Is There Life After Medicare?

Medicare is dying, and if the politicians would just admit it, we could get on with building a fairer alternative.

Now that the second Reagan administration and the new Congress are comfortably ensconced in Washington, they'll probably be reciting the usual rationales for gigantic spending programs. Medical programs are a prime example.

Medicaid is usually rationalized as necessary to help the poor. Veterans' Administration hospitals are said to be necessary for national defense. Vast subsidies for medical research are claimed to be necessary for improving the general welfare.

These familiar goals—helping the poor, strengthening national defense, and improving the general welfare—are often stretched and twisted beyond recognition, but not even they can be utilized to defend one of the biggest programs of all. That is Medicare, the taxpayer-funded program that pays most of the medical bills of more than 30 million people in America.

Medicare and the benefits it provides constitute a health-insurance policy for people 65 years old and over, for the disabled, and for those with kidney failure. For Medicare recipients, the benefits are sizable. In 1982, the average reimbursement per enrollee (that is, the average amount of money that each person eligible for Medicare actually received) was $1,565 for the aged and $2,089 for the disabled.

The Medicare program was put in place in 1965 as part of President Lyndon Johnson's "war on poverty." Ever since, it has been viewed as a poverty program, but this perception is incorrect. In fact, Medicare does not take from the rich and give to the poor.

On average, the people who are receiving benefits under Medicare are better off than the people who are paying for those benefits—current taxpayers. The disposable income of the elderly is higher than the disposable income of the nonelderly. In 1980 the elderly had an average of $6,300 in after-tax income per capita, whereas the nonelderly had $5,910 in after-tax income.

Not only do the elderly have more income than the nonelderly, but they also have more assets. Many of the taxpayers actually financing the Medicare system are poor, while many of the recipients are rich.

Some poor people, of course, do benefit from Medicare. And many elderly people with limited fixed incomes need some plan for coping with the prospect of high medical bills. But there is an alternative to Medicare—one that would help keep health costs down, provide security and free choice, and relieve the taxpayers' burden for health care. To appreciate the significance of this plan, it is first necessary to understand just how inefficient and inequitable the existing Medicare system is.

That an alternative to Medicare is needed is readily apparent both from its dismal financial picture and from the highly skewed distribution of its benefits.

What does Medicare currently cost American taxpayers? According to the Department of Health and Human Services, the grand total for fiscal year 1984 is expected to be $64.2 billion. Moreover, that figure is expected to climb to $106.6 billion (in constant dollars) by fiscal year 1988—an increase in four years of 66 percent.

The program's future prospects are even more disquieting, since Medicare is not paying its own way. The 1984 annual report of Medicare's Hospital Insurance Trust Fund confessed that if the current system continues as presently organized, Medicare will be without a nickel to its name by 1991. That's just six years away.

Of course, there are ways to keep the system afloat—such as more payroll taxes. A few years ago, A. Haeworth Robertson, a former chief actuary of the Social Security Administration, which administers the Medicare program, projected what payroll taxes might be 70 years from now under various sets of assumptions. Under the most pessimistic assumption, Robertson calculated that payroll taxes for Social Security and Medicare together might have to be between 40 and 50 percent of an individual's taxable income to finance that package of benefits.

But these projections by no means represent the worst case, because Robertson didn't take into consideration the likelihood that life expectancy might be dramatically increased. And if that happens, it would spell disaster for the Social Security and Medicare programs even with payroll taxes at the 50 percent level. Clearly we are putting our children and grandchildren at great risk.

Medicare's predicament isn't as bad as Social Security's—it's worse. Medicare has a special financial problem that does not affect Social Security. Social Security money goes in predetermined amounts directly to the pensioner, who decides how that money will be spent. Under Medicare, by contrast, the money goes to the providers—physicians, hospitals, and nursing homes. And these providers have little incentive to contain costs because a third party—Medicare—is paying the bills. It is a situation that breeds enormous inefficiency and waste.

It also breeds enormous injustice. The people who are receiving Medicare pay far less than a comparable private plan would cost. For example, take a man earning the average income for his age group and who is retired in 1983 at age 65. Within two years, the benefits he draws from Medicare will have exceeded the $2,640 in Medicare taxes he paid into the system during his entire working life. Even under the conservative assumption that Medicare spending per beneficiary will not rise, he can expect to receive about $25,615 more in benefits than he ever paid in taxes. And if he has a dependent spouse, the benefits will approach $59,720. In essence, the American public is writing a $59,720 check to this worker and his spouse upon his retirement.

Even if there were no increase in Medicare spending per beneficiary in the future, a 65-year-old man retiring in 1983 could expect to receive 10 times more in Medicare benefits than he paid in taxes. And a 70-year-old man could expect to receive 21 times more in benefits than he paid in taxes. If these beneficiaries have a dependent spouse, the expected benefits relative to taxes will more than double.

What are the reasons for doing this? To benefit minorities or the young? Hardly. In fact, Medicare discriminates against both of these groups in significant ways.

As for minorities, the newest life-expectancy statistics from the National Center for Health Statistics indicate that a black male born today has a life expectancy of 64.8 years (compared to 71 years for white males). Although he will pay taxes into the system throughout his working life, he can expect to die two months before he becomes eligible for benefits. If the retirement age is raised to 67 (as recommended by the Advisory Council on Social Security, which is looking at ways to reform Medicare), the black man can expect to die approximately two years before he becomes eligible for any benefits that are based on his age.

He would not be alone. A study done last year by the National Center for Policy Analysis (NCPA) showed that the recently legislated increase in the Social Security retirement age from 65 to 67 by 1990 will be devastating for minorities generally. The proposed changes in Medicare are even worse. It has been recommended not only to raise the age of eligibility from 65 to 67 but to index it as well. In effect, this proposal would mean that whenever there is a general improvement in life expectancy, the age to qualify for benefits would go up.

Even with the initial increase from 65 to 67, a 20-year-old black man would lose 100 percent of his expected future benefits from Medicare. His white counterpart would lose only 25 percent. Meanwhile, a 20-year-old black woman would lose 19 percent of her expected benefits, while a white female of the same age would lose only 14 percent.

Medicare's discrimination against minorities is reflected in another way. About twice as many minority taxpayers are paying into the system as are drawing benefits from it: nonwhite persons account for 14.4 percent of the taxpaying population but only 8.6 percent of Medicare beneficiaries.

Medicare is also unfair to the young. There's no question that it has been a bonanza for those currently covered by the program, mainly individuals 65 and older. But the enormous benefits received by today's beneficiaries are made possible by the taxes paid into the system by the working population. Young workers who are paying these taxes will never receive anything like the deal the elderly are receiving today. In fact, most young workers entering the labor force right now will pay considerably more into Medicare than they can ever expect to receive in return.

The NCPA study calculated the present value of Medicare for workers at different age levels under the conservative assumption that Medicare spending per beneficiary will grow no faster than the rate of growth of nominal wages. A 20-year-old white man can expect to pay about $8,500 more in taxes than he will receive in benefits, and a black man the same age can expect to pay about $14,000 more in taxes than he will receive in benefits. Moreover, almost anything that Congress seems likely to do to relieve the financial crisis of Medicare—raise the payroll tax, raise the eligibility age, or raise deductibles or coinsurance rates—will lower the expected benefits to young workers and reduce the return on their Medicare "investment" even below what is projected now.

Under current law, the combined payroll tax on employers and employees is scheduled to rise from the current 2.6 percent to 5.08 percent by 1995. If, in order to reduce the Medicare deficit, Congress also raises the eligibility age to 67, the penalty imposed on young workers will be substantial. With a 5.08 percent Medicare payroll tax and an eligibility age of 67, a 20-year-old white man could expect to pay about $33,171 more in taxes than he would receive in benefits. Similarly, a 20-year-old white working woman could expect to pay about $6,685 more in taxes than she would receive in benefits.

Finally, it's important to note that in addition to Medicare discriminating against the young and minorities, the criteria for eligibility in Medicare are highly arbitrary. The basic requirement is to reach 65 years of age, at which time almost everybody can qualify to get benefits. They don't have to be poor. There are 254,000 millionaires in the United States who are either covered by Medicare or who could be covered if they chose. They don't even have to be retired.

Thus, David Rockefeller, a 69-year-old who works for Chase Manhattan Bank, is eligible for Medicare, financed partly by the taxes on 39-year-old cleaning ladies and cab drivers in Harlem. Rockefeller's local Medicare bureaucrats would not inquire into his estimated net worth of more than $1 billion. It wouldn't affect his eligibility. Indeed, he doesn't even have to be retired to qualify for Medicare. True, he can't get Social Security until he retires from his banking empire, but he can get Medicare benefits.

The best deal of all is had by some people who get Medicare without ever having paid anything into the system. There are people over 83 who didn't pay a dime into Medicare, yet they are covered. People retiring today without having paid anything into Social Security can get covered simply by paying special premiums, and for most of them that turns out to be a splendid deal.

In sum, Medicare is a system that takes billions of dollars from the working population and hands it over to people who, by and large, are not working. It gives billions of dollars in medical benefits to people who did not earn them. It takes taxes from the working poor to pay the medical bills of people who are generally better off. It distributes costs and benefits in a highly arbitrary way. It is costly and is going to get more costly. The time has come for as much reform as is politically possible.

Unfortunately, the Advisory Council on Social Security, which is studying Medicare, is taking the same approach that the National Commission on Social Security Reform (the Greenspan Commission) took toward Social Security in 1983. Their assumption is that the system should be salvaged. They are wrong. The system cannot and should not remain intact in the next century.

There is a way, however, to build an essentially private alternative to Medicare. The proposal, developed by Gerald Musgrave, Peter Ferrara, Richard Rahn, and myself, is based on a concept developed by healthcare economist Jesse Hixson. It is not a purely free-market solution. In the present political climate, it is unrealistic to hope for that. But the proposal would be a vast improvement over the status quo.

Under the plan, individuals would be allowed to make annual contributions to qualified individual retirement accounts called Health Bank IRAs. These would be similar to existing IRAs, except that their funds could be spent only for medical expenses, and financial institutions offering Health Bank IRAs would assume a fiduciary responsibility for the accounts, like a bank managing a trust.

After a 30-year period, sufficient funds could accumulate in these accounts to allow individuals to pay for their own medical expenses or to purchase private health insurance for their retirement years. These individuals would opt out of the basic Medicare program, and they would rely on Medicare only in case of very large, catastrophic medical expenses. Workers now closer to retirement, or workers who chose not to contribute to a Health Bank IRA every year for 30 years, would be entitled to a prorated portion of Medicare benefits.

The choice to opt out of Medicare would be voluntary. However, individuals who chose the IRA option would get tax credits for their Health Bank IRA contributions—that is, for every dollar a person put in a Health Bank IRA, his or her income tax would be reduced by a dollar, up to a designated limit. (The average worker today pays about $460 a year into Medicare, and the NCPA estimates that a tax credit of $500 per person annually would be sufficient to encourage the vast majority of the working population to choose the private IRA alternative to Medicare.)

For poor Americans, a special provision would be made. Individuals with no earnings would be granted an income tax "refund" equal to the amount of the allowed tax credit. The refund would be placed in their Health Bank IRAs. This would give people living in poverty a source of funds with which to purchase their own medical care during retirement.

Money deposited in a Health Bank IRA would be the private property of the individual who created the account. Moreover, this money would be part of the individual's estate and could be passed on to his heirs. As a result, if individuals spent their Health Bank IRA money, they would be spending their own money, not someone else's.

If given a tax incentive to do so, people would very likely choose this plan. Over time, the total amount of Medicare spending would begin to fall, and the payroll tax could be progressively lowered. And although the federal deficit would increase in the short term, the supply of credit (through IRAs) would increase.

Most of all, the plan provides a practical means of realizing an important social value, that individuals can and should be responsible for providing for their own health care during retirement. Adherence to this principle is the best way to provide future generations of elderly citizens with the financial security they need. It is the best way to ensure that elderly citizens retain their dignity and self-esteem. And it accomplishes these objectives in a manner generally consistent with the spirit of a free society.

John C. Goodman is a professor of economics at the University of Dallas and president of the National Center for Policy Analysis, a Dallas-based think tank.