Dean Baker
The American Prospect, October 11, 2010

See article on original website

When people in the center-right in Washington come to agreement on policy, it is almost certainly a really bad idea. The War in Iraq is exhibit A. The current drive to slash Medicare, along with the companion effort against Social Security, falls into the same category.

The story is a simple one: The long-term budget projections paint a scary picture. While the latest baseline numbers from the Congressional Budget Office are relatively benign, the "alternative scenario," which CBO Director Douglas Elmendorf argues is more likely, paints a far darker picture. In this scenario, the deficit would be a whopping 9.8 percent of gross domestic product by 2025.

The leading villain in this story is Medicare and other public-sector health-care programs, the costs of which are projected to increase by 2.9 percentage points of GDP by 2025 in the alternative scenario. Medicare alone is projected to cost 5 percent of GDP in 2025, up from 3.6 percent of GDP in 2010. Clearly, Medicare accounts for a disproportionate share of the projected deficit growth and is an obvious and inviting target for cuts.

A slightly deeper investigation tells a very different story. First, it is important to recognize that the cost growth for Medicare is not driven by inefficiency in the program. Rather, Medicare costs will be driven by rising health-care costs more generally and a rapid increase in the portion of the population over age 65. The share of the population over age 65 is projected to rise from 12.9 percent in 2010 to 17.8 percent in 2025. As a first approximation, we should expect the cost of Medicare as a share of GDP to rise roughly in proportion to the growth in the share of the elderly in the population.

However, the alternative scenario projects that Medicare costs will rise much more rapidly than the growth in the over-65 population. The reason is not the inefficiency of Medicare. For the last four decades, per-person Medicare costs have actually risen slightly less rapidly than per-person costs for private insurers, an average of 8.3 percent annually per beneficiary for Medicare compared to 9.3 percent in the private-insurance system (this trend was reversed after the 2003 Medicare prescription-drug benefit went into effect). Rather, the problem is simply the inefficiency of the U.S. health-care system more generally. Medicare is a payment mechanism, not a separate delivery system. It pays for health care delivered by the private sector. As the cost of this care rises, the cost of Medicare rises as well.

In fact, Medicare as an insurance system is considerably more efficient than private insurers. In 2008, its administrative costs were 5.6 percent of the money paid out in benefits each year, compared to an average of 13.3 percent for private insurers. The reasons for Medicare's lower costs are straightforward. The system doesn't have an expensive marketing apparatus, it doesn't have executives drawing millions or tens of millions in compensation each year, and it doesn't have to pay out dividends to shareholders. For these reasons, Medicare is the most efficient part of the (inefficient) U.S. health-care system. Indeed, most of the proposals being put forward to reduce Medicare costs are not about eliminating waste; they are targeted at the meat of the program, undermining its ability to ensure decent care to retirees and the disabled.

Targeting Doctors. For example, one of the strategies already in current law would substantially reduce doctors' reimbursements under Medicare. Congress routinely passes measures that temporarily put off the imposition of these legislated compensation reductions, which would be 21 percent below current levels. There is an argument for reducing the doctors' compensation. Doctors in the United States make far more than their counterparts in other wealthy countries, with the biggest gap in most cases among highly paid medical specialists.

However, responding to this gap by reducing payments under Medicare and not taking steps to increase the supply of doctors, would simply mean that many Medicare beneficiaries would find it difficult or impossible to get doctors who will treat them. Medicare reimbursements in many categories are already substantially less than payments from private insurers, causing many doctors to limit the number of Medicare patients that they accept. This problem would be considerably more serious if the legislated reductions in rates actually took effect.

Increasing Co-Pays. Another favorite proposal involves requiring Medicare beneficiaries to make larger co-payments or to increase the portion of the Supplemental Medical Insurance (Part B) paid by beneficiaries. Currently Medicare beneficiaries typically pay 20 percent of the expenses covered through the program. In assessing proposals to shift costs to recipients, it is important to recognize that the elderly already incur substantial health-care costs under the program as it is now structured. In 2008, people over age 65 paid an average of 11.9 percent of their after-tax income for health care compared to 4.8 percent for the population as a whole. And, this figure has been consistently high, even with the introduction of the Medicare drug benefit. In 1984, seniors paid 11.3 percent of their after-tax income for health care. Increasing health-care payments from seniors means making a substantial burden even larger among a segment of the population that has a median household income of less than $30,000.

Means-Testing Medicare. Another favorite remedy topic is subjecting Medicare to income testing. The story here is that we will just reduce benefits for those who can afford to pay more. The problem is that relatively few seniors can afford to pay more, and affordable private insurance for seniors is just not available -- that's why we needed Medicare in the first place. It's not clear exactly when someone should be viewed as affluent, but if President Obama's cutoffs for tax increases were applied ($200,000 for individuals and $250,000 for families), then the cuts would affect less than 2 percent of seniors, which means that it could only save 2 percent of the program's cost, and that's if we cut these seniors out of Medicare altogether. Conversely, if we turn Medicare into something like Medicaid -- a program limited to the very poor -- then the political support for it will evaporate.

Voucherization. A final route for cutting Medicare is turning the payment into a voucher and not having the voucher keep pace with the cost of care. This can definitely save the government money, but the cost is that seniors will no longer be assured of decent health care. Those who can pay more out of pocket will do fine, but that is only a small minority of the elderly. We know that a voucher system will drastically raise administrative costs and create an enormous problem of adverse selection -- insurers will try to avoid insuring people with high medical expenses. If vouchers do not keep pace with the projected growth of health-care costs, they will be grossly insufficient to pay for private insurance. This saves money at the cost of undermining the purpose of the program; a voucherized Medicare system will not allow most seniors to afford decent medical care.


The problem of Medicare costs inevitably gets back to the problem of the health-care system as a whole. We will not be able to contain Medicare costs unless we slow the rate of growth of overall health-care costs. The recently enacted reform legislation only began this process. While provisions for comparative effectiveness testing and measures to promote competition with the newly created exchanges may be helpful, the cost-control measures in the bill are not the sort of big structural changes that are needed to truly rein in costs. At the very least, we will need a robust public option of the sort that Obama originally put forward in the primaries. Such a plan will have the market power to constrain costs and force private plans to do likewise or go out of business.

The policy types in Washington will invariably complain that this sort of change is hard. The powerful interest groups in the industry will do everything they can to prevent such change, just as they did in the recent health-care reform debate.

This is true, but that is not a reason that the ordinary workers should make it easy for the Washington crew to take away their Medicare benefits. Implicitly, this is saying that because the Washington politicians are scared to challenge the insurance companies, the pharmaceutical companies, the highly paid medical specialists, and others who profit under the current system, the public should allow these politicians to turn around and take away their Medicare.

Of course, there are steps that can be taken to reduce Medicare costs even within the current structure. The provision in the health-care reform bill that ended the subsidies in the privatized Medicare Advantage program is a good start. This program costs the government 13 percent more per beneficiary than the traditional public Medicare program.

Medicare can also negotiate lower drug prices for its beneficiaries. At present, Medicare beneficiaries pay drug prices nearly twice as high as the prices negotiated by the Veteran's Administration. Lower drug prices could save hundreds of billions of dollars over the next decade.

And, we could even have a voucher program in Medicare -- except that the voucher would allow beneficiaries to buy into the more efficient health-care systems in Europe or Canada. The government and the beneficiary could split the savings. Any conservative who actually supports the free market should support this option. In addition to saving money, getting more Americans directly exposed to foreign medical systems might reduce fears of a different system and increase the pressure to make the U.S. system more efficient.

The health-care reform passed earlier this year was a good first step toward getting more people covered. However, a more efficient health-care system generally is the way to save money in Medicare, not arbitrary cuts that undermine the purpose of the program.

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