The
Medicare debate has focused almost exclusively on what form of drug
benefit to provide to senior citizens. Lost in the debate is what
the huge new unfunded liability implicit in the drug legislation
would mean to American taxpayers. There are no free lunches, and
future taxpayers will have to pick up the commitment to senior
citizens.
To
appreciate what this means, Americans should consider the fact that
the unfunded portions of the Medicare drug bills currently being
considered by Congress would:
- Cost taxpayers a total of $2 trillion
through 2030 alone, with escalating costs thereafter. (All dollar
amounts are adjusted for inflation and expressed in 2003
dollars.)
- Mean that a 40-year-old head of household
in 2003 could expect his or her family to pay $16,127 in extra
taxes until retirement to pay for other people's drug benefit
before paying for his or her own drug coverage. This is on top of
taxes already needed to pay for existing unfunded Medicare
obligations, as well as taxes for the Social Security
shortfall.
- Mean that a baby born today would inherit
at age 27 an extra tax burden averaging $1,125 per household in
2030. That annual cost would increase every year, and it would be
in addition to Medicare payroll taxes and any taxes needed to cover
the projected shortfalls in Social Security and the current
Medicare program.
- By 2030, cost the average household $3,980
per year in higher taxes when combined with Medicare's current $5
trillion projected shortfall through 2030. (The Medicare shortfall
is defined as the portion of Medicare spending not covered by
payroll taxes and premiums, which must eventually be covered by
raising taxes and/or premiums.)
The
budgets of mandatory programs, such as Medicare, are classified as
"uncontrollable" because the government cannot directly control how
much is spent. Lawmakers merely set eligibility requirements and
benefit levels, and the program's cost is determined by how many
eligible individuals enroll in the program. Reducing program
spending requires that Congress rewrite the eligibility and benefit
levels.
Popular mandatory programs typically
experience increased enrollment. This in turn creates pressure for
Congress to expand eligibility to a wider constituency and increase
benefit levels. With no brakes, costs soar, forcing Congress either
to raise taxes or to reduce benefits.
The
uncontrollable, unknowable costs of mandatory programs explain how
Medicare could be created in 1965 based on a projected annual cost
of $10 billion and end up costing $244 billion by 2003. Medicare
spending is on pace to double in the next decade, and that growth
rate will accelerate when the baby boomers begin retiring. With the
payroll tax insufficient to fund Medicare's costs, the program will
run a $5 trillion deficit through 2030.
Adding an expensive new drug benefit will
substantially worsen Medicare's already shaky finances. Estimating
the long-term cost of a drug benefit is difficult, but it would be
irresponsible for Congress to create this benefit without
attempting to calculate its long-term costs and producing a
credible plan to pay for it.
The
10-year cost estimates performed by the Congressional Budget Office
(CBO) do not capture the substantial cost that will likely be felt
by taxpayers in 15, 20, and 30 years. This paper estimates those
costs.
The Total Shortfall
Like
the CBO, the authors estimate that the current Medicare drug bills
would cost approximately $328 billion over the next 10 years ($400
billion without adjusting for inflation). Yet costs accelerate
substantially beyond the 10-year budgeting window. In the following
10 years, from 2014 through 2023, the drug benefit is projected to
cost $772 billion. That rapid growth rate continues through 2030.
Chart 1 shows that the Medicare drug
benefit is projected to face a shortfall of:
- $42 billion in 2010,
- $83 billion in 2020
- $148 billion in 2030.
Adding in the projected shortfall of the
current Medicare program, the combined shortfall is:
- $132 billion in 2010,
- $276 billion in 2020, and
- $525 billion in 2030.
For
2003 through 2030, the current Medicare program faces a total
shortfall of $5 trillion. The drug benefit would add approximately
$2 trillion to this amount.
What the Shortfall Means for
Taxpayers
When
the baby-boom generation enters Medicare and causes it to plunge
deeper into the red, Congress will likely use deficit spending to
fund the shortfall. Deficits, however, must eventually be repaid
through either taxes or fees. Lawmakers will likely resist massive
increases in Medicare premiums, leaving the taxpayers to cover the
$5 trillion Medicare shortfall as well as the $2 trillion shortfall
created by a drug benefit. The effects of the combined shortfall on
two typical households are detailed below.
Example 1: A
married couple, both 40 years old
This couple already pays the 15.3 percent
payroll tax to fund current Medicare (and Social Security)
beneficiaries. Because the payroll tax will not provide enough
revenue to fund Medicare for all retirees, this couple also faces
$39,894 in additional taxes between now and their own retirement in
2030.
The proposed Medicare drug benefit will
add $16,127 to that tax burden, but none of these taxes--neither
the payroll tax, the tax need to fund the current Medicare
shortfall, nor the tax needed to fund a drug benefit
shortfall--will be set aside for their own retirement. Every dollar
will fund spending for current Medicare recipients.
Example 2: A
couple with a baby born in 2003
By age 27, the child has likely married, begun a
career, and started a family--and inherited an overwhelming tax
burden.
In 2030, when the child is 27, the
person's household would pay $1,125 in taxes just to cover the
unfunded drug benefits of seniors. This is in addition to the 15.3
percent payroll tax, plus the $2,855 in additional taxes needed to
cover the shortfall in the current Medicare program. These taxes
will increase rapidly over the next 40 years before this person's
own retirement.
Chart 2 shows the annual cost on a
per-household basis. To cover Medicare's prescription drug
shortfall, taxes must be raised by:
- $371 per household in 2010,
- $680 per household in 2020, and
- $1,125 per household in 2030.
Adding this into Medicare's current
projected shortfall, the total becomes:
- $1,168 per household in 2010,
- $2,262 per household in 2020, and
- $3,980 per household in 2030.
How Such New Taxes Could Be Levied
Taxpayer funding of the Medicare drug
benefit shortfall would require raising individual income taxes by
approximately 5 percent through 2030. Raising that amount of income
tax could be done in one of the following ways or some combination
of them:
- Raising
the current 25, 28, 33, and 35 percent income tax brackets by 2 to
3 percentage points each;
- Eliminating most of the home mortgage
interest tax deduction;
- Repealing the earned income tax credit;
or
- Repealing the child tax credit.
When
combined with the shortfall in the current Medicare program, the
necessary income tax increase is 18 percent through 2030. Examples
of such tax increases include:
- Repealing every tax cut enacted since
2001--including marriage penalty relief, the expanded child tax
credit, the expanded adoption tax credit, and the reduced 10
percent tax bracket for lower-income families--and imposing
additional taxes elsewhere;
- Raising
the current 25, 28, 33, and 35 percent income tax brackets by 7 to
9 percentage points each; or
- Repealing the tax exclusion that exempts
employees from paying taxes on the value of their health
insurance.
Two-thirds of these tax increases would
fund the current Medicare shortfall, and one-third would fund the
new drug benefit.
What Congress Should Do To Avoid This New
Tax
Most
seniors already have private drug coverage. Thus, targeted help to
those who need it would make much more sense than a large new
unfunded drug benefit for all seniors. Moreover, the absence of
drug coverage in today's Medicare program is the result of
deficiencies in the way Medicare benefits are modernized over
time.
Currently, revising key benefits takes an
act of Congress. It would be much more sensible to enact reforms
that allow revised benefits, such as drug coverage, to be
introduced into Medicare gradually over time, paid for with changes
in other less valuable benefits, and done so in a way that reflects
the preferences of seniors. The best model for this is Congress's
own health plan, the Federal Employees Health Benefits Program
(FEHBP). In the FEHBP, market competition and consumer choice leads
to plans that reflect enrollee needs.
Congress should address the needs of some
seniors for drug coverage in a way that preserves two critical
principles:
- A Medicare drug bill should impose no new
unfunded liabilities on future generations.
- Medicare should be revamped to resemble
the FEHBP so that drug benefits and other features can become
common and cost-effective features of plans driven by consumer
choice and competition.
Conclusion
President George W. Bush and many in
Congress cite tax relief as the centerpiece of their economic
agenda. Lawmakers who vote for the Medicare drug benefit are voting
for a $2 trillion tax increase. Responsible lawmakers who oppose
such substantial tax increases should look beyond the 2004 election
and examine the burden that a Medicare drug burden will impose on
future generations.
Brian M. Riedl is Grover M. Hermann
Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute
for Economic Policy Studies, and William W. Beach
is Director of the Center for Data Analysis, at The Heritage
Foundation.
Appendix
Methodology
The
2003-2030 annual cost estimates for the current Medicare program
and for the Senate's proposed drug benefit come from data produced
by Dr. Andrew Rettenmaier and Dr. Thomas Saving, respectively
Executive Associate Director and Director of the Private Enterprise
Research Center at Texas A&M University. Dr. Saving also is one
of two public trustees of the Social Security and Medicare trust
funds. Dr. Saving's projections of Medicare costs as a percentage
of taxable payroll were converted into nominal and then real
dollars using the economic projections of the 2003 Annual Report of
the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds.
The
tax cost was converted into percentage income tax increases based
on projections of future baseline tax revenues from the Global
Insight U.S. Macroeconomic Model and supporting Global Insight
databases.
The
methodologies, assumptions, conclusions and opinions in this report
are entirely the work of Heritage Foundation analysts. They have
not been endorsed by, and do not necessarily reflect the views of,
Dr. Saving or the owners of the Global Insight U.S. Macroeconomic
Model.
Data
used in this Backgrounder are available upon request from the
authors.