The Medicare Monster

A Cautionary Tale

Steven Hayward & Erik Peterson from the January 1993 issue

(Page 2 of 5)

The crafty Wilbur Mills responded to these alternatives by saying, in essence, thank you very much, we’ll just add features from both of these onto the existing bill and create an even bigger program. Mills called the result ‘a three layer cake." Supplemental Medical Insurance was added to cover costs of doctors and other outpatient services. Finally, Medicaid was created to provide medical care for the nonelderly poor. (The costs of the Medicaid program, which requires state matching funds, now threaten to bankrupt many states.)

The hospital-insurance portion of Medicare was to be supported through a payroll tax shared equally by employers and employees. The voluntary Supplemental Medical Insurance was to be financed by premiums paid by the participants with dollar-for-dollar federal matching funds. The mechanism for increasing revenue for the hospital-insurance plan, when necessary, was the raising of the taxable earnings base.

To keep solvent, the Supplemental Medical Insurance system would adjust the insurance premium until premiums and matching funds covered expenditures. Congress generally dismissed fears of cost overruns. Rep. Claude Pepper (D-Fla.) said: "The cost will not be greater than our present efficient [sic] and wasteful fee-for-service system. According to experts the charge to the average family under a national health-insurance program will actually be less than it pays now, partly because the employer and government will contribute to the fund."

The deliberations about the cost of the hospital-insurance program make for a fascinating and almost comical story. Because it is hard to predict changes in medical technology and hospital costs, it was decided that the program could only be projected out 25 years, instead of the 75-year horizon that is used for Social Security projections. Even with this shorter time horizon, the projections turned out to be wildly inaccurate.

The most serious error the planners made was the assumption that hospital costs wouldn’t rise faster than wages. Hospital costs had been rising 2.7 percentage points a year faster than wages over the previous decade. But the House Ways and Means Committee said it was a "reasonable" and "conservative" assumption that the difference between the rates of increase for wages and hospital costs would disappear by 1975, after which wages and hospital costs would rise at the same rate. Obviously, if hospital costs rose faster than wages, there would have to be a sharp increase in either the payroll-tax rate or the wage base against which it was levied.

A 1965 House Ways and Means Committee report on the actuarial basis for the hospital-insurance program proudly declared that "Congress has very carefully considered the cost aspects of the proposed hospital insurance system" and that "Congress very strongly believes that the financing basis of the new hospital insurance program should be developed on a conservative basis." The report acknowledged that hospital costs were rising faster than wages. But it dismissed the alternative scenarios that have turned out to be closer to what has in fact happened.

"It is inconceivable," the committee report says, "that hospital prices would rise indefinitely at a rate faster than earnings because eventually individuals–even currently employed workers, let alone older persons–could not afford to go to a hospital under such cost circumstances....Quite obviously, it is an untenable assumption that there can be a sizable differential between the increase in hospitalization costs and the increase in earnings levels that will continue for a long period into the future." This airtight logic didn’t consider the effect of the increased demand that Medicare set off.

Anticipating a 3.5-percent annual inflation rate, government actuaries predicted that the cost of a day’s hospital stay by 1985 would be $155 and that the hospital insurance portion of Medicare would cost $9 billion by 1990. The actual average cost of a hospital day by 1985 was over $600; instead of $9 billion, the hospital-insurance program cost $63 billion in 1990.

By the time Medicare passed the cost assumptions had been a subject of controversy for several years, especially with Ways and Means Chairman Mills. In a 1963 Ways and Means hearing, Mills clashed with the Social Security Administration’s chief actuary, Robert Myers, about the accuracy of cost estimates made for previous Medicare proposals. Mills pointed out that if any of the previous bills had been passed in the late 1950s or early 1960s, they would already be underfunded. A few excerpts from the transcript tell the story:

"The Chairman: I am concerned about your estimates of the cost of the present [1963] program as 11ook back to see what happened to your estimates of cost with respect to these other programs....Isn’t it a fact that it would be about 100 percent underfunded today if we had enacted it in 1958 and provided exactly the tax then suggested as appropriate...?

"Mr. Myers: Mr. Chairman, I can’t answer that question exactly now. [A week later Myers submitted a memorandum to Mills concluding that the program would have been about 50-percent underfunded.]

"The Chairman: What would be the situation had we enacted the so-called Kennedy-Anderson program in 1960 and continued the payroll tax then suggested as being appropriate....l think today you would find it would be about one-third underfinanced.

"Mr. Myers: It is possible that that is right. [Myers’s subsequent memorandum confirmed Mills’s view on this second bill as well.]

"The Chairman: What do you do with hospital costs? Do they remain constant, or do you contemplate in your estimates an increase in those costs?

"Mr. Myers: The cost estimates really can be looked at in either of two ways.

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