Medicare's Long Fiscal Shadow

Volume V, Number 1 January 21, 1999

With the National Bipartisan Commission on the Future of Medicare due to release its report on March 1, federal health benefit spending on the elderly is again in the news. That's a good thing for the debate over Social Security reform, which cannot proceed intelligently unless we understand how the explosive growth in Medicare constrains our fiscal options.

Many believe that we've already turned the corner on Medicare spending. But even in the near term, this is a very optimistic reading of the numbers. While the 1997 Balanced Budget Act (BBA) promises large savings over the next decade, it's doubtful all of it will materialize. Congress and the White House may succumb to pressure to spend some of the budget surplus on Medicare. Even if they don't, health-care costs are accelerating, which will make the BBA's savings targets hard to meet.

As for the long term, Medicare remains as unsustainable as ever. Even after the BBA, the Trustees project that the cost of Medicare will more than double as a share of worker payroll over the next forty years. And this projection, based on optimistic assumptions, may vastly underestimate the future cost burden.

Dubious Premises

Let's start with the near term. By the simple expedients of ratcheting down on provider payments and giving beneficiaries more "choice" to enroll in managed care options, the BBA is supposed to cut Medicare by roughly 10 percent beneath the prereform projections.

This savings of course assumes that current law remains unchanged--a dubious premise now that the budget is running surpluses. Industry groups from hospitals to HMOs to home health-care agencies are lobbying Congress to ease up on the BBA. Meanwhile, senior advocates are urging new benefit expansions--with prescription drugs topping the list. "Everyone is lining up at the cash register," explains Medicare Commission member Stuart Altman. "It's the sport of the year."

But there's an even more dubious premise--namely, that large savings are possible without asking beneficiaries to give something up. The reasoning behind the BBA goes like this: Medicare costs have been rising faster than private health-care 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. Private costs slowed dramatically in the mid-1990s as the managed care revolution swept America's workplaces. But this was just a one-time savings--and the latest data show that costs are again accelerating. According to the consulting firm Towers Perrin, premiums for employer health benefits at large firms will jump by an average of 7 percent in 1999, compared with 4 percent in 1998 and 2 percent in 1995. Looking ahead, the Health Care Financing Administration now projects that total private spending growth will speed up from 2.9 percent per year between 1993 and 1996 to 7.2 percent between 1998 and 2001--even as the growth rate in Medicare is slated to be cut from 9.9 percent to 5.0 percent.

These numbers don't compute. Yes, once upon a time Medicare might have been able to slash payment rates in the face of a rising private 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 BBA will save less than anticipated. Or else beneficiaries will begin to see real cuts in the health care they receive--an outcome for which political leaders have failed to prepare the public. The outcry over the decision of some forty HMOs to pull out of unprofitable Medicare markets in 1999 is a harbinger of things to come.

The Long-Term Outlook

And what about the long term outlook? According to the latest (1998) Trustees' projection, which takes the BBA into account, Medicare will grow from 5.4 percent of payroll today to 13.6 percent by 2040.

This projection may appear pessimistic. But just the opposite is true. Not only do the Trustees assume that the growth in elder longevity will slow down and that the growth in worker wages will speed up. They posit a further cut in Medicare cost growth far beyond anything legislated in the BBA. Since 1970, real per-beneficiary Medicare spending has grown at the blistering rate of 5 percent per year. Yet the Trustees assume that this growth will slow all the way to 1 percent per year by the 2020s. Without that slowdown, Medicare would by 2040 cost over 40 percent of payroll.

The Trustees don't cite any specific reforms that might explain the remarkable slowdown in long-term costs. They simply assume that costs must someday be capped if Medicare is not to consume the entire economy. But merely to assert that something will happen begs the real question: How will we make it happen?

The Underlying Cost Drivers

Political leaders like to pretend that there are simple fixes that don't require anyone to give anything up. Just clamp down on fraud, or cut back on excessive paperwork, or eliminate all the unnecessary tests and procedures--and presto, the problem will be solved.

Health experts see it differently. "Pure waste," they point out, is no easier to pinpoint in the health system than it is in the federal budget. And even if we could identify and eliminate all of it, the underlying cost drivers--from technology to expectations to aging--would soon cause spending to grow again as fast or faster than before.

There's no doubt that America's technology-intensive style of medicine--there are more MRI units in greater Atlanta than in all of Canada--is the single most important reason we spend so much more on health care than other nations do. In a recent survey of fifty health economists, four out of five agreed that "technological change in medicine" is the main cause of rising health expenditures over the past thirty years.

But technology isn't the only reason costs keep growing. There's also society's expanding definition of health itself. In recent decades, we have steadily broadened the definition of insurable health care to include whole new realms of social life--from psychiatric counseling for troubled youths to home care for the frail elderly. "Good health," moreover, is a subjective standard, one that naturally rises as society becomes more affluent. As these trends interact with technological progress, they are transforming the practice of health care. While once health care meant an occasional visit to the doctor or hospital, it is fast becoming a lifelong process of diagnostics and fine tuning in which any extra dollar spent is likely to confer some perceived benefit.

Finally and most fatefully, there is the aging of America's population. Nearly every measure of illness, disability, and health-care utilization rises with age, even among the elderly themselves. On average, each older American consumes about four times as much in medical services as a younger adult and about seven times a much as a child. Although the elderly now comprise just 13 percent of the U.S. population, they account for roughly 40 percent of U.S. medical bills.

It is unclear whether tomorrow's elderly will be more or less healthy than today's. Some experts believe that health spans will lengthen along with life spans. Others, however, take the opposite position. According to what is sometimes called the "failure of success" hypothesis," longer life spans will be accompanied by a rising incidence of chronic disease, from diabetes and hypertension to arteriosclerosis and Alzheimer's.

Either way, health benefit spending on the elderly will continue to grow faster than the economy so long as we pretend that costs can be controlled without any sacrifice. Let's be clear: Costs aren't rising because of the proliferation of useless medical services. They're rising because medical science can do more for more people--and because what it can do is often very expensive.

Setting limits in Medicare will mean moving toward a whole new paradigm--one in which prospective budgets at the program level and capitation at the beneficiary level finally compel us to make tradeoffs between health care and other national priorities.

Precisely Backwards

Defenders of the status quo argue that Social Security and Medicare are "separate deals"--and that, while terrifying long-term projections may be pushing Medicare toward a major overhaul, these shouldn't influence the debate over Social Security. It's as though Medicare's bleak future is a reason not to worry about Social Security.

But this logic is precisely backwards. Both Social Security and Medicare tax the same people (mostly workers) to pay benefits to the same people (mostly retirees). What matters fiscally and economically is the total burden of senior benefits. Even under the official projections, this is due to reach 35 percent of payroll by 2040--flattening the growth in worker living standards over the next half century. Because controlling health benefit spending will be so difficult, it is all the more urgent to save what we can in Social Security.


. Last updated: 21 Jan 1999