Reformers Should Look beyond Medicare’s Trust Funds

O n March 31, key members of President Biden’s cabinet released Medicare’s annual trustees’ report. It paints a similar picture as past reports: Medicare’s tens of trillions of dollars in unfunded liabilities represent a severe fiscal challenge. But it is important that policy-makers understand just how severe that challenge is, so that they can undertake the bold, wide-ranging reforms that the crisis calls for.

Medicare is financed by two “trust funds,” though in reality, it is largely funded in a pay-as-you-go manner. The Hospital Insurance Trust Fund (HI TF) provides payments for Part A’s inpatient hospital and post-acute-care benefits, while the Supplemental Medical Insurance Trust Fund (SMI TF) finances Part B’s physician and outpatient benefits and Part D’s prescription-drug benefits. Payments for Medicare Advantage, or Part C, are also funded out of these accounts.

The HI TF’s income comes from payroll taxes. In the past, this tax revenue exceeded spending, which created a positive “balance” that the Treasury borrowed to fund other federal expenses. But according to the trustees’ report, the HI TF is on track to become insolvent by 2031, when growing expenditures will exhaust the fund’s balances — which in turn will require a 10 percent reduction in Part A payments, since expenditures cannot exceed revenues. This is an improvement from the projected 2028 insolvency date in last year’s report, primarily due to 3 percent higher payroll-tax revenue and 4 percent lower benefit payments than expected in 2022. But despite these improvements, the insolvency date is still less than a decade away.

Understandably, policy-makers are keen to avoid unintended cuts to Part A benefit payments. But many have erred by treating HI TF solvency as an end in and of itself. They should consider the bigger budget picture.

The SMI TF’s income comes mostly from general tax revenues. In theory, this means “solvency” of this account is not an issue, since the Treasury can always provide enough funding to prevent its balances from being exhausted. But general revenues, though vast, are still finite and wholly inadequate to meet the many obligations required of them. (Hence the $1.4 trillion deficit in 2022.) The trustees have issued their fifth consecutive “funding warning” in response to Medicare’s overreliance on general revenues. These warnings require the president to submit a plan to Congress to reduce general-revenue funding of Medicare, although this requirement has generally gone unfulfilled.

The SMI TF’s biggest expenses, and the main reason for the climb in the percentage of Medicare expenses covered by general revenues, are Part B services, which are expected to account for two-thirds of Medicare-spending growth in the next decade, according to the trustees. The trustees also estimate that SMI TF spending will rise from 13 percent of all federal income-tax revenue in 2022 to 22 percent in 2030. Thus, Medicare expenses are directly crowding out other federal priorities and will contribute more to the federal debt moving forward, despite the “trust fund” financing structure.

Fixing the looming problem of trust-fund insolvency is thus not enough. Proposals that simply redirect tax revenues or unrelated spending reductions from elsewhere in the federal budget can paper over the program’s cracks, but they will create broader fiscal pressures and leave the underlying problem of cost growth unaddressed. Growing expenses across Medicare also directly harm beneficiaries, who will already spend an average of 28 percent of their Social Security checks on Part B and Part D expenses this year.

A positive takeaway from this year’s report is that increased flexibility and innovation in Medicare have helped control Part A’s spending growth. One example is the shift in hip and knee replacements from inpatient hospitals to cheaper outpatient and ambulatory settings as a result of regulatory changes made by the Trump administration.

There are also other simple policy reforms that do not require raising taxes or cutting benefits. In the recent past, both parties have supported policies that would save hundreds of billions of dollars in Medicare spending, including over $300 billion for the HI TF alone, fully covering the next decade’s funding shortfalls.

The debate around the HI TF’s coming insolvency can be helpful insofar as it compels Congress to control health-care spending; any fiscal prudence in Washington is worth encouraging. But Medicare’s true financing problem cannot be solved by focusing solely on accounting issues within Part A. Instead of relying on gimmicks and stopgaps that will do nothing to address the significant budgetary pressures the trustees warn about, we need commonsense policy changes that save money for the government and seniors alike.

Editor’s note: This article has been edited since its original publication.