Congress’s Medicare Financing Mess is Bigger Than You Think

While Congress talks about the federal debt, it’s still hesitating to deal with one major source of rising deficits—Medicare—that it can’t avoid much longer. Medicare’s Hospital Insurance (HI) fund expenses increasingly exceed its revenues, and it is scheduled to run out of reserves to help pay for those expenses by 2028. If that happens, Medicare would only be able to pay about 90 cents on the dollar for hospital services. Absent some new means of finances, it would have to cut real benefits for retired and disabled individuals.  

But the program’s issues extend beyond the need for more HI revenue. Much of Medicare’s total costs are not paid out of the HI fund. The financing of health care for Medicare recipients currently comes from three broad categories: payroll taxes on workers, general revenue transfers, and payments by beneficiaries. Yet each category contains multiple components, resulting in a complex web of 15 different streams. These are summarized in the table below and explained in more depth in a recent study.

How Healthcare for Medicare Beneficiaries is Financed

Taxes on Workers Dedicated to the HI trust fund

1. Standard payroll tax
2. An “Additional Medicare Tax” applied to wages, compensation and self-employment income over a certain threshold

“General Revenue” Transfers & Sources Associated with Medicare

1. Income taxation of Social Security cash benefits
2. The “Medicare surtax” on Net Investment Income
3. Income and other taxes
4. Borrowing (federal deficits)
5. Reductions in non-Medicare spending 
6. State transfers

Payments by Beneficiaries

1. Standard Part B (doctors and related service) premium
2. Standard Part D (prescription drug) premium
3. Part B income-related monthly adjustment amount (IRMAA)
4. Part D income-related monthly adjustment amount (IRMAA)
5. Premiums for Medicare supplement plans
6. Copayments
7. Other out-of-pocket payments for uncovered services

Even this laundry list of revenue sources is more complex than it looks at first glance. “General revenues” doesn’t just mean revenues; it means any payments not covered by the dedicated payroll tax, such as borrowing and any reduction in non-Medicare spending due to the program’s growing share of total federal spending.

General revenues also include a portion of income taxation of Social Security cash benefits that Congress decided in 1993 to dedicate to the Hospital Insurance trust fund. And since 2013, certain types of income have faced a “Medicare surtax” (which differs from the “Additional Medicare tax”—don’t ask) that sends revenue to the federal government’s general fund, helping to cover the parts of Medicare that lie outside of hospital care. Premiums, meanwhile, include supplementary higher monthly premiums for higher income recipients, while Medicare recipients also get hit with copayments, cost of supplemental plans, and outlays for uncovered services.

Don’t worry if you don’t understand many of these items. Your member of Congress almost assuredly doesn’t either. And that’s a problem when these same lawmakers need to know how to keep the program fiscally solvent.

This hodge-podge of financing sources, much out of general revenues, works against the trust fund logic of requiring Congress to strike a balance between how much it wants to pay providers and how much it wants to collect from taxpayers.

To give an idea of how much this hides the true cost of Medicare, let’s suppose Congress decided to make the financing of Medicare more transparent by using a single source of revenue, by the end of the 2030s it would take almost all of the payroll tax devoted to both Social Security and hospital insurance benefits to cover the cost of Medicare alone.

This convoluted system also takes appropriations power away from Congress and gives it to healthcare providers, as when a drug company raises prices or hospital administrators find new way to charge Medicare. Each old or new source of financing for Medicare creates a dependency that gets tangled up with broader efforts at tax or health reform.

The bottom line: Congress needs to address the financing side of Medicare reform broadly and not just its level but overall structure. If it tries simply to jerry-rig the system one more time and merely move out the date of HI trust fund exhaustion for a few years, it may only add to its long-term financing conundrum.