Medicare’s funding future: income v. payroll taxes

(cross posted at freeforall)

The 2012 Medicare Trustees report is out (h/t @sarahkliff), and one graph jumped out at me: the historical and projected financing components of Medicare (payroll taxes, income taxes, premiums, and the much smaller items of taxes on benefits for higher income persons and state contributions for Part D).

Historically, payroll taxes have been the primary funding mechanism, but the further in the future we go, income taxes become increasingly important (general revenue transfers) for financing Medicare. As the report says on p. 25

The Trustees expect growth in SMI Part B and Part D premiums and general fund transfers to continue to outpace GDP growth and HI payroll tax growth in the future. This phenomenon occurs primarily because, under current law, SMI revenue increases at the same rate as expenditures, whereas HI revenue does not. Accordingly, as the HI sources of revenue become increasingly inadequate to cover HI costs, SMI revenues would represent a growing share of total Medicare revenues.

There are obviously many moving parts to such a projection, and there is great policy uncertainty about what we might do in the future. With that proviso I note two points:

  • Shifting more Medicare financing burden to income taxes is an increase in the use of a more progressive form of taxation (income taxes given current tax code) to fund Medicare
  • Payroll taxes and history of beneficiaries having paid payroll taxes have been a key part of the popularity of Medicare, and reinforced the (incorrect) notion that beneficiaries had pre-funded their Medicare costs (it is a pay as you go system). If income taxes are used to pay a larger portion of Medicare in the future, it may help to end the perception that beneficiaries already paid for the cost of their care. This post shows that payroll taxes by beneficiaries do not cover the cost of their care; they weren’t designed to do so, but the perception lingers to powerful effect that makes addressing the cost side of the program very hard

Author: Don Taylor

Don Taylor is an Associate Professor of Public Policy at Duke University, where his teaching and research focuses on health policy, with a focus on Medicare generally, and on hospice and palliative care, specifically. He increasingly works at the intersection of health policy and the federal budget. Past research topics have included health workforce and the economics of smoking. He began blogging in June 2009 and wrote columns on health reform for the Raleigh, (N.C.) News and Observer. He blogged at The Incidental Economist from March 2011 to March 2012. He is the author of a book, Balancing the Budget is a Progressive Priority that will be published by Springer in May 2012.

5 thoughts on “Medicare’s funding future: income v. payroll taxes”

  1. Don,

    I am sceptical that the shift to a different taxation source (which will go unnoticed and/or misunderstood by all but the most wonky recipients) will convince people that they haven’t pre-paid for their benefits.

    An interesting psychological experiment would be for the government to send out statements to all social security recipients and medicare enrollees telling them what they had paid in and what they had thus far taken out. SSA sends out such statements now, but only to future beneficiaries.

    1. @Keith Humphreys
      prolly right about folks becoming more willing to tolerate cuts as payroll taxes become smaller portion. The idea of sending here is your contributions and here is your receipts is an interesting one.

  2. For those not wonky enough to know, SMI is Supplemental Medical Insurance, that is, beneficiaries Part B and D premiums.

    1. @Dennis
      thanks. And key issue is that Part B premiums (doctor insurance), for example, are set at 25% of true cost, so isn’t capped in the same way that payroll taxes are….it can’t ‘go bust’ in the same accounting way that the Part A Hospital insurance trust fund can.

  3. I am sceptical that the shift to a different taxation source (which will go unnoticed and/or misunderstood by all but the most wonky recipients) will convince people that they haven’t pre-paid for their benefits.

    40% of the people don’t even know who the VP is…
    So yeah I am skeptical too:

    http://www.washingtonpost.com/blogs/the-fix/post/what-people-dont-know-about-the-supreme-court–in-one-chart/2012/04/18/gIQA5w6gQT_blog.html

    Regarding this:

    This post shows that payroll taxes by beneficiaries do not cover the cost of their care; they weren’t designed to do so, but the perception lingers to powerful effect that makes addressing the cost side of the program very hard

    Right now I am happy with people thinking they’ve “earned” their Medicare.
    Seems to me that makes that makes it harder to take it away from them.
    This may will be a self-serving misunderstanding that aids and abets where I want the culture to go.

    On the other hand I could be wrong: People knowing that Medicare isn’t paid for by contributions may cause them to understand that the whole system of having middle-men leeches (private insurers) is a Capitalistic boondoggle. A sort of corporate tax they really don’t need to pay. And I suppose that could push the population towards single-payer. I am not prepared to give the American population the benefit of that sort of self-serving calculation however…

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