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The Facts on Medicare Spending and Financing

Overview of Medicare Spending

Medicare, the federal health insurance program for 54 million people ages 65 and over and people with permanent disabilities, helps to pay for hospital and physician visits, prescription drugs, and other acute and post-acute services. In 2013, spending on Medicare accounted for 14% of the federal budget (Exhibit 1). Medicare also plays a major role in the health care system, accounting for 20% of total national health spending in 2012, 27% of spending on hospital care, and 23% of spending on physician services.1

Exhibit 1: Medicare as a Share of the Federal Budget, 2013

Exhibit 1: Medicare as a Share of the Federal Budget, 2013

Medicare benefit payments totaled $583 billion in 2013; roughly one-fourth was for hospital inpatient services, 12% for physician services, and 11% for the Part D drug benefit (Exhibit 2). Another one-fourth of benefit spending was for Medicare Advantage private health plans covering all Part A and B benefits; in 2014, 30% of Medicare beneficiaries are enrolled in Medicare Advantage plans.

Exhibit 2: Medicare Benefit Payments, 2013

Exhibit 2: Medicare Benefit Payments, 2013

Both in the aggregate and on a per capita basis, Medicare spending growth has slowed in recent years and is expected to grow at a slower rate in the future than in the past—and even slower than was projected just a few years ago. And in a break from the historical pattern, net Medicare spending is projected to be a roughly constant share of the federal budget and the nation’s economy in the coming decade.

Historical and Recent Trends in Medicare Spending

On a historical basis, Medicare spending per enrollee grew at an average annual rate of 7.7% between 1969 and 2012, slower than the 9.2% average annual growth rate in private health insurance spending per enrollee (this comparison includes benefits commonly covered by Medicare and private health insurance over this period, including hospital services, physician and clinical services, and other professional services, and durable medical products).2

More recently, total and per capita Medicare spending have grown more slowly each year since 2010. Based on a comparison of CBO’s August 2010 and April 2014 baselines, Medicare spending in 2014 will be about $1,000 lower per person than was expected in 2010, soon after passage of the 2010 Affordable Care Act (ACA).3

Medicare spending projections in CBO’s August 2010 and subsequent baselines take into account the anticipated effects of the ACA, along with other factors that are expected to affect future Medicare spending. The ACA included reductions in Medicare payments to plans and providers and introduced delivery system reforms that aimed to improve efficiency and quality of patient care and reduce costs, including accountable care organizations (ACOs), medical homes, bundled payments, and value-based purchasing initiatives. The law also increased the Medicare Part A payroll tax rate on earnings for higher-income people and increased Part B and Part D premiums for higher-income beneficiaries. In addition, the Budget Control Act of 2011 lowered Medicare spending through sequestration that reduced payments to providers and plans by 2% beginning in 2013.

Future Trends in Medicare Spending

Looking ahead, net Medicare outlays (that is, Medicare spending minus income from premiums and other offsetting receipts) are projected to increase by two-thirds from $512 billion in 2014 to $858 billion in 2024—an average annual growth rate of 5.3% in the aggregate—due to growth in the Medicare population and increases in health care costs (Exhibit 3). These estimates do not take into account additional spending that is likely to occur to avoid reductions in physician fees scheduled under current law. The growth in health spending, which affects all payers, is influenced by increasing volume and use of services, new technologies, and increasing prices.

Exhibit 3: Net Medicare Spending, 2010-2024

Exhibit 3: Net Medicare Spending, 2010-2024

Yet despite annual growth in outlays, net Medicare spending is projected to be a roughly constant share of the federal budget and the nation’s economy in the coming decade. Medicare’s share of the federal budget is projected to be 14.5% in both 2014 and 2024 (varying slightly between these years), while Medicare spending as a share of GDP is projected to be 3.0% in 2014 and 3.2% in 2024 (Exhibit 3). On a per capita basis, Medicare spending is projected to grow at a slower rate between 2013 and 2022 than it did between 2000 and 2012 (4.0% vs. 6.1%) (Exhibit 4). Medicare spending also is projected to grow more slowly than private health insurance spending on a per capita basis in the coming years. According to CBO, in the coming decade (2015-2024), the rate of Medicare per capita spending growth will be roughly in line with growth in GDP per capita, while private health insurance premiums are expected to grow 2 percentage points faster.

Exhibit 4: Historical and Projected Average Annual Growth Rate in Medicare Per Capita Spending and Other Measures

Exhibit 4: Historical and Projected Average Annual Growth Rate in Medicare Per Capita Spending and Other Measures

Over the longer term, however, both CBO and the Medicare Actuaries expect Medicare spending to begin to rise more rapidly due to a number of factors, including the aging of the population, an increase in service use associated with greater severity of illness, and faster growth in health care costs than growth in the economy on a per capita basis. According to CBO’s most recent long-term projections, net Medicare spending will grow from 3.0% of GDP in 2014 to 3.8% of GDP in 2030, 4.7% in 2040, and 5.5% in 2050. Through 2039, CBO projects that the aging of the population will account for a larger share of spending growth on the nation’s major health care programs (Medicare, Medicaid, and subsidies for ACA Marketplace coverage) than either “excess” health care spending growth or expansion of Medicaid and Marketplace subsidies.

How Is Medicare Financed?

Medicare is funded primarily from three sources: general revenues (41%), payroll tax contributions (38%), and beneficiary premiums (13%) (Exhibit 5).

Exhibit 5: Sources of Medicare Revenue, 2013

Exhibit 5: Sources of Medicare Revenue, 2013

Part A (the Hospital Insurance program) is financed primarily through a 2.9% tax on earnings paid by employers and employees (1.45% each) (accounting for 88% of Part A revenue). Higher-income taxpayers (more than $200,000/individual and $250,000/couple) pay a higher payroll tax on earnings (2.35%).

Part B (the Supplementary Medical Insurance program) is financed through general revenues (73%), beneficiary premiums (25%), and interest and other sources (2%). Beneficiaries with annual incomes over $85,000/individual or $170,000/couple pay a higher, income-related Part B premium reflecting a larger share of total Part B spending, ranging from 35% to 80%; the ACA froze the income thresholds through 2019, which is expected to increase the share of beneficiaries paying the higher Part B premium.

Part D is financed through general revenues (73%), beneficiary premiums (14%), and state payments for dual eligibles (13%). Similar to Part B, enrollees with higher incomes pay a larger share of the cost of Part D coverage.

The Medicare Advantage program (Part C) is not separately financed. Medicare Advantage plans such as HMOs and PPOs cover all Part A, Part B, and (typically) Part D benefits. Beneficiaries enrolled in Medicare Advantage plans typically pay monthly premiums for additional benefits covered by their plan in addition to the Part B premium.

Solvency of the Medicare Hospital Insurance Trust Fund

The solvency of the Medicare Hospital Insurance trust fund, out of which Part A benefits are paid, is a common way of measuring Medicare’s financial status. Solvency is measured by the level of assets in the Part A trust fund. In years when annual income to the trust fund exceeds benefits spending, the asset level increases, and when annual spending exceeds income, the asset level decreases. When spending exceeds income and the assets are fully depleted, Medicare will not have sufficient funds to pay all Part A benefits.

Each year, the Medicare Trustees provide an estimate of the year when the asset level is projected to be fully depleted. Because of slower growth in Medicare spending in recent years, the solvency of the trust fund has been extended. In 2014, the Trustees project that the Part A trust fund will be depleted in 2030, four years later than was projected in the 2013 report and six years later than was projected in the 2012 report (Exhibit 6).

Exhibit 6: Solvency Projections of the Medicare Part A Trust Fund, 2005-2014

Exhibit 6: Solvency Projections of the Medicare Part A Trust Fund, 2005-2014

Part A Trust Fund solvency is affected by growth in the economy, which affects revenue from payroll tax contributions, health care spending trends, and demographic trends: an increasing number of beneficiaries, especially between 2010 and 2030 when the baby boom generation reaches Medicare eligibility age, and a declining ratio of workers per beneficiary making payroll tax contributions.

Part B and Part D do not have financing challenges similar to Part A, because both are funded by beneficiary premiums and general revenues that are set annually to match expected outlays. However, future increases in spending under Part B and Part D will require increases in general revenue funding and higher premiums paid by beneficiaries.

In addition to the solvency of the Part A trust fund, Medicare’s financial condition can be measured in other ways. For example, the Independent Payment Advisory Board (IPAB), which was authorized by the ACA, is required to recommend Medicare spending reductions to Congress if projected spending growth exceeds specified target levels. IPAB is required to propose spending reductions if the 5-year average growth rate in Medicare per capita spending is projected to exceed the per capita target growth rate, based on inflation (2015-2019) or growth in the economy (2020 and beyond). The ACA required the IPAB process to begin in 2013, but CBO has estimated that spending reductions will not be triggered for several years because Medicare spending growth is expected to be below the target growth rate during the next decade.

Future Outlook

Several questions remain unanswered about recent trends in Medicare spending and what they portend about future spending levels: What are the primary reasons for the recent slowdown in Medicare spending? How are delivery system reforms influencing the Medicare spending trajectory? Are the Medicare changes in the ACA having an even larger effect on spending than expected? Can the slowdown be sustained and can this be done without adversely affecting access to or quality of care?

While Medicare spending is on a slower upward trajectory now than in the past, Medicare is likely to be a focus of future policy discussions about reducing the federal budget debt, given the health care financing challenges posed by the aging of the population. A number of changes to Medicare have been proposed, including: restructuring Medicare benefits and cost sharing; eliminating “first-dollar” Medigap coverage; increasing Medicare premiums for all beneficiaries or those with relatively high incomes; raising the Medicare eligibility age; shifting Medicare from a defined benefit structure to a “premium support” system; and accelerating the ACA’s delivery system reforms. How the recent slowdown in Medicare spending growth will affect the prospects for these proposals is unclear, but it could provide an opportunity for thoughtful consideration of these and other ways to bolster the program for an aging population.

Endnotes
  1. Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Group, National Health Expenditures Tables (January 2014).

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  2. Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Group, National Health Expenditures Tables (January 2014).

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  3. Tricia Neuman and Juliette Cubanski, "The Mystery of the Missing $1,000 Per Person: Can Medicare's Spending Slowdown Continue?" Kaiser Family Foundation (July 2014); available at http://kff.org/medicare/perspective/the-mystery-of-the-missing-1000-per-person-can-medicares-spending-slowdown-continue /.

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