It is now an open question whether Medicare will provide adequate health coverage to the baby-boom generation as it begins turning 65 just over a decade from now. The source of uncertainty is not whether America has the resources to sustain the program; we do. The real challenge comes instead from proposals to save Medicare. Far from preserving its benefits, the major restructuring proposals under discussion would radically alter the principles on which Medicare rests and erode the protection it affords.
The enactment of Medicare in 1965 reflected political support for three fundamental principles regarding health care for the elderly. We decided then that insurance is the right way to spread the risk to the elderly of sizable health care costs, that redistributing income through the tax system is necessary to make that insurance affordable and universal, and that the insurance and taxes are best administered by the federal government if the system is to serve all of the elderly regardless of their income or health.
These principles of insurance, redistribution, and government responsibility are now at risk. The challenge comes from both sides of the political aisle in proposals that would convert Medicare from a universal entitlement to public insurance into a government voucher for private insurance. Such a shift has become the major issue in deliberations by the Bipartisan Commission on Medicare's Future. If these proposals prevail, Medicare may become a dwindling basis of security in old age.
Medicare unquestionably faces big financial problems. In the not-too-distant future, the costs of the hospital insurance program (Part A) of Medicare, which is financed through a dedicated payroll tax, will exceed the revenue that the tax brings in. This immediate problem stems not from the aging of the population, but from the fact that health care costs, whether public or private, tend to rise faster than payroll. When Con gress passed the Bal anced Budget Act of 1997, it slowed the rate of growth in Med i care's payments to providers and health plans and shifted some payment responsibilities for home health services out of Part A. That action delayed the date when revenue will be exhausted to about the time the baby-boom generation begins entering the program.
At that point, there is a problem that is uniquely Medicare's. By 2030, the program is likely to have double the number of beneficiaries it has today—76 million compared to today's 38 million. Social Security's actuaries project that in 2030 one in five Americans (and, counting disabled Medicare beneficiaries, one in four Americans) will be on Medicare—compared to about one in eight today. Too few workers will be paying the payroll tax to support the elderly population that depends on it.
Instead of considering alternative ways to address this imbalance, the standard reaction is to say that Medicare is fiscally "unsustainable" and that government responsibilities for the health care of the elderly have to be retracted. But to treat the problem as purely budgetary obscures the real challenge of an aging population and ignores Medicare's fundamental purpose. For the last 30 years, Medicare—with some significant help from Medicaid for low-income elderly and for long-term care—has provided affordable health insurance for the nation's elderly citizens without the problems that plague health insurance for younger Americans. Medicare is nearly universal, and it avoids dividing the healthy from the sick and the poor from the better-off.
Limiting the government's liabilities for health care won't make those liabilities go away. Rather, it will shift them back to the elderly and their families. In either case, Medicare's signal advantages—its ability to spread risk and to make insurance affordable—will be lost. That is not solving the problem; it's abdicating responsibility.
This shift of risks back to the elderly would take place under the option that many reformers have been promoting: transforming Medicare from the defined benefit it now represents (the guarantee to beneficiaries of a specified set of benefits) into a defined contribution (the guarantee only of a fixed-dollar amount, or voucher, for purchasing private insurance). The Balanced Budget Act passed by the Republicans in 1995 for the most part adopted this strategy, and that was one of the major reasons President Clinton vetoed it.
Two years later, however, the President joined Congress in a proposal that would gradually pave the way for a voucher approach. Although the Balanced Budget Act of 1997 slowed the growth in Medicare costs by cutting payments to providers, it also set up an expanded "choice" system for Medicare. This is an arrangement allowing beneficiaries to choose from a number of competing health plans, including the traditional Medicare system. In theory, such a competitive system can achieve greater efficiency in Medicare by making consumers sensitive to price and providers sensitive to costs. In practice, however, a competitive system poses a major challenge to the principles of risk spreading, redistribution, and government responsibility on which Medicare rests.
Breaking up the Pool
For the bulk of its history, Medicare has operated as a single insurance pool, spreading the costs of any individual's illness across the full population. By contrast, a system of competing health plans threatens to fragment the pool, separating the healthy from the sick. The easiest way for insurers to keep premiums low, and thereby win more enrollees, is to attract the healthy and avoid people who are sick and will run up heavy claims. Not only insurance plans, but also healthy beneficiaries have a short-term stake in this separation since they pay less until they need health care. But this fragmentation or risk selection undermines the pooling of risk that insurance is supposed to provide. It leaves sick people in a smaller pool with higher costs.
Any system of choice, even Medicare's previous arrangements allowing beneficiaries to join HMOs, raises the likelihood of risk selection. The Balanced Budget Act took explicit steps to minimize that likelihood, including rules to require health plans to accept all applicants and charge them the same premiums, regardless of their health. It also required Medi care to adjust its method of paying health plans to pay less for healthier patients and more for sicker ones.
Other provisions, however, actually aggravated the problem. The Medical Savings Accounts (MSAs) established under the act are attractive to people with both minimal health needs and the resources to take risks and profit from tax shelters. New "provider-sponsored" organizations, run by doctors and hospitals, are exceptionally well-positioned to separate the healthy from the sick, since they will know which beneficiaries are which and will benefit financially from sorting them appropriately. Although these arrangements have been slow to take off, advocates of "choice" see the limited availability of private plans as the problem needing to be fixed—not the likely appetite of the plans for skimming off the cream.
Even the architects of choice recognized that if plans are paid based on average risk and they enroll beneficiaries who are healthier than average, Medicare will overpay and the taxpayers will lose. To correct that problem, the Balanced Budget Act required the secretary of Health and Human Services (HHS) to develop a new way of paying Medicare's health plans that recognizes or "adjusts" for risk selection. When the act was passed, everyone agreed that was a good idea, although a difficult one to implement. But once HHS announced a method that, not surprisingly, would reduce payments to health plans, the insurance industry cried foul. In part, the dispute reflects the technical difficulty of tying payment to risk. But it also reflects the political difficulty of countering the rational behavior of private insurers. As a result, it seems unlikely that Medicare will be able to overcome the tendency of insurers to attract the healthy and avoid the sick, and the fiscal problems that sorting creates.
The Risk to Equal Treatment
Federal policy has promoted equal treatment of Medicare beneficiaries regardless of income in two ways. First, it has limited what health plans and providers can charge above what Medicare pays. Second, through Medicaid, it has extended assistance to low-income families to cover the payments that Medi care requires. The 1997 legislation began to unravel these protections.
For the first time, the act authorized so-called "unrestricted fee-for-service" or traditional indemnity insurance plans in Medicare. Unlike other plans offered to beneficiaries, these plans and their providers are allowed to charge more than Medicare's limit. Another provision allows physicians and beneficiaries to contract directly for services outside the Medicare program, with no restrictions on charges—a provision known as the Kyl Amendment, which some would like to expand.
Advocates of these provisions argue that they are "liberating" Medicare beneficiaries from unreasonable restrictions, enabling them to pay more to get more. In practice, however, such provisions are far more likely to liberate physicians to increase their charges and avoid beneficiaries who are unable to pay. Although there has been little market response to these new provisions so far, their introduction into the program lays a foundation for pulling the higher-income elderly away from the rest.
New policies affecting the elderly poor have had a more significant impact. Historically, Medicaid has helped low-income beneficiaries pay the premiums and copayments required of Medicare beneficiaries. The Balanced Budget Act, however, limited Medicaid's obligation to cover the copayments; now it must do so only to the extent that Medicare pays a provider less than a state Medicaid program would have. Where Medicaid fees are low, as they are in many states, this policy change cuts off help that the elderly poor have counted on. In the future, the low-income elderly will be treated more as Medicaid than as Medicare beneficiaries, and they will thus face the very barriers to treatment that Medicare was supposed to eliminate.
The Balanced Budget Act also increased the premiums that beneficiaries are required to pay, while explicitly limiting assistance to seniors with low and modest incomes. Although the act established state block grants to make up for these cuts, the grants are adequate to serve only about a third of the beneficiaries who could qualify for help. Many beneficiaries with modest incomes will find the price they must pay for Medicare's protection beyond their means.
A Setup for Failure?
Choice and competition do not eliminate a role for government. "Managed competition" implies that government establishes and enforces rules for health plans and provides information and support to consumers—all to promote efficient service delivery rather than avoiding risk and denying care. But whether policy will actually take this direction is open to question.
In recent years, proponents of health care competition have been more committed to competition than to its management. Even carrying out the Balanced Budget Act itself—approving plans, setting better rates, educating beneficiaries—is an enormous task that requires more resources than Congress has apparently been willing to provide. Inadequate preparation for further expansion of private options may actually prove a setup for government failure.
Although the Balanced Budget Act of 1997 did not eliminate the entitlement to Medicare's traditional fee-for-service program, its structural arrangements set the stage for moving Medicare the rest of the way toward a voucher approach. If that happens, Medicare beneficiaries would receive a fixed amount to shop with and their access to the traditional program would depend upon the ability to pay extra.
Already there is considerable agreement across party lines on vouchers. The chief difference of opinion is about how the vouchers should be set. One way is to establish a dollar value for the vouchers and then allow it to grow at a predetermined rate. That approach explicitly ignores the cost of health care or pretends that the magic of managed care and the marketplace will keep it low. The alternative is to peg the voucher to a share of the average premium, which would mean that the value of the voucher would rise as costs increase. That approach, called a "premium support," still favors a competitive system but does not assume savings in advance. For that reason, it is more benign than the fixed-growth approach.
Even the "good" voucher, however, threatens to abandon the three premises on which Medicare is based. A system that sends individual seniors out to shop among competing health plans is not the same as a system that brings all seniors together into a single health plan. The competitive market would be likely to separate the sick from the healthy. Instead of the redistributive arrangements that assure the affordability of Medicare, the elderly would face a market in which the better-off would pay more and the less well-off would take what they can get. And in the long run, budgetary politics may transform the "good" voucher into a "bad" one, downgrading the "premium support" from average costs to "average minus 5 percent," minus 10 percent, and so on.
This restructuring of Medicare is also a fraud as a solution to the fiscal problems that the program really faces. Managed competition or managed care will do little more to reduce Medicare's per-capita costs than Medicare can already achieve using traditional cost controls. Medicare's enormous market power has long enabled it to obtain the discounts in purchasing that private managed care plans have lately discovered. In fact, Medicare has already taken advantage of the discounting strategy that has probably contributed most to the recent slowdown in private health care costs. And Congress used this market power in the Balanced Budget Act of 1997 to bring Medicare's per-capita spending growth into line with or even below growth projected for the private sector. The only way to gain any further savings is to push Medicare well below the private-sector growth rates.
Moreover, Medicare's benefits are not that comprehensive to begin with. They do not include prescription drugs and do not limit out-of-pocket expenses like most policies provided through employers do. As a result, the typical Medicare beneficiary already pays about 20 percent of income on Medicare premiums, cost-sharing, and health services that Medicare doesn't cover, without even counting spending for long-term care.
The restructuring now being proposed only solves Medicare's financing problem if it dismantles Medicare's protections. That's no solution. Slowing growth in health care costs is a national problem, which Medicare cannot solve on its own. Medicare's particular problem is not per-capita costs; it's the number of "capitas." And to address that problem, the right focus for public policy is on revenues.
The most ardent proponents of restructuring claim that the nation cannot afford new revenue for Medicare. But the economy is growing, and the population as a whole, including the elderly with significant incomes, provides a sufficient tax base. As the elderly increase from the current 12 percent to 20 percent of the nation's population, they will necessarily, and appropriately, absorb a larger share of national income. The current payroll tax does not provide for the increased funds Medicare will need to support the larger numbers of people who will need Medicare. Whether by increasing that tax or relying on other revenue sources, the financing must change. A modest increase in the payroll tax (or other comparable revenue sources), combined with efforts to control Medicare spending over time and perhaps modest increases in beneficiary contributions, can keep the program on a strong footing for many years to come. For example, the Medicare actuaries have estimated that a 0.5 percent increase in the payroll tax both on employers and employees would by itself extend the date of exhaustion of the Part A trust fund to 2032.
President Bush used to justify limits on social expenditures on the grounds that Americans had more will than wallet. The truth is that we have more wallet than will. The United States is no less able today than it was 30 years ago to use the dividends of economic growth to provide health care for the elderly. The question is whether we have the political resolve to do it.
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