The Magazine

The Train Wreck Ahead

Medicare is rolling toward disaster, and there is no easy way to fix it.

Jun 16, 2008, Vol. 13, No. 38 • By JAMES C. CAPRETTA
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Boiling Medicare's financial predicament down to its mathematical essence--per capita spending rising faster, perpetually, than the program's revenue base--may add to the despair of some. Is it even reasonable to think such a long-standing trend can be reversed? But there really is no other choice. It should be self-evident that the country cannot afford a Medicare entitlement that outpaces the economy forever. Shouldn't Congress get on with fixing the problem?

In the past, opponents of Medicare reform have argued, effectively, that it would be unfair to penalize Medicare enrollees with a reform of Medicare alone. To these critics, Medicare is just one of many railcars hooked onto a runaway cost train. The solution is therefore not Medicare reform but a concerted effort, led by the government, to implement reforms that will improve efficiency and eliminate low value services for everyone buying insurance and services, including employers.

This is the kind of thinking behind the health care plan of the Democratic presidential candidate. Senator Barack Obama has not offered any substantive reform for Medicare beyond perfunctory calls to cut payments to private insurers and impose price controls on prescription drugs. Rather, he supports a laundry list of measures that he asserts will solve the cost problem for employers and public programs alike: more and better health information technology, new efforts to coordinate care for those with chronic illnesses, and better prevention.

These efforts, which most Republicans also support, may, in fact, modestly ease cost pressures, but they do not come close to solving the problem of costs rising faster than income. And there is certainly no expectation that they would narrow Medicare's financing gap in any significant way. With plans for massive new spending on insurance subsidies, the Democratic candidate, if he won, would have little choice but to turn to the kinds of cost controls his party favors (but does not advertise) anyway: caps on premium increases each year, enforced with price controls governing private and public payments for services. The end result is predictable: deterioration in the quality of care, fewer suppliers of services, and waiting lists.

The irony is that the federal government has been trying to slow Medicare spending with tighter payment regulations for nearly three decades, with almost no success. So even if one were to assume that price controls in the private sector might cut costs, it is hard to see how the government could make further headway on Medicare spending using price controls given their already extensive, and ineffective, use by program administrators.

A heavily governmental approach to cost control can and should be rejected simply for the damage it would do to the quality of health care services provided to patients. But it should also be rejected because it is based on a flawed understanding of what lies beneath today's cost pressures. Most notably, it fails to account for the role of Medicare's current design in the rapid escalation of costs in American health care.

In an important 2006 study, Amy Finkelstein, an economics professor at the Massachusetts Institute of Technology, demonstrated that the creation of Medicare in the mid-1960s triggered an explosion in the health care infrastructure in regions with previously low levels of insurance enrollment among seniors. Hospitals were built, and physicians and others opened up offices to provide newly enrolled Medicare beneficiaries with a much improved level of service. This was, of course, all to the good, as the primary purpose of Medicare was to improve the quantity and quality of health care services provided to seniors. But, four decades later, with cost escalation now the cause of so much financial distress for families and governments, policy-makers must also understand that expansive insurance is the fuel for expensive care and rising costs.

Medicare is not solely to blame. Employer-provided insurance also expanded rapidly in the postwar era. And demand for more and better health care naturally grows with increasing wealth and higher incomes. But Medicare is a large part of the cost problem. In her paper, Finkelstein offered the rough estimate that about half of the real cost increase in health care spending in the United States from 1950 to 1990 can be attributed to the spread of Medicare and other expansive third-party insurance.