Beware of Medicare: Why Tax Cuts Are No Threat to Medicare

May 17, 2001 21 min read

Authors: Robert Moffit and D. Wilson

Americans are understandably confused by the rhetoric in Washington over the possible impact of President Bush's tax and budget plans on federal programs, especially Medicare. The arcane character and complexity of Medicare's financing formulas as well as the federal budget make it easy for opponents of the President's plan to misrepresent Medicare's true financial condition and frighten vulnerable senior citizens. The fact is that both eligibility for Medicare and Medicare benefits are entitlements set by law. Moreover, neither President Bush nor any principal congressional proponent of Medicare reform is proposing a change in Medicare eligibility or benefits in order to provide tax relief.

Medicare reform and tax relief are both vital to the economic health of the country and achievable. Nevertheless, opponents of these policies often make claims that pit tax relief against Medicare reform. These "Mediscare" claims are riddled with misinformation. For example:

Claim #1: Giving Americans significant tax relief will threaten Medicare's financing. In other words, Congress will need to raid the Medicare surplus in order to provide tax relief. This is simply not true. Nothing in the Bush tax and budget proposals requires Congress to raid the Medicare trust fund. Under the President's plan, every penny of Medicare taxes collected and premiums paid, and more, will continue to go into the Medicare program.¹ The President's budget plan--after increasing government spending by $853 billion from fiscal year (FY) 2002 to FY 2011, providing $1.6 trillion in tax relief, and setting aside $2.6 trillion for Social Security and $526 billion for Medicare--still leaves a $317 billion surplus.
Claim #2: Medicare reform with tax relief will require Congress to cut seniors' benefits. In reality, no serious Medicare reform proposal includes a net cut in benefits. In fact, the Bush budget plan devotes $153 billion over 10 years to additional Medicare spending. A bipartisan Medicare proposal introduced by Senators John Breaux (D-LA) and William Frist (R-TN) also calls for an improved package of benefits that includes prescription drug and catastrophic coverage.²

President Bush's tax relief plan does not threaten the Medicare trust fund or Medicare benefits. This is true whether one uses a static estimate of the tax revenue "cost" of Bush's tax reduction plan ($1.7 trillion) or a more accurate dynamic estimate of the cost of the Bush tax plan ($1.1 trillion).3 Strengthening the economy by lowering tax rates will actually increase employment, and thus the employment-based federal payroll tax revenue going into the Medicare trust fund for hospitalization insurance. Moreover, Congress could provide substantially more tax relief than the $1.35 trillion called for in its budget resolution without threatening Medicare.

Taxpayers and seniors need an honest debate. The gravity of the issues involved and the need for carefully constructed long-term reforms of the Medicare system require a different way of doing business in Washington.

MEDICARE'S COMPLICATED FINANCIAL CONDITION

The Medicare program today covers approximately 40 million retired and disabled persons.

It requires the taxes of four workers to support each Medicare beneficiary's benefits. By 2040, enrollment will jump to an estimated 81 million, but there will be only about two workers per beneficiary. It is widely recognized that the federal entitlement program is burdened with two broad problems: how to pay for the sharp increase in demand for services when the nation's 77 million baby boomers begin to retire in 2011 and become eligible for Medicare, and how to ensure high-quality health care for the next generation of retirees in the face of exploding costs, excessive regulation, and gaps in coverage.

The entire Medicare program is financed through two trust funds, known as Part A and Part B. These trust funds have very different methods for paying out benefits and very different sources for funding those benefits:

Medicare Part A reimburses hospitals and is financed by a dedicated payroll tax of 2.9 percent. The payroll tax revenue for Medicare Part A is deposited in the Hospitalization Insurance (HI) trust fund. This trust fund is currently running an annual surplus, but the Medicare Trustees forecast that this will be depleted by 2029.⁴
Medicare Part B pays for physician and outpatient services and is financed by a combination of beneficiary premiums and general tax revenues.⁵ The Part B, or Supplemental Medical Insurance (SMI), trust fund is simply an accounting device; it cannot be threatened with insolvency because it is open-ended. The amounts of funds for Part B that come from beneficiary premiums and from general tax revenues are automatically adjusted each year to cover the cost of its benefit payments.

Medicare's Financial Condition

The President's Assessment. The President's budget plan acknowledges that Medicare will have a surplus of $526 billion from FY 2002 to FY 2011 but notes correctly that this amount comes entirely from Part A of the program.⁶ Because it would be inaccurate to mention this surplus without also mentioning Part B's rising costs and increasingly large draw on general tax revenues, combining the bottom lines for Part A and Part B gives Americans a better understanding of Medicare's total financial condition.

From the perspective of the overall federal budget, Part B will have a $1.2 trillion deficit from FY 2002 to FY 2011, a cost that will have to be paid using general tax revenues since SMI beneficiary premiums cover only 25 percent of Part B's program costs.⁷ As President Bush correctly notes, the total Medicare program--both Part A and Part B--will not experience a surplus from FY 2002 to FY 2011. It will actually run a $645 billion deficit that must be covered by general tax revenues (see Table 1).

This presentation of Medicare financing is an honest assessment of the entire program's fiscal condition.⁸ The President's budget plan recognizes that even though the HI trust fund is solvent today, Medicare is not solvent overall. The government must go beyond Medicare's dedicated payroll tax and beneficiary premiums and rely on huge infusions of general revenues in order to continue paying benefits. This problem will worsen significantly when the baby-boom generation begins to retire in 2011. The Concord Coalition argues in an independent analysis that the current trust fund accounting method is a major obstacle to Medicare reform because it papers over Medicare's cash deficits and perpetuates an out-of-date distinction between hospital care and physician care.⁹

Opponents' Views on Medicare's Financial Condition. Opponents of the President's tax and budget plans claim that he is ignoring the statutory requirement that general tax revenues be used to fund Medicare Part B spending not covered by beneficiary premiums.¹⁰ Relying on the traditional trust fund accounting method to portray Medicare's financial condition, they claim that Medicare Part A's $526 billion surplus should be set aside from the rest of the budget. They charge that the President effectively includes the surplus as part of his contingency fund in order to use it to pay for other programs.¹¹

Implicit in their methodology is an assumption that an unlimited and ever-larger draw on the U.S. Treasury for Medicare is not a problem, regardless of how that demand for spending would affect taxpayers, Medicare beneficiaries, or funding for other government programs. This is unrealistic.

Financing Medicare: Same Data, Different Analysis

How Medicare financing is talked about can be very confusing, as recent statements demonstrate. According to a joint report by the Senate and House Democratic Policy Committees, for example,

"The Bush Administration argues that if you combine the Part A and Part B programs, there is no real Medicare surplus-even while their own budget tables project a $526 billion surplus over ten years. This argument is deliberately misleading, and wrongly assumes that the only funding sources for the Medicare program are Part A payroll taxes and Part B premiums. It ignores the statutory requirement under the Social Security Act to use general revenue funds to finance Part B program expenses not covered by beneficiary premium contributions. Based on this logic, any government program paid for with general funds is in deficit-including defense."¹

The Concord Coalition, on the other hand, has published a different analysis:

"Critics object to combining HI and SMI. But why, when they pay benefits to the same people for the same general purpose? Old Age and Survivors Insurance and Disability Insurance, which have much less in common, are routinely totaled up and called "Social Security". The critics are right that SMI was never designed to be self-financing. But that is precisely the point. Its general revenue subsidy gives Medicare a large, growing, and permanent claim on the rest of the budget."²

1. Senate Democratic Policy Committee and House Democratic Policy Committee, The Medicare Trust Fund Finances the President's Bloated Tax Cut: Sacrificing the Health Security of America's Seniors, March 14, 2001.

2. Concord Coalition, "What Medicare Surplus?" Facing the Facts, March 22, 2001.

Understanding the President's Contingency Fund
The President's budget plan includes a contingency fund of $841 billion, which includes the Medicare Part A surplus. Since his plan shows that Medicare will run a deficit of $645 billion from FY 2002 to FY 2011, it logically does not mention that the Medicare Part A surplus is part of the contingency fund. Opponents of the President's tax relief plan do not want the Medicare Part A surplus of $526 billion from FY 2002 to FY 2011 to be counted in the contingency fund.

A less confusing way to present the President's budget plan, which the House Budget Committee has used, would be to create two contingency funds--one for the Medicare Part A surplus and another for the remaining budget surplus (see Chart 1).¹²

MEDISCARE TACTICS AND MISLEADING CLAIMS

Opponents of the President's proposed tax relief plan rely on the confusion surrounding Medicare's financing and the contingency fund to further their goal of limiting substantial tax relief. They are making a number of claims that regrettably scare far too may seniors and cloud the debate over Medicare and tax reforms. Each of these claims, however, can be refuted.

Claim #1: Giving Americans significant tax relief will threaten Medicare's financing. For example, a joint report of the Senate and House Democratic Policy Committees charges that the Bush Administration "has to spend the Medicare surplus in order to pay for its tax cut."¹³ In another report, FamiliesUSA, a Washington-based organization that campaigns for greater government control of the health care system, also charges that the Bush plan would finance one-third of the proposed tax cuts by raiding the Medicare program: "The $526 billion of additional [Medicare surplus] resources in the general fund are available to support almost one-third of the President's proposed $1.6 trillion tax cut."¹⁴

Reality: A close examination of the President's tax relief plan shows that it will not threaten Medicare's surplus. This is true whether one uses a static estimate of the tax revenue "cost" of the Bush tax plan ($1.7 trillion) or a more accurate dynamic estimate of the cost of the Bush tax plan ($1.1 trillion).¹⁵ Using a static analysis, which does not include an analysis of how changes in tax policy affect economic activity, the 10-year budget surplus would be large enough to support the President's tax relief plan without threatening Medicare.¹⁶

The Office of Management and Budget (OMB) estimates that the total surplus from FY 2002 to FY 2011 will exceed $5.6 trillion. Reducing this surplus by the amount of the President's tax relief plan, as well as his proposed spending increases for Medicare and other priorities and additional debt service requirements, still would leave a surplus of over $3.4 trillion (see Table 2). Further removing $2 trillion of the Social Security surplus used to reduce publicly held federal debt would leave a surplus of $1.4 trillion: $574 billion in Social Security, $526 billion in Medicare, and $317 billion in general revenue for the contingency fund.¹⁷ These remaining funds would have to be invested with banks and the Federal Reserve, or in some other private-sector asset, or used to reform Social Security and Medicare.

Many prominent economists believe that the static analysis used by OMB and others is outmoded because it fails to account for behavioral changes in work and savings that result from changes in tax rates. Heritage Foundation analysts therefore conducted dynamic analyses of tax policy changes to account more accurately for how such changes affect economic activity. A dynamic analysis of the President's tax plan reveals that the federal surplus, excluding the Social Security and Medicare surpluses, would be over $1.0 trillion from FY 2002 to FY 2011--not the $317 billion in the contingency fund using the static analysis.¹⁸ This amount would be more than enough to modernize and improve Medicare.

Arcane budget rules can be used to confuse and scare an uninformed public. Clarity can be brought to the discussion by taking the President's budget plan and separating the Medicare surplus from the rest of the contingency fund (see Table 2).

The assertion that President Bush's plan to give tax relief to Americans would threaten the Medicare surplus is based on outdated trust fund accounting methods and static revenue estimates that ignore economic reality. Opponents also inflate the static size of the President's tax relief plan from $1.7 trillion to $2.6 trillion in order to make their charges.¹⁹ In reality, because income tax rate reductions increase economic activity and employment, Medicare's payroll tax revenues would increase by $39 billion from FY 2002 to FY 2011.²⁰ Moreover, broad and generous tax relief would make it even easier for many retired Americans to purchase prescription drug coverage, regardless of whether Congress moves forward with Medicare reform to include a prescription drug benefit.

Claim #2: Medicare reform with tax relief will require Congress to cut seniors' benefits. For example, the Senate and House Democratic Policy Committees recently issued a report on the Medicare trust funds and the President's "bloated tax cut" that had an inflammatory subtitle: Sacrificing the Health Security of America's Seniors.²¹ FamiliesUSA likewise charges that "insolvency, under the President's budget, would occur 15 years earlier than current projections, thereby impairing seniors' abilities to count on inpatient services nine years from now."²² This scares seniors into thinking that their benefits are at risk if tax relief is enacted.

Reality: No individual would lose medical services under either Medicare Part A or Part B as a result of President Bush's budget proposals. Among the President's top budget priorities is that seniors' "current guarantee of access" to their Medicare benefits be preserved. Moreover, the President is proposing to enhance that range of benefits by giving every Medicare recipient a personal choice of health plans, including the option of purchasing a plan that covers prescription drugs.²³

President Bush has indicated his intention to preserve and modernize Medicare's benefits, including the addition of prescription drug coverage. Moreover, the President's budget plan presents the financial health of Medicare by looking at Part A and Part B together, which is a more realistic presentation of the program's problems and sustainability. Opponents have misrepresented both the intent and the substance of the President's reform proposals.

Too many Members of Congress have resisted reforming this troubled program to put it on sound financial footing. In addition, too many simply want to add a new drug benefit without reforming the old program. They would displace existing private-sector drug coverage and guarantee explosive costs without the normal market mechanisms to control them. Such an approach will not "preserve" Medicare benefits, but only worsen Medicare's financial condition.

Medicare's future is threatened by runaway government spending, not by the President's efforts to reduce the record-high tax burden on American workers. Since FY 1998 alone, federal spending has exceeded the statutory limits by $199 billion, an average increase of 6 percent per year--far more than the inflation rate of 2.4 percent.²⁴ History shows that the only way to make Washington rein in its excessive spending is not to send money to Washington in the first place, but this requires tax reform.

AVOIDING DESTRUCTIVE POLITICS

Americans were put through a bitter and confusing debate on Medicare in 1995 and 1996. Misrepresentations of the purpose and substance of the reform proposals succeeded in derailing serious efforts to put Medicare on a firmer financial footing, delayed necessary changes in the program, and contributed to the decline in the civility of American political discourse. Former President Clinton accused congressional leaders of trying to "destroy" Medicare, and his allies in Congress echoed that charge.²⁵ The editors of The Washington Post were so dismayed by the poisonous attacks on reform efforts that they wrote, "There's plenty to be said about the proposals the Republicans are making.... But that's not what the Democrats are engaged in. They're engaged in demagoguery, big time."²⁶

Improving the health care system for the next generation of retirees is a serious task. Experts from the Congressional Budget Office, the General Accounting Office, and the Office of Management and Budget all stress that Medicare needs to be reformed. A summary of the 2001 annual report from the Medicare Trustees concludes that Medicare needs to be reformed and strengthened at the "earliest opportunity."²⁷ Nevertheless, the opponents of tax relief and Medicare reform are trying to block the Administration's efforts; as one newspaper article noted, "criticisms from Democrats and their allies suggest that they have decided that, in trying to obstruct the tax cut, they can wield the Byzantine financing of Medicare to their advantage."²⁸

Members of Congress should refrain from engaging in divisive politics that derail efforts to improve Medicare and the tax code, and they should ignore the rhetoric of those who promote that agenda. Moreover, they should be aware that by refusing to act responsibly now, they are ensuring that their options will be far more difficult in the future: to make real cuts in Medicare benefits or to approve huge tax increases in order to cover the program's soaring costs. Members of Congress should work together in a bipartisan fashion with the Administration to craft sound reforms before the first wave of the baby-boom generation becomes eligible for Medicare in just 10 years.

CONCLUSION

Congress should recognize the real distinction, underscored in the President's budget, between tax policy and Medicare reform and examine each of the President's policy proposals on its own merits rather than relying on claims that reforming tax policy will seriously affect Medicare financing. In 1995, misleading and often sensational claims, including deceptive information on the budgetary impact of the reform proposals, marred the Medicare reform debate. Seniors and taxpayers need an honest debate by their representatives and elected officials in Washington, not misrepresentation and misinformation. The gravity of these issues and the need for carefully constructed long-term reforms require bipartisan cooperation and a different way of doing business in Washington.

Robert E. Moffit, Ph.D., is Director of Domestic Policy Studies, and D. Mark Wilson is a former Research Fellow in the Thomas A. Roe Institute for Economic Policy Studies, at The Heritage Foundation.

Endnotes

1.President Bush's budget plan calls for $153 billion in new Medicare spending from fiscal year (FY) 2002 to FY 2011. The congressional budget resolution calls for up to $300 billion in new Medicare spending from FY 2002 to FY 2011. See Office of Management and Budget, A Blueprint for New Beginnings: A Responsible Budget for America's Priorities, February 28, 2001, at http://www.whitehouse.gov/news/usbudget/blueprint/budtoc.html; see also Budget Resolution FY2002 (H. Con. Res. 83) at /static/reportimages/C996B732F0BFAC2120FA4C54B9AE8509.pdf.

2.For a description of the Breaux-Frist legislation, see Robert E. Moffit, Ph.D., "Using the Breaux-Frist Medicare Proposals to Craft Solid Medicare Reform," Heritage Foundation Backgrounder No. 1423, March 27, 2001.

3.D. Mark Wilson and William W. Beach, "The Economic Impact of President Bush's Tax Relief Plan," Heritage Foundation Center for Data Analysis Report No. CDA01-01Rev, April 27, 2001.

4.Social Security and Medicare Boards of Trustees, Status of the Social Security and Medicare Programs; A Summary of the 2001 Annual Reports, A Message to the Public, at http://www.ssa.gov/OACT/TRSUM/trsummary.html.

5.Medicare beneficiary premiums cover 25 percent of the costs of Part B, and general tax revenue covers 75 percent of the cost.

6.The HI trust fund balance is available to finance future benefit payments and other trust fund expenditures only in a bookkeeping sense. The HI trust fund does not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of a large trust fund balance, therefore, does not by itself make it easier for the government to pay benefits.

7.Office of Management and Budget, A Blueprint for New Beginnings, p. 13.

8.The President's basic understanding of Medicare's financial condition is shared, for example, by Congressional Budget Office Director Dan L. Crippen, who noted in recent testimony that the widening gap between total Medicare expenditures and dedicated revenues would amount to 30 percent of Medicare's gross outlays by 2011. See Dan L. Crippen, "Prescription Drugs and Medicare Financing," statement before the Committee on Finance, U.S. Senate, 107th Cong., 1st Sess., March 22, 2001, p. 4.

9.Concord Coalition, "What Medicare Surplus?" The Truth About Entitlements and the Budget, Vol. VII, No. 2 (March 22, 2001).

10.Senate Democratic Policy Committee and House Democratic Policy Committee, The Medicare Trust Fund Finances the President's Bloated Tax Cut: Sacrificing the Health Security of America's Seniors, Joint Special Report, March 14, 2001, at /static/reportimages/04F3AC5B7C18F682E122534BF71F59C1.pdf (April 28, 2001).

11.Ibid.

12.See the House budget resolution summary chart at /static/reportimages/D6191B2761B2B54132FE240613F4539C.pdf (March 26, 2001).

13.Senate Democratic Policy Committee and House Democratic Policy Committee, The Medicare Trust Fund Finances the President's Bloated Tax Cut.

14.FamiliesUSA, "Special Report: Bush Budget Speeds Medicare Insolvency by 15 Years," p. 2, at /static/reportimages/AF77AF118EAE477726CEF1D76EB903E0.pdf (March 15, 2001).

15.Wilson and Beach, "The Economic Impact of President Bush's Tax Relief Plan."

16.See William W. Beach et al., "How Faulty Official Figures Greatly Overstate the Cost of the Bush Tax Plan," Heritage Foundation Backgrounder No. 1416, March 6, 2001.

17.The House issued an explanation of its budget resolution that supports this static analysis. See

/static/reportimages/D6191B2761B2B54132FE240613F4539C.pdf (March 26, 2001).

18.Wilson and Beach, "The Economic Impact of President Bush's Tax Relief Plan."

19.Senate Democratic Policy Committee and House Democratic Policy Committee, The Medicare Trust Fund Finances the President's Bloated Tax Cut.

20.Wilson and Beach, "The Economic Impact of President Bush's Tax Relief Plan."

21.Senate Democratic Policy Committee and House Democratic Policy Committee, The Medicare Trust Fund Finances the President's Bloated Tax Cut.

22.FamiliesUSA, "Special Report: Bush Budget Speeds Medicare Insolvency by 15 Years."

23.Office of Management and Budget, A Blueprint for New Beginnings, p. 51.

24.Ibid.

25.In 1995, opponents of Medicare reform charged that the projected savings from Medicare changes would be used to pay for tax cuts. This was incorrect. In fact, the congressional leadership in 1995 adopted a "lock-box" provision similar to an idea promoted repeatedly by former Vice President Al Gore. Under the 1995 congressional proposal, all savings generated from changes in Medicare Part B would have been put back into Medicare through the creation of a new Medicare Preservation Trust Fund. Furthermore, the plan would have statutorily prohibited any transfers from that fund to pay for tax cuts.

26.Editorial, "Medagogues," The Washington Post, September 15, 1995, p. A24.

27.Social Security and Medicare Boards of Trustees, Status of the Social Security and Medicare Programs; A Summary of the 2001 Annual Reports, A Message to the Public.

28.Amy Goldstein, "Medicare Becomes Critics Weapon in Tax Cut Battle," The Washington Post, March 13, 2001, p. A5.