Budget Explainer: Medicare
July 30, 2012
President Lyndon Johnson signed Medicare into law 47 years ago. Addressing the program's rising costs is a subject of great controversy. Some argue that Medicare is "broke," while others advocate for making few, if any, changes to a program on which so many people rely. This budget explainer describes the program, how it is financed, what it pays for, and what role it plays in financing American health care.
What is Medicare? How much does it cost? How does it work?
Medicare is a major federal program that provides health insurance to elderly and disabled people. In 2011, Medicare provided benefits to more than 16 percent of the population or nearly 49 million people — more than 40 million seniors and more than 8 million persons with disabilities. The program plays a vital role in the country's health care system, paying for nearly one-fourth of all personal health care expenditures (including about 45 percent of the country's home health bills).
Medicare consists of four program "parts" that are financed by two trust funds. The Hospital Insurance trust fund finances Medicare Part A, which pays for hospital care. Revenue for Part A comes from a payroll tax on all workers and employers. The Supplemental Medical Insurance is a voluntary program that finances Medicare Parts B and D, which pay for ambulatory care such as physician services, and prescription drugs. Revenue for Parts B and D comes from premiums paid by beneficiaries and general revenues of the federal government. Part C is Medicare Advantage, which allows beneficiaries to enroll in private health plans to receive their benefits.
Medicare spending is a growing share of the federal budget.
SOURCES: Data from Congressional Budget Office, Budget and Economic Outlook: Fiscal Years 2010 to 2020; Budget and Economic Outlook: Fiscal Years 2012 to 2022; Long-Term Budget Outlook, June 2012. Compiled by PGPF.NOTES: Chart uses CBO's alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur. Numbers may not add up to 100 due to rounding.
In 2011, the Medicare program cost $560 billion, or 16 percent of federal government spending. After Social Security and defense, Medicare is the third largest program in the federal budget.
In coming years, the program faces significant financial pressures. Although the growth of health care spending appears to have slowed in the past year or so, those costs are still expected to grow faster than the economy over the next several decades, largely because of the retirement of the baby boomers and continuation of fast growth of health care costs. If current policies continue, Medicare spending will rise from 3.7 percent of GDP in 2011 to 6.4 percent of GDP in 2035.
The growth of these costs will put growing pressure on the system's finances — and the rest of the budget. Indeed, the growth of federal spending on major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies for the health insurance exchanges) is projected to account for four-fifths of the rise in federal non-interest spending over the next 25 years.
Medicare has several sources of financing. Over time, the contribution from general revenues has increased and is projected to grow larger.
*"Other" includes proceeds from the taxation of Social Security benefit, which help to finance Medicare Hospital Insurance costs, as well as drug fees and state transfers.SOURCE: Historical data and projections from 2012 Medicare Trustees' Report. Compiled by PGPF.
Who pays for Medicare?
One of the biggest misconceptions about Medicare is that it is self-financed by current beneficiaries through premiums and by future beneficiaries through payroll taxes. In truth, the program is heavily subsidized with general revenues. Premiums cover only a small fraction of Medicare's overall costs, while payroll taxes cover less than half of its costs.
Medicare financing has changed significantly over the past forty years. In 1970, 60 percent of its costs were financed by payroll taxes, paid by both workers and employers with each paying 0.6 percent of wages. Beneficiaries also paid premiums for physician services under Part B, but those premiums covered only about 40 percent of Part B's costs or 13 percent of Medicare's overall costs. In total, payroll taxes and premiums covered about 75 percent of Medicare's costs in 1970. General revenues funded the remaining 25 percent.
By 2010, however, the share funded through payroll taxes had dropped to 40 percent, as wages and payroll taxes grew more slowly than Medicare's costs. That decline would have been bigger if payroll tax rates had not been raised to 2.9 percent in 1986 (1.45 percent each for employers and employees). At the same time, the share funded by beneficiaries remained about the same as it did in 1970, though Medicare added a new prescription drug benefit through Part D in 2006 that required beneficiaries who enrolled in the new program to pay premiums. However, those premiums covered less than 10 percent of Part D's costs. In total, payroll taxes and premiums covered only about 55 percent of Medicare's costs in 2011. General revenues subsidized the remainder, with the exception of a small amount of revenue coming from taxes on high-income beneficiaries.
Looking forward, general revenues will fund a growing share of the Medicare program. By 2050, the trustees project that the general taxpayer will subsidize about half of the program.
As Medicare's benefit structure has changed, so has the composition of its payments. Hospital expenses have decreased but are still the largest category of Medicare spending.
SOURCE: Centers for Medicare and Medicaid Services, National Health Expenditure data. Compiled by PGPF.
Medicare pays for a diverse range of services
Medicare offers an array of benefits. The above chart details the distribution of total Medicare spending for these benefits and shows how the composition of program spending has changed throughout the program's history.
Hospitalizations are associated with very high cost health episodes — and that fact is reflected in Medicare's program expenditures. Hospital expenses are the largest single component of program spending, accounting for about 43 percent of the total.
The share of spending devoted to hospital care has declined, though, from about 70 percent at the program's inception. In part, this is because the Medicare program was expanded to provide additional benefits. While spending for physician services has hovered around 20 to 25 percent throughout the program's history, the share devoted to other benefits has grown. In particular, the introduction of the prescription drug benefit dramatically shifted the composition of Medicare spending.
Medicare covers more than 40 percent of the nation's home health care bills and more than 20 percent of most other health services.
SOURCE: Centers for Medicare and Medicaid Services, National Health Expenditure data. Compiled by PGPF
Medicare plays an important role in financing American health care
Medicare is a major player in our nation's health system. The program pays for nearly 45 percent of all home health spending in the country, nearly 30 percent of all hospital bills, and more than 20 percent of all nursing care expenses. For all health care spending, it finances about 21 percent of the total.
Medicare's share of payments for other services has also increased over the past twenty years. Although Medicare's share of the costs for physician services and hospital care has risen only modestly, its share of other health care services has increased dramatically. For example, in 1990, Medicare paid for less than 0.5 percent of total prescription drug costs; in 2010 it financed more than 20 percent of the total. Major increases can also be seen in Medicare's share of home health, nursing, and equipment and device spending.
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