Courtesy of the Non-Profit Petersen G. Petersen Foundation
President Lyndon Johnson signed Medicare into law 47 years ago. Addressing the programs rising costs is a subject of great controversy. Some argue that Medicare is "broke," while others advocate for making few, if any, changes to a program on which so many people rely. This budget explainer describes the program, how it is financed, what it pays for, and what role it plays in financing American health care.
Medicare is the third largest program in the federal budget and cost nearly $560 billion in 2011 — or 16 percent of total federal spending. Medicare is a major driver of long-term spending; the retirement of the baby boom, combined with fast growth of health care costs, is projected to push Medicare spending from 3.7 percent of GDP in 2011 to 6.4 percent of GDP in 2035. General federal revenues subsidize 44 percent of the programs costs; the rest is covered by dedicated payroll taxes and premiums paid by beneficiaries. Medicare has a large impact on the overall health care market: it finances nearly one-fourth of all personal health care expenditures.
In 2011, the Medicare program cost $560 billion, or 16 percent of federal government spending. After Social Security and defense, Medicare is the third largest program in the federal budget. In coming years, the program faces significant financial pressures. If current policies continue, Medicare spending will rise from 3.7 percent of GDP in 2011 to 6.4 percent of GDP in 2035. The growth of these costs will put growing pressure on the systems finances — and the rest of the budget. Indeed, the growth of federal spending on major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies for the health insurance exchanges) is projected to account for four-fifths of the rise in federal non-interest spending over the next 25 years.
One of the biggest misconceptions about Medicare is that it is self-financed by current beneficiaries through premiums and by future beneficiaries through payroll taxes. In truth, the program is heavily subsidized with general revenues. Premiums cover only a small fraction of Medicares overall costs, while payroll taxes cover less than half of its costs. In 1970, 60 percent of its costs were financed by payroll taxes, paid by both workers and employers with each paying 0.6 percent of wages. Beneficiaries also paid premiums for physician services under Part B, but those premiums covered only about 40 percent of Part Bs costs or 13 percent of Medicares overall costs. In total, payroll taxes and premiums covered about 75 percent of Medicares costs in 1970. General revenues funded the remaining 25 percent.
By 2010, however, the share funded through payroll taxes had dropped to 40 percent, as wages and payroll taxes grew more slowly than Medicares costs. At the same time, the share funded by beneficiaries remained about the same as it did in 1970, though Medicare added a new prescription drug benefit through Part D in 2006 that required beneficiaries who enrolled in the new program to pay premiums. However, those premiums covered less than 10 percent of Part Ds costs. In total, payroll taxes and premiums covered only about 55 percent of Medicares costs in 2011. General revenues subsidized the remainder, with the exception of a small amount of revenue coming from taxes on high- income beneficiaries.
Hospitalizations are associated with very high cost health episodes — and that fact is reflected in Medicares program expenditures. Hospital expenses are the largest single component of program spending, accounting for about 43 percent of the total. The share of spending devoted to hospital care has declined, though, from about 70 percent at the programs inception. In part, this is because the Medicare program was expanded to provide additional benefits. While spending for physician services has hovered around 20 to 25 percent throughout the programs history, the share devoted to other benefits has grown. In particular, the introduction of the prescription drug benefit dramatically shifted the composition of Medicare spending.
Medicare is a major player in our nations health system. The program pays for nearly 45 percent of all home health spending in the country, nearly 30 percent of all hospital bills, and more than 20 percent of all nursing care expenses. For all health care spending, it finances about 21 percent of the total. Medicares share of payments for other services has also increased over the past twenty years. Although Medicares share of the costs for physician services and hospital care has risen only modestly, its share of other health care services has increased dramatically. For example, in 1990, Medicare paid for less than 0.5 percent of total prescription drug costs; in 2010 it financed more than 20 percent of the total. Major increases can also be seen in Medicares share of home health, nursing, and equipment and device spending.