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Ed Lotterman: Medicare mess is a political challenge

The way we have managed Medicare has brought our nation to a fine fare-thee-well. Yes, the program meets an enormous need. It has been and continues to be a vital lifeline for tens of millions of people. Current beneficiaries have themselves paid in hundreds of billions of dollars with the promise of receiving payouts, so ending the program abruptly would be a huge injustice.

At the same time however, the problems described in last week’s column remain. Medicare was intended to be a social insurance program into which members of each generation would pay taxes that added up to an actuarial sum about equal to the benefits they would receive when they got older. Instead, Medicare has turned into an enormous income-redistribution entitlement program, that, at an estimated Treasury cost of $590 billion for the 2016 fiscal year (that starts Oct. 1 ), has outlays exceeding those for the Defense Department.

Contrary to original intent and to what most people apparently believe to be the case, this outlay exceeds the accumulated value of taxes paid in by current beneficiaries about three times over. The money can come only from younger workers who inevitably will get much less, relative to what they pay in, than do today’s recipients. This is at a time when many in younger cohorts, for nearly the first time in U.S. history, face the prospect of lifetime earnings no higher than their parents, and in some cases less.

Finally, in contrast to the much smaller income transfer programs such as Temporary Assistance to Needy Families, Supplemental Security Income and SNAP (food stamps), Medicare is not means-tested. Everyone is eligible once they reach age 65, regardless of income.

Moreover, because it is funded by a flat 2.9 percent tax, with no zero-bracket amount for low-income households, applying only to labor income and not interest, dividends or capital gains, it is regressive. The 1993 change that removed the cap on earnings subject to Medicare FICA, that still applies to Social Security itself, reduced this situation somewhat. But because “earned income” as a proportion of the total tax liability shrinks as household income increases, those in the upper 20 or 10 or 1 percent of the income distribution pay a much smaller fraction of income for Medicare than do people on minimum wage.

How did we get here?

There are at least three factors.

First, when established in the booming 1960s, eligibility was extended immediately to all older than 65, even if they had paid in little or nothing in taxes. This contrasted with Social Security itself, where taxes started soon after passage of the 1935 act, but the first benefits didn’t go out until 1940. This immediate start to Medicare may have been the most just thing to do at the time, but it set a political precedent of giving benefits that cost well more than the taxes collected.

Moreover, Social Security benefits varied with earnings history, so those who had paid in little got little. And there was no increase in benefits, even for inflation, until 1950.

Medicare, however, was more open-ended with regard to prices of medical care and coverage of many new procedures. Both of these factors, unit costs and new treatments, grew much faster than anyone anticipated. The process has accelerated in recent decades. This is the largest single factor behind the current excess of benefits over taxes paid.

Finally, while we had raised tax rates over the first 20 years of Medicare as costs increased, we froze the rate at 2.9 percent in 1986. We have not raised it since, even as health costs have grown much faster than incomes or economic output as a whole. Yes, to the extent that covered incomes rose, tax revenues did rise. But the proportion did not change. Can one think of any private-sector health plan in which the cost did not rise relative to total payroll over the past 30 years? For most employers, it has risen multiple times over.

What can be done?

From the point of view of the burden on younger people relative to old, the horse is already gone from the stable. Current beneficiaries are past their FICA-paying years, and they are going to go down in history as having gotten a great deal.

But we don’t need to continue giving that deal to all of them. We can means-test Medicare benefits just as we do nearly every other income-transfer program.

The political challenge is where to set the cut-off point, or the levels and rate at which benefits might progressively be scaled back. Warren Buffett and George Soros clearly don’t need Medicare. But what about people earning only a quarter-million a year or those with only $100,000? The lower you set it, the more you reduce outlays, but the more politically unpopular it becomes. Some sort of sliding scale would be better than an all-or-nothing threshold.

Over a fifth of baby-boomers have retired, but that leaves another 14 birth years of them to go. Taxes have to go up sooner or later. Doing it sooner would get some money out of that group. Each year we delay the inevitable increases the degree to which we stick it to those born later, especially those currently under 35.

The impact of an increase in FICA rates on low-income people could be softened by introducing a zero-bracket amount for Medicare taxes like that for general income taxes. Or we could have a complete exemption or lower rates for those younger than 20 or 25.

We could also adopt two, three or four progressive rate brackets as for income tax.

We could define a basic health package for everyone over 65, regardless of income, funded out of FICA taxes, and then provide supplementary benefits above that level funded from general tax revenues. The fact that Part D drug benefits, added on to Medicare during the George W. Bush administration, already are funded from the general treasury rather than FICA sets a precedent.

We could follow ex-GOP congressman Eric Cantor’s proposal to turn Medicare into a voucher system. A lot of economists favor that approach generally, but Cantor got bounced out by an even more conservative Republican and no one else is pushing the idea.

As state-based exchanges, first proposed by GOP senators in 1993 and established by the Affordable Care Act under President Barack Obama, mature, we could transition to a system in which everyone, regardless of age or employment, buys coverage on these exchanges. Those over 65 would get Medicare reimbursement for a basic plan. This would not be much different from Switzerland’s system or from Cantor’s proposed vouchers. This may be the way things are going whether we realize it or not.

And then we can just remain deadlocked, with older people getting a lot more out then they ever paid in, thus condemning younger people to eventually paying in much more than they ever will get out. This certainly can continue until a smoldering fiscal crisis becomes an acute political one. This “after me, the deluge” approach is becoming pretty habitual for baby boomers. It is tragic, and it is unjust for our kids and grandkids, but it is the most likely scenario.

Just as only a Republican president, Richard Nixon, could open up Communist China, so perhaps only a Democrat can force the issue on revamping Medicare. An elder statesman with nothing to lose. like Joe Biden, might have the guts, but don’t expect it from Clinton, Sanders or Warren — or Biden, even, if he chooses to run for president next year.

A Republican President Kasich or Rubio might dare raise the issue, especially in a second term, but whether they would have the political skills to weather the inevitable storm of demagoguery that would erupt is an open question.

St. Paul economist and writer Edward Lotterman can be reached at