by Medicare that has to now pay medical expenses for more years per person. COVID gave us a temporary reprieve by preferentially killing Medicare beneficiaries and reducing average U.S. life expectancy by 2.3 years. But this reprieve will be short-lived as life expectancy returns to 2019 values over the next few years.
2. The American birth rate has fallen
Americans are having fewer children and increasingly, more American women are having no children at all. The birth rate is the number of live births per 100,000 population. The fertility rate is the number of live births per women of childbearing age and is a better measurement of the number of children women are having. In 1965, the U.S. fertility rate was 3 live births for every 1 woman. Today, the U.S. fertility rate is only 1.62 live births for every 1 woman. In other words, the U.S. birth rate is about half of what it was in 1965 when Medicare was enacted.
As Americans have fewer children and those children grow up to become working adults, there are fewer working adults to pay payroll taxes and thus fewer working adults to support today’s Medicare beneficiaries.
3. Baby boomers are enrolling in Medicare
There have been two recent surges in the U.S. total population – the baby boomer surge and the peak millennial surge. The peak millennials are the children of the baby boomers. In the graph below, these two surges can be seen in the males and females at age 60-64 (baby boomers) and at age 30-34 (peak millennials).
When a population surge hits age 65, there is a sudden increase in the number of people retiring from the workforce going on Medicare and this will reduce the ratio of current workers to current Medicare beneficiaries. The baby boomer surge has contributed to the inability of current payroll taxes to fund Medicare Part A. The United States will experience a similar surge in 30 years when the peak millennials enter Medicare.
The net effect of Americans living longer, the decreased U.S. fertility rate, and the baby boomer population surge has resulted in a disproportionately large increase in the number of Americans who are over age 65. In 1965, 9.6% of Americans were over age 65 and today, 17.6% of Americans are over age 65.
Medicare was designed to care for about 10% of the U.S. population but today, it has to cover nearly 18% of Americans. The Medicare funding equations that worked in 1965 simply do not work in 2024.
4. Americans work fewer years
When Americans retire, they are no longer paying payroll taxes. When Americans retire at an earlier age, there are fewer Americans paying payroll taxes and thus less total money going into Medicare Part A every year. In 1965, at Medicare’s inception, the average American man retired at age 66. Today, the average American man retires at age 65. On the surface, this does not seem like much – only one year. However, that one year is usually at the point in a person’s career when they are earning the most money and therefore paying the most payroll taxes.
In contrast to men, American women are retiring later in life than in the past. In 1965, the average American woman retired at age 56 and today women retire on average at age 62. This increase represents a trend over the past 50 years for more women to work outside of the home while raising children and to continue working after those children leave home. The bad news is that American men’s income continues to be higher than American women’s income (the gender wage gap). The average American woman earns only 83.6% of the average American man. Thus, men retiring 1 year earlier has a greater reduction in payroll taxes than the increase in payroll taxes when women work 1 year longer.
But retirement age only tells part of the story when it comes to the number of years a man or woman works and contributes payroll taxes. The other part of the equation is when a man or woman enters the workforce and that generally does not happen until the completion of education. In 1965, 12.0% of men and 7.1% of women had a college education. In 2021, 36.2% of men and 39.0% of women had a college educations. Furthermore, more Americans are attending graduate school after college – 13% of Americans have a master’s degree, 3.5% have a professional degree, and 2% have a doctorate. By going to college, people enter the workforce about 4 years later in life than if they went to work directly after high school. Graduate school adds another 2-6 years. Although college educated people earn more than non-college educated people, they pay payroll taxes for fewer total years before retiring.
Although Americans are working fewer years between completion of education and retirement, the Medicare payroll tax rate of 2.9% has not changed in the past 38 years. However, there was a 0.9% tax premium on top of the base Medicare payroll tax for people earning more than $200,000 per year ($250,000 if married) that was enacted in 2013.
The growth in Medicare beneficiaries is unsustainable
Since Medicare’s inception in 1965, the age of Medicare eligibility has not changed – it was age 65 in 1965 and it is still age 65 in 2024. On the other hand, the Social Security full retirement age has increased from age 66 in 1954 to age 67 today. Thus, the Social Security full retirement age is two years later than the age that Americans start Medicare. And herein lies a philosophical question – what should the Medicare age be tied to? Should it remain the (somewhat arbitrary) age of 65? Should it be tied to the Social Security full retirement age of 67? Should it be tied to life expectancy? Should it be tied to the number of working years?
If nothing is done, then the Medicare Part A trust fund will be depleted in 2036 and Medicare will no longer be able to fully cover inpatient hospital care, nursing home care, and hospice care. In the next post, we will examine options for preventing this from happening.
July 24, 2024
