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Is Medicare a Ponzi Scheme?

Tuesday, October 25, 2011

Many retirees feel they have ‘paid’ for benefits through their payroll taxes. This is much closer to being true for Social Security than it is for Medicare.

Most Medicare recipients receive far more in benefits than they “pre-pay” through payroll taxes. Far too few Americans understand this simple truth, with the result that too many Americans think politicians have no business cutting “my Medicare.” Even though much vitriol of late has been directed at Social Security, Medicare is arguably far more of a Ponzi scheme than Social Security ever was.

The payroll taxes used to finance Part A Medicare benefits (hospital, nursing home, home health, and hospice care) don’t finance the rest of Medicare (physician and other outpatient services, pharmaceuticals, durable medical equipment, and preventive services). So over a lifetime, Medicare beneficiaries typically receive two to six dollars in benefits for every dollar they paid in Medicare payroll taxes (figure 5.6a).

Conover Figure 5.6a

In contrast, the various types of beneficiaries depicted in the above chart who turned 65 in 2010 had paid between 89 cents and $1.51 in Social Security payroll taxes during their working years for every dollar received in Social Security benefits. In that regard, Social Security is much more of an “earned” (meaning pre-paid) entitlement than is Medicare.

Leaving aside the intergenerational promise implicit in either entitlement, reducing future Social Security benefits is more akin to taking someone’s accumulated retirement savings than is an equivalent dollar reduction in expected Medicare benefits. This is not to argue that trimming future Social Security benefits—e.g., by adjusting the wage index used to determine downstream benefits—is illegitimate. It is simply to acknowledge that the visceral feeling many retirees or near-retirees have about Social Security—that they have “paid” for those benefits through their lifetime payroll tax contributions—is much closer to being true for Social Security than it is for Medicare.

Note that for those who started receiving Medicare in 1980, the situation was much worse. Because Medicare did not begin until 1966, beneficiaries had only made Medicare payroll tax contributions for at most 14 years rather than for a full working career (in contrast, the numbers for 2010 assume that beneficiaries contributed for 42 working years: from age 22 through 64).

Over a lifetime, Medicare beneficiaries typically receive two to six dollars in benefits for every dollar they paid in Medicare payroll taxes.

Readers may also be aware that until 1994, the 2.9 percent payroll tax levied for Part A was only applied to wage and salary income below a certain capped amount (the same maximum taxable earnings amount to which Social Security payroll taxes apply today: $106,800 in 2011). Today, there is no upper limit on the amount of earnings to which the Medicare payroll tax applies.

Moreover, under the Patient Protection and Affordable Care Act (PPACA), beginning in 2013, the 2.9 percent hospital insurance tax will continue to apply to the first $200,000 of income for individuals or $250,000 for couples filing jointly, but will rise to 3.8 percent on income in excess of these amounts.

However, none of these changes to “very high income” workers affects the figures on the chart. Why? For the purposes of the chart, “high wage” is defined as 160 percent of the average wage—$69,600 in 2011. That is well below the Social Security maximum earnings cap in 2011. Since even couples that include such high income workers are drawing twice as much in Medicare benefits as they are paying into the system (see bar farthest to the right), it’s clear that only very high income workers are actually able to self-finance their benefits through their payroll tax contributions.

Of greater concern, even accounting for the reductions in Medicare spending programmed into the PPACA, is that the ratio of lifetime benefits to lifetime payroll taxes will be nearly identical for 65-year-olds qualifying in 2030 as for those who began getting Medicare benefits in 2010. Thus, for most beneficiaries, the PPACA will help the country tread water, but has not significantly shrunk the fiscal imbalance.

So today and for the foreseeable future, the only group that self-finances their Medicare benefits are those who earned roughly three times the average wage—about $130,000 a year in 2011—throughout their working careers. This implies lifetime earnings over a 42-year career in excess of $5 million—a figure applicable only to a tiny fraction of the U.S. workforce.

Today and for the foreseeable future, the only group that self-finances their Medicare benefits are those who earned roughly three times the average wage throughout their working careers.

Ironically, only those who were already paying their own way will see their payroll tax contributions increased by one third under the PPACA. Unless we address Medicare reform head-on, everyone else will continue to enjoy benefits that greatly exceed their payroll tax contributions.

People can reasonably disagree about whether this tiny group already pays its “fair share” of taxes. But from the standpoint of Medicare as “insurance,” the outsized contributions of these highest-income earners relative to their expected benefits make as much sense as charging Warren Buffett more for his auto insurance merely because he has a greater ability to pay.

Moreover, as I’ve argued earlier, given the 44 cent penalty each additional federal tax dollar imposes on the economy, it makes no particular sense to be using tax dollars to pay for Warren Buffett’s Medicare bills in the first place. By the time he dies, he and his now-deceased wife jointly will have had in excess of $350,000 in expected lifetime Medicare benefits bankrolled by taxpayers. Even though he assuredly will have self-financed every penny, the economy will have lost $150,000 in output by running those dollars through the U.S. Treasury instead of letting Mr. Buffett pay for his own retiree medical expenses. There may be some unhinged Occupy Wall Street protesters who think that’s a smart idea. I do not. Serious Medicare reform is going to require a radical rethinking of the role of government in financing retiree health expenses.

Christopher J. Conover is a research scholar at Duke University’s Center for Health Policy and Inequalities Research and an adjunct scholar at the American Enterprise Institute. The charts shown are from his new book American Health Economy Illustrated, to be released in January 2012 by AEI Press. See PowerPoint version of Figure 5.6a and Excel spreadsheet on lifetime benefits and taxes for Medicare and Social Security from 1980-2030 for data, sources, and methods.

FURTHER READING: Conover also writes “Entitled to Leisure?” “Feeling Poorer? Healthcare Bears Some Blame,” “Government Share of Healthcare Is Far Bigger Than Advertised,” and “Health Is the Health of the State.” He also contributes regularly to the Enterprise Blog.

Image by Rob Green | Bergman Group

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