Medicare Needs a Budget and Structural Reform

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BY KATHRYN NIX AND ALYENE SENGER – Medicare faces a dismal future that could threaten its very existence. In two recent papers, Stuart Butler, Ph.D., and Robert Moffit, Ph.D. of the new Heritage Center for Policy Innovation analyze the problem and offer detailed solutions on how to reverse course.

Butler explains that many objections to Medicare reform are fueled by myths. For instance, many Americans believe that seniors have paid for their own Medicare through payroll taxes. But in reality, only Medicare Part A is financed through payroll taxes. Parts B and D are voluntary and financed through a combination of beneficiary premiums (covering just 25 percent of costs) and subsidies from taxpayers.


Next, Butler points out, there is no true Medicare trust fund. The program operates as a pay-as-you-go system, meaning revenue immediately goes out the door to pay for current benefits. Another myth is that the payroll tax is a premium and quite different from the income tax. Butler explains, “Since the Medicare payroll tax, unlike the Social Security tax, does not have an income cap, it is actually indistinguishable from a regular income tax bracket.”

Another big misconception is the notion that adjusting Medicare benefits based on retirement income would be a radical change. This is false; wealthier seniors already pay higher, income-related premiums in both Part B and Part D.

Recognition of the Medicare reality is essential for reform. From there, the first step is to put the program on a budget. Medicare is currently categorized as “mandatory” spending, which allows the program’s cost to grow on autopilot. Its budget is open-ended, and spending is determined by whatever the hospital, drug, and physician bills add up to. Instead, Medicare should operate under a real long-term budget, similar to other federal programs like defense.

There is bipartisan consensus that Medicare spending should be capped; in fact, Obamacare has already introduced a top-down spending cap on the program. But without the right fundamental changes, this alone is insufficient to control costs. The next, big step is to transform the program into a premium-support system, a defined-contribution system of financing.

Moffit’s in-depth analysis explains exactly how to move Medicare to this type of consumer-driven system. It would allow seniors to choose their own health plan and receive a defined contribution from the government to offset its cost. Seniors would have access to affordable, adequate benefits, regardless of age or health condition. As Moffit points out, one model of premium support, “the Federal Employee Health Benefits Program (FEHBP), serving federal workers and retirees, has been a popular and successful premium-support program.”

As Senators Richard Burr (R–NC) and Tom Coburn (R–OK) wrote in a recent Politico editorial, “The way to save Medicare is to build on what is working.” Moffit shows in his research that the FEHBP has outperformed Medicare in every dimension of performance: “It has better benefits, better service, catastrophic limits on what enrollees must pay, and far better premium cost control.”

A consumer-driven, market-based Medicare program can foster competition and control costs without sacrificing quality of care. Patients would be able to seek out and receive better value for dollars spent, impacting the entire health care system. And Moffit’s research shows the benefit for the federal budget: “Based on the estimates of the Heritage Center for Data Analysis (CDA), a Medicare premium-support program would yield $702 billion in savings over 10 years beginning in 2016.”

Butler states, “Patching the framework, or tweaking it at the edges, is not going to address the long-term weaknesses of the program or the enormous financial load it adds to the country’s structural financial problems.” Instead, Medicare needs structural reform that works. To learn more about the Heritage Foundation’s comprehensive budget reform proposal, which includes transformation of Medicare, visit Saving the American Dream.