The Medicare Monster

A Cautionary Tale

Steven Hayward & Erik Peterson from the January 1993 issue

(Page 3 of 5)

"Either it is assumed that hospital costs will remain level in the same way that wages do, or that, if they rise, eventually wages will catch up with them....[A]lthough in the past, hospital costs have been rising faster than wages, it seems reasonable to me to assume that over the long run these two elements will move at about the same rate.

"The Chairman: What is there in the program to give us any assurance that hospital costs can be so contained that they will not continue to rise by 3 or 4 percent more rapidly than earnings levels in these future years?

"Mr. Myers: This, as you point out, is matter of judgment."

Mills continued to press Myers on the subject, with a series of questions aimed at preventing Myers from wiggling out of the issue with bureaucratic equivocations. Myers finally had to admit that a doubling of the projected payroll tax rate was possible.

"Mr. Myers: My difficulty [with Mills’s scenario] is that if the increase continued indefinitely, hospital costs would pyramid so high that they would be eventually as much as the total of all wages [i.e., the wage base against which the payroll tax would be levied], but let me try to make an assumption that is a little more finite in this respect.

"The Chairman: All right.

"Mr. Myers: Suppose that this situation went on for, let’s say, 20 years and then the hospital costs caught up to general wages. Under an assumption like that, I think that what you said is quite correct–that the required combined employer-employee contribution rate would be somewhere around I percent of payroll, instead of 1/2 percent of payroll."

In 1965, Medicare architects declared that the initial tax rate of I percent of income after 1967 would be sufficient to fund the program for 25 years with only slight upward adjustments in the taxable income base of $6,600. (Income above that level wasn’t taxed.) But it was clear at the outset that the fiscal projections for Medicare were essentially wild guesses, and the subsequent history of the program has shown little improvement in the ability to forecast the cost of the program.

The Medicare hospital-insurance program was already out of actuarial balance and about 50-percent underfunded by the early 1970s, requiring in 1972 the first of several increases in both the payroll tax rate and the wage base against which it was levied. The 1972 amendments to the Social Security Act also expanded what the Medicare program covered, including expensive renal dialysis.

Chastened by the high inflation of the early 1970s, the Social Security Administration developed new actuarial projections that substituted "dynamic" assumptions about wages and costs in place of the "static" assumptions of the 1965 projections. But these projections still expected that hospital costs would soon stop soaring at a faster rate than wages. "Public influence toward reducing the rate of increase in hospital expenditures is assumed in the cost estimates," says a 1973 Ways and Means Committee report. (This was at the time of President Nixon’s so-called Economic Stabilization Program, better known as wage and price controls.)

Recent Hospital Insurance Trust Fund annual reports and forecasts for the Medicare hospital-insurance program are more sober but have drawn surprisingly little attention for how alarming they are. Forecasts for the last several years have employed three alternative scenarios for income growth over the next 75 years. Even under the most optimistic assumption, the Medicare payroll tax will have to nearly double, to 4.38 percent, shortly after the year 2000.

Under the pessimistic assumption, the payroll tax will have to soar to 13.79 percent for the program to stay solvent. The increases will come quickly; the tax will have to increase to 5.62 percent by about the year 2000. Under any of the assumptions, the Medicare trust fund will go broke within the next 20 years, possibly as soon as the year 2000.

But even the supposedly pessimistic assumptions behind these projections aren’t realistic, and herein lies another small drama. Roland King, the chief actuary of the Health Care Financing Administration (HCFA), has been blowing big holes in the projections. King has to sign off on the "actuarial soundness" of the projections in the annual report each year. Acknowledging the "garbage-in, garbage-out" quality of the projections, King has noted in his statement that the projections assume unprecedented growth in average wages over the next generation.

The projections assume real income growth (pay increases adjusted for inflation) substantially above the trend line of the last 25 years. Calling this "unjustified optimism," King notes that even the "pessimistic" projection assumes that real income will grow at an annual rate that is faster than the cumulative rate for the last 25 years.

King concludes in a memorandum he circurates with copies of the Medicare annual report: "Indeed, the assumptions are so optimistic that even the pessimistic assumptions project real earnings increases during the next quarter century, and each quarter century thereafter, will be many times the increases of the last quarter century....The Trustees’ assumption that real earnings growth rates will suddenly accelerate to levels that substantially exceed the real earnings growth rates of the last quarter century must be viewed as unreasonable." King believes that the actual actuarial deficit will be 60-percent higher than even the pessimistic forecast.

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