Medicare’s Financing Problems: The Basics

I recently wrote a little bit about the solvency of two huge entitlement programs: Social Security and Medicare (U.S., not Canada). This post goes a little further in depth on Medicare’s financing issues, as requested by a reader. Subsequent posts will provide additional details and some proposed solutions.

To understand Medicare’s financing problems one has to understand a little how Medicare is structured and financed, naturally. I wrote about this at some length in three earlier posts (on traditional Medicare, on the Medicare Advantage program, and on prescription drug plans), but I can summarize it succinctly here thanks to a concise American Academy of Actuaries “Backgrounder” on the topic.

Broadly and with respect to financing, Medicare has two arms: (1) earmarked 2.9% payroll taxes finance the Medicare Hospital Insurance (HI) trust fund and (2) beneficiary premiums and general revenue finance Medicare Supplementary Medical Insurance (SMI). As the names suggest HI covers inpatient hospital services and SMI covers physician and outpatient hospital services and drugs.

Since SMI is funded from premiums and general revenue it can’t formally have a solvency problem. Congress can simply raise premiums and/or contribute more general revenue to cover costs. That puts SMI’s funding problems in the same class as health care funding more generally. It is eating up a greater share of national income and the federal budget year after year. That’s an issue, but not formally a solvency problem.

HI has a solvency problem because its revenue is capped by payroll taxes. In fact in the last year spending for HI services exceeded payroll tax revenue. By 2017, it is projected that all of the HI’s assets (held in the form of Treasury bonds in a trust fund) will be depleted. By that time payroll tax revenue is expected to only cover 81% of expenditures. The shortfall will increase rapidly each year thereafter.

That’s a big gap and one that will be reality very soon. I’ll discuss some more of the details and some possible solutions to Medicare’s HI solvency problem in my next post on this topic.

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