The Real Tax Gap: Paying for Unfunded Benefits

The Real Tax Gap: Paying for Unfunded Benefits

The Health Care Reform Bill is the largest Medicare cut ever. But it’s not enough


The 2010 annual report of Medicare’s trustees was released on Aug. 5. It shows that the Affordable Health Care Act, which was opposed by every Republican, will substantially reduce long-term spending. In a related report, Medicare’s actuaries make clear that Republican plans to effectively abolish Medicare are utopian in the extreme.

It’s worth starting with Medicare’s 2009 annual report. If one goes to page 69, it shows that last year Medicare’s actuaries were estimating a long-run deficit of $36 trillion in just Part A, which pays for hospitalization. This is equivalent to 2.8 percent of the gross domestic product in perpetuity.

On page 112 of the report, it shows that Medicare Part B, which pays for doctor’s visits, had a long run deficit of $37 trillion or 2.8 percent of GDP; that is, the amount of the program’s costs covered by general revenues over and above premiums paid by participants, which are capped by law at 25 percent of the program’s costs. (Originally, they were set at 50 percent.)

Finally, on page 127 there is data for Medicare Part D, which pays for prescription drugs. This program was rammed into law by George W. Bush and a Republican Congress in 2003 despite the large deficits that were already projected for Parts A and B. The Republicans provided no dedicated funding for Part D and its long-term deficit was estimated at $15.5 trillion last year, or 1.2 percent of GDP.

To sum up, Medicare’s 2009 report showed that taxpayers were on the hook to the tune of 6.8 percent of GDP. That is how much taxes would have to rise to pay all of the benefits that had been promised at that point. To put this number in perspective, federal income taxes are expected to equal about 10 percent of GDP over the long term, according to the Congressional Budget Office. Thus taxpayers were looking at a 68 percent increase in federal income taxes just to pay the unfunded costs of Medicare.

The 2009 report of Social Security’s trustees (p. 64) showed a long-term actuarial deficit in that program of $15 trillion or 1.2 percent of GDP. If one adds up all of these unfunded entitlement program promises, it came to 8 percent of GDP, which would have required an 80 percent increase in federal income taxes to fully fund.

The Difference a Year Makes
Now we turn to Medicare’s 2010 report. It shows enormous improvement in the program’s long-term costs as a result of the Affordable Health Care Act. Starting with Part A, we see that Medicare’s actuaries are projecting no long-term deficit whatsoever. Last year’s projected deficit of $36 trillion has literally fallen to zero (p. 85). Part B’s finances also show significant improvement, with the long-term deficit falling from $37 trillion to just $12.9 trillion or 1.5 percent of GDP. Medicare Part D’s finances are unchanged. The long-term deficit is estimated to be $15.8 trillion or 1.1 percent of GDP.

Putting these numbers together, we see that Medicare’s unfunded liability fell from almost $90 trillion in 2009 to less than $30 trillion, a two-thirds improvement in one year. As a percent of GDP, the taxpayers’ obligation has fallen from 6.8 percent to 2.6 percent. Throw in Social Security’s unfunded liability, estimated by its actuaries (p. 65) this year at $16.1 trillion, or 1.2 percent of GDP in perpetuity, we see that the potential tax increase from entitlement programs has fallen in half, from 8 percent of GDP to 3.8 percent. That still means a possible income tax increase of 38 percent, but that’s a lot better than 80 percent.

Although the trustees report represents the official projection for Medicare, its actuaries simultaneously published an unusual dissent suggesting a more likely alternate scenario than the one endorsed by the trustees.

According to a memorandum issued the same day as the trustees report, Medicare’s actuaries said the trustees are overoptimistic about certain provisions of current law — upon which the trustees report must necessarily be based — that are unlikely ever to be implemented. In particular, current law requires a sharp cut in payments to Medicare providers in coming years. Under a law enacted in 1997 but always postponed by both Republican and Democratic Congresses, Medicare providers will receive a 23 percent cut in payments on Dec. 1, a further 6.5 percent cut in 2011, and another cut of 2.9 percent in 2012.

The actuaries believe that Congress is almost certain once again to override the law with some sort fix. They are undoubtedly correct in believing so. Consequently, spending for Medicare Parts A and B will probably be much higher than the trustees report projects.

The actuaries estimate that spending for Part A in 2080 will more likely be 3.87 percent of GDP instead of 2.17 percent as the trustees report projects. Importantly, this is still well less than the 4.96 percent of GDP estimate projected in the 2009 trustees report, an improvement of 1.1 percent of GDP due to enactment of health care reform.

For Part B, the actuaries memorandum projects very substantially higher spending than the trustees report does. The trustees project that spending for Part B will be 2.47 percent of GDP in 2080, but the actuaries think it will more likely be 5.07 percent of GDP. The 2009 trustees report estimated Part B spending would be 4.43 percent of GDP in 2080.

Looking at the whole Medicare program, the actuaries see spending rising to 10.7 percent of GDP in 2080 from 3.59 percent of GDP this year, while the trustees report sees spending at 6.37 percent of GDP. Total Medicare spending in 2080 was estimated to be 11.19 percent of GDP in the 2009 trustees report.

The Impact of Health Care Reform
Insofar as the Affordable Health Care Act is concerned, the Medicare actuaries are still projecting a reduction in spending of half a percent of GDP—which is a lot when one considers that aggregate GDP is projected to be $1.4 quadrillion over the infinite time horizon.

More importantly, the provisions of law that the actuaries think won’t be implemented were part of the law in 2009 as well. This means that the actuaries should have been equally skeptical about last year’s trustees report. If one assumes that the magnitudes haven’t changed, then it means that the Affordable Health Care Act still reduced long-term Medicare spending by as much as the current trustees report estimates, or better than 4 percent of GDP in perpetuity.

Of course, it goes without saying that all long-term projections are subject to extreme uncertainty. Historically, spending for Medicare has been higher than projected. Just 8 years ago in the 2002 trustees report spending for parts A and B was projected to be 2.54 percent of GDP this year and it turned out to be 3.15 percent plus another 0.43 percent of GDP for Part D, which was not anticipated in 2002.

One reason that the Social Security and Medicare actuaries are required to use current law to base their official projections is that there is no reason to think their political judgment about what Congress may or may not do is better than anyone else’s. Once one gets into the realm of theoretically possible changes to law, it’s too easy to just assume away all of Medicare’s financial problems.

The Ryan Plan
That’s essentially what Rep. Paul Ryan, R-Wisc., has done in his widely praised plan to cap Medicare spending by converting the whole program into a voucher plan. The elderly would henceforth buy their own health insurance with federal vouchers that would be worth less than the per capita cost of Medicare. Moreover, these vouchers would be indexed to less than the historical cost increase for Medicare. Ryan just assumes that the health care system would adjust so as to prevent a very, very sharp cut in health care quality for the largest voting bloc in the country.

Ryan’s plan might work if it were ever actually enacted — which is politically impossible — and Congress allowed real Medicare spending to decline perpetually. But that is also politically impossible. Medicare’s actuaries don’t even think the relatively modest cuts contained in current law will ever be allowed to take effect, and Ryan would cut compensation for doctors, hospitals and insurance companies far, far more drastically.

In effect, the Medicare actuaries have shown the absurdity of the Ryan plan by denying that Medicare cuts already enacted into law are even worthy of projecting into the future. Of course, something will have to be done — either tax increases or benefit cuts because Medicare’s finances are not sustainable. But the Republican fantasy that all of the adjustment will come on the spending side is ridiculous. And the Affordable Health Care Act, which all of them opposed, is the biggest cut in Medicare spending ever enacted.