Have We Turned The Corner On Medicare Costs?

Volume VI, Number 6 May 30, 2000

The news about Medicare seems to get better and better. After slowing in 1998, spending actually declined in 1999 for the first time in the program's history. Meanwhile, the projected bankruptcy of Medicare's Hospital Insurance (HI) trust fund has receded by nearly twenty-five years, from 2001 to 2025. Along the way, the debate has shifted from cost-savings to more pleasant topics--such as dispensing new benefits. The shift is understandable, but it's a colossal mistake. Even in the near-term, the outlook for Medicare is uncertain. The latest data show that health costs are accelerating, and this could make it more difficult to achieve the savings legislated in the Balanced Budget Act (BBA) of 1997. At the same time, Congress has eased up on many of the Act's provisions. As for the long term, Medicare remains as unsustainable as ever. The extension in the solvency of the HI trust fund says nothing about Medicare's burden on the budget or economy. What matters is Medicare's annual cost, and the Trustees project that this will double as a share of GDP over the next forty years. The Trustees, moreover, acknowledge that this projection "may be optimistic." More prudent projections show that Medicare could cost three times what the Trustees project. Yes, Medicare needs to be "modernized"--which means, among other things, integrating prescription drug coverage into a redesigned benefit package. We shouldn't create new entitlements, however, until we can afford the old ones. Those who believe that we've already turned the corner on Medicare costs haven't looked closely at the numbers.

A Dubious Premise

To be sure, the experience of the past two years has been remarkably favorable. When the BBA was enacted, the CBO expected that it would slow the growth in Medicare spending to 5.5 percent per year between FY 1997 and FY 2002. Actual spending grew by just 1.5 percent in 1998--and in 1999, it declined by 0.8 percent. The extra savings is attributable to several factors. The projections underestimated the BBA's home health savings. They also failed to anticipate the widespread payment delays associated with implementing the Act's provisions--or the reaction of providers to stepped-up efforts to root out "fraud and abuse." The bad news is that the good news can't last. The payment delays merely shift costs from one year to the next. And cracking down on fraud only yields one-time savings, even if it's genuine fraud that's being eliminated. Much of it isn't. Many providers are simply "downcoding" services--in other words, billing less than they're entitled to--while they sort out Medicare's new regulations. It's like the taxpayer who foregoes a legitimate deduction to avoid attracting an audit. As for the BBA itself, it was never designed to be a permanent solution. With a few exceptions, the Act does nothing to change the incentives facing patients or providers. Its savings come almost entirely from cuts in payment rates. Some of the cuts have already been rolled back by the Balanced Budget Refinement Act of 1999. The others are mostly due to expire after 2002. For all of these reasons, CBO and HCFA both project that Medicare spending will soon pick up again. There's a more fundamental problem. The BBA's whole approach to cost control is based on a dubious premise--namely, that large savings are possible without requiring beneficiaries to give up something. The reasoning goes like this: Medicare costs have been rising faster than private health costs, which means that Medicare must be overpaying providers, which in turn means that there's room for lots of painless savings. While this may have been true a few years ago, it no longer is. According to the Kaiser Family Foundation, employer health premiums jumped by 4.8 percent in 1999, compared with an average increase of 1.9 percent per year from 1995 to 1998. Meanwhile, HCFA reports that the growth in total private health spending sped up from 3.3 percent per year between 1993 and 1997 to 6.9 percent between 1997 and 1999--even as the growth in Medicare fell from 9.6 percent to less than 1.0 percent. This divergence is not sustainable. Yes, once upon a time Medicare might have been able to keep squeezing payment rates in the face of a rising cost trend by shifting costs to private payers. But in today's competitive health-care marketplace, there's no silver lining. Either providers must offset Medicare rate cuts by increasing the volume of Medicare services they bill, in which case the savings will be nullified, or else beneficiaries will begin to see real cuts in the health care they receive. The decision of many HMOs to pull out of unprofitable Medicare markets and cut back on extras like prescription drugs is a sign that the BBA's approach is played out. Merely squeezing payment rates without changing incentives eventually leads to less choice, lower quality, and widespread queuing--outcomes for which leaders have utterly failed to prepare the public.

An Outlandish Assumption

And what about the long term? The place to start is to forget about HI's solvency. Yes, today's booming economy is swelling payroll tax revenue, and so it is also swelling the HI trust fund. But government trust funds are just accounting devices. Their assets represent claims on future taxpayers, not economic savings. HI may now be solvent until 2025. But as soon as annual HI outlays exceed annual earmarked tax revenue--in 2009, according to the latest (2000) Trustees' report--Congress will have to raise taxes, cut other spending, or borrow from the public to pay benefits.

Growth in Real Per-Beneficiary Medicare Spending


1970-75 4.9%
1975-80 6.6%
1980-85 6.7%
1985-90 3.4%
1990-95 5.7%
1995-00 1.1%
Trustees' Projection
2000-05 2.4%
2005-10 2.0%
2010-15 1.8%
2015-20 1.6%
2020-25 1.4%
2025-75 1.3%

The focus on trust-fund solvency also ignores Supplementary Medical Insurance (SMI), which now accounts for 40 percent of Medicare spending and which is projected to grow faster than HI. In fact, the focus is one reason for SMI's faster growth. Why? To make HI look better on paper, the BBA shifted much of home health spending from the HI trust fund to the SMI trust fund, where general revenues automatically plug any gap between beneficiary premiums and outlays. The purpose of such shell games is to divert attention from the only bottom line that matters: Medicare's total cost. Even after the BBA, the Trustees project that Medicare will grow from 2.3 percent of GDP today to 4.8 percent by 2040. This projection may appear pessimistic. But just the opposite is true. Consider: Since 1970, real per-beneficiary Medicare spending has grown at the average rate of 4.7 percent per year. The Trustees assume that this growth rate will never again rise above 2.3 percent--and that, throughout most of the next seventy-five years, it will be just 1.3 percent, roughly the projected rate of growth in worker payroll. This is an outlandish assumption--and one with a huge impact on the projections. If real per-beneficiary spending grows in the future at the same rate it has grown in the past, Medicare will cost not 4.7 percent of GDP by 2040, but a staggering 14.9 percent.* The Trustees defend their projections on the grounds that Medicare spending must be constrained if it is not to consume the entire economy. This is true enough. But merely to assert that something must happen begs the real question: How will we make it happen?

More Honest Numbers

Ultimately, Medicare must be entirely recast. Its benefit package needs to be modernized by combining HI and SMI into a single program that includes prescription drug coverage and much better back-end protection against catastrophic costs. Its incentives need to be reordered by moving more in the direction of capitation or "premium support." The National Bipartisan Commission on the Future of Medicare pointed the way, but unfortunately its recommendations have been ignored. In the meanwhile, the debate needs more honest numbers. The Concord Coalition urges the Trustees to produce a new baseline--one in which the underlying forces driving up health costs, from new technologies to rising expectations, are not arbitrarily assumed away. It also calls on them to put less emphasis on trust-fund solvency and more on indicators like cash balance that reflect Medicare's burden on the budget and economy. This is precisely what the recent Advisory Board Technical Panel recommended for Social Security. The current Medicare slowdown affords the perfect opportunity to embark on more fundamental reform. It would be tragic if leaders squander it because the official numbers obscure the challenge that remains.

* Assumes that real spending growth per age-adjusted beneficiary returns to its long-term (1970 to 2000) average after 2005.