THE BEST WAY TO FIX MEDICARE

When the trustees of the Medicare trust fund released their annual report in April, the Republican leaders in Congress were shocked–shocked!–to learn that the fund is projected to run out of money in 2002, just seven years from now. This reaction was odd. The trustees issue a report every year, and never before has any leading politician, Republican or Democrat, expressed so much panic. This year’s report actually showed an improvement over last year’s, which projected that the trust fund would go bust in 2001. Yet House Speaker Newt Gingrich and other Republicans suddenly declared with one voice that immediate steps were necessary to “save Medicare.”

The reason, of course, was spin. The Republicans are planning deep cuts from projected Medicare spending as part of the effort to balance the budget. And the amount they’re hoping to squeeze out of Medicare–$270 billion over seven years–is embarrassingly close to the amount–$245 billion–they’re planning in tax cuts, mainly for the affluent. Naturally, they would prefer to portray their Medicare cuts as an effort to “save Medicare.” But $270 billion is double what would be needed just to stabilize the trust fund.

President Clinton’s own version of a balanced budget calls for $128 billion of Medicare savings in the first seven years. So there is now bipartisan agreement that Medicare will be trimmed. The only questions are how much to trim and how to do it.

The next move is up to the Republicans, who are expected to unveil the details of their plan sometime after Labor Day. Senate majority leader Bob Dole says the reform has to be “done” by Sept. 22. That leaves three weeks for the public to assess and debate the most radical change in the system since its creation in 1965. (Republicans last year criticized the Clinton Administration for producing in secret a health-care reform plan that was publicly debated for 10 months.) To meet Dole’s schedule, we will all have to be marvels of a well-informed citizenry. The propaganda coming from both Republicans and Democrats so far hasn’t helped.

The first thing to get straight is this business about a “trust fund.” It is an accounting myth. Like the trust fund for Social Security, the Medicare fund is “invested” in special government securities that are not counted as part of the national debt. Medicare’s income and outlays are figured into each year’s budget as if the trust fund didn’t exist. Thus, as the government figures it, each dollar pruned from Medicare magically does double duty: it both saves a dollar for the trust fund and reduces the current year’s deficit by a dollar. Furthermore, like the Social Security trust fund, the Medicare fund receives money from one group of people (current workers) and pays out to a different group (retirees). And, like Social Security, Medicare pays current beneficiaries far more than they ever put in.

The trust fund covers only half of Medicare: hospitalization insurance, known as Part A. It is financed by a payroll tax-currently 2.9%, split equally between employee and employer. Part B, for doctor bills, is voluntary, but such a good deal that nearly everyone eligible signs up. Beneficiaries pay a premium–currently $46.10 a month–but this covers only 29% of the cost. The rest comes from general funds. In all, Medicare covers 37 million Americans (33 million senior citizens and 4 million disabled people) at a projected cost this year of $181 billion.

So is there a crisis? The “trust fund” panic is just political stagecraft. But Medicare does need to be substantially overhauled, for two reasons.

The first is the total cost, which is rising at a pace that is unsustainable: 10% a year right now; even faster in 15 years or so when the baby-boom generation starts to reach retirement and decrepitude. There is simply no way that the current system can continue indefinitely. Although there is nothing magic about the years 1995 or 2002, the sooner reforms are made, the less drastic they will have to be.

The second reason for reform is that even now Medicare is too big a part of the federal budget to ignore. It is more than 10% of all federal spending, ranking behind only defense, Social Security and interest on the debt. If we want to balance the budget without a major tax increase, Medicare can not be sacrosanct. Moreover, it shouldn’t be sacrosanct. Medicare is a program that takes money from working Americans–either through the special Medicare tax or through general taxes or through future payments on the national debt–and pays it to retirees. Many of these retirees are poorer than the average worker, but many are not. All are getting a far better deal from Medicare than today’s workers will get when they retire, even if the inevitable reforms could be avoided, since current retirees were paying into the system during years when it cost far less.

Practically and morally, therefore, Medicare should take a large hit. There is no scientific answer to the question, How large? But the hit that the G.O.P. has in mind–which would reduce projected Medicare spending 23% in 2002, the year the budget is supposed to be balanced–is not unreasonable.

As the Republicans point out when anyone accuses them of courage in proposing such deep Medicare cuts, their proposal would still allow Medicare spending to rise; they merely want to slow the rate of growth, from 10% a year to 6.4%. American politicians of both parties love to declare a terrible crisis, then unveil a painless solution. But it is dishonest to suggest that slowing the growth of Medicare more than a third will not involve real cuts in benefits. Medicare is not projected to increase 10% a year because “Washington” is expanding the program. It is growing because the population is getting older. That means more people are entitled to benefits, and the average beneficiary, being older, has more health problems. It is growing because health-care costs in general are increasing. And it is growing because wonderful but expensive new weapons are constantly being added to the medical arsenal.

Thus there are basically only three ways to extract the necessary billions out of Medicare. One is to make Medicare beneficiaries pay more. Another is to reduce the quality and/or quantity of care that Medicare delivers. And the third is to deliver the same services more efficiently. Naturally, everyone prefers the third option. But no serious person believes that efficiency alone can produce the necessary savings. And even efficiency is not a free lunch. The fat in the current health-care financing system, both public and private, helps to support teaching hospitals, medical research and health care for people without insurance. Squeezing out the fat means squeezing out these indirect subsidies. It also will involve disconcerting changes for Medicare beneficiaries.

Among the various proposals out there for reforming Medicare, one is strikingly absent. Nobody is suggesting that Medicare should be turned into block grants for the states, as many are proposing for other federal programs, including Medicaid, the health-care system for the poor. Apparently, the vaunted superiority of state governments–their magical ability to find solutions that elude Washington–is not to be trusted when a popular federal program is at stake.

Of the proposals that actually are under discussion, some are variations on what might be called “the King Canute solution”: just order the tide of Medicare spending to stop. The King Canute solution comes in large and small sizes. The large version is a cap on total Medicare spending. But a cap is not a plan; it is merely an aspiration. It puts off the inevitable decisions about how exactly the spending tide is to be stopped, and at whose expense.

The small-size King Canute solution is the one most often resorted to in past attempts to restrain Medicare costs: ever tighter restrictions on payments to doctors, hospitals and so on. There is nothing wrong with squeezing health-care suppliers; Medicare has been a gold mine for them, and the government–as the nation’s largest purchaser of health care–has the right and duty to get the best deal it can. But past efforts have been ham-handed and may have reached their limits. And without a market mechanism at work, it is impossible to say whether a provider is charging too much, not enough or just the right amount.

The most direct way to save money on Medicare is by slicing benefits. One simple approach would be to raise the qualifying age. The case for this (as with Social Security) is that life expectancy has increased since the program started, and therefore 65 is no longer as old as it used to be. The case against it is that cutting benefits in this particular way takes most from those who happen to die earlier–disproportionately, blacks and the poor–after paying into the system all their working lives. They are already losers in both the game of life and the game of Medicare. Why penalize them further?

The other direct way to make Medicare less costly for the government is to make it more costly for the participants. The Part B premium, for example, was originally intended to finance half the cost of the health care it provides. But now it covers less than a third. Raising the premium, at least for better-off beneficiaries, seems fair enough. The seniors lobby is geared up to label any such change a “tax increase on the elderly,” which is unfair, since it is actually a reduction in the subsidy they are receiving. (It is fitting revenge, though, on the conservatives who now propose it, since they have been quick to label many a similar subsidy reduction as a “tax increase” in the past.)

But squeezing the necessary billions directly out of seniors has its limits, besides the obvious political ones. Even now, Medicare covers only about 45% of health-care spending of the elderly. Premiums, co-payments, deductibles and noncovered items like prescription drugs cost the average senior $2,750 a year. And this doesn’t even include the enormous expense of long-term nursing-home care. In fact, despite the government’s projected $181 billion cost for Medicare this year, seniors today spend more, in real terms, on health care annually than they did before Medicare started in 1965. Most important, shifting the cost of health care from one pocket to another–from the government to seniors themselves–doesn’t address the central problem, which is the rising cost of health care generally. That is why serious Medicare reform must involve constraining costs in the best way anyone has yet discovered: through market forces.

The problem is that Adam Smith’s invisible hand doesn’t work well in the medical marketplace for several reasons, not all of which are easy to change. First, most people are insured, making them fairly indifferent to the cost or necessity of individual health-care purchases. Second, most people don’t even buy their own insurance. They get it–heavily subsidized–from their employers or the government. This isolates them even further from the economic consequences of their health-care decisions. Third, most health-care purchasing decisions (to consult a specialist, to take a drug, to have an operation) are made by the doctor–who isn’t paying in any event–not by the consumer-patient. Fourth, buying health care is not like buying a cantaloupe: it is hard for any lay person to know which purchases make sense and at what cost. Fifth, even intelligent, well-informed people will never be tough shoppers when their health is at stake. Who is going to bargain with a brain surgeon?

During the era that health-care providers understandably remember as the Golden Age, circa 1965 through 1985, all these factors operated at full force to isolate American medicine from financial reality. Medicare and Medicaid added millions of paying customers, and in the meantime, neither the government nor private insurers put up much resistance to rising prices. By now, though, the private sector has wised up. Almost two-thirds of privately insured Americans are under so-called managed care: 20% in health-maintenance organizations, which provide all or most medical services under one roof, and 44% in preferred-provider organizations, which negotiate prices in advance with certain doctors and hospitals. Although adherents fiercely debate their relative merits, the principle of HMOS and PPOS is the same: controlling costs by having the insurer “manage”–that is, limit–the consumer’s choices.

Medicare is rapidly becoming the last bastion of traditional “fee-for-service” insurance, in which you are free to choose any doctor you want and have any treatment he or she recommends. And even Medicare is experimenting with managed care. For more than a decade, enrollees have had the option of joining an HMO, if one is available in their area. Some 9% are currently signed up. Medicare usually pays the HMO a premium equal to 95% of its average per person costs in the area, adjusted for a few factors like age and sex. Nevertheless, Medicare loses money on the deal. Why? The main reason is that these are people who cost the system less than 95% of the average. Healthier people tend to be the ones who sign up with HMOS.

It is too late to argue that it would be unfair to “railroad” Medicare patients into managed care against their will. Most of us are already in managed care, and few of us had any choice about it: our employers put us there. Managed care can be excellent or terrible–it can achieve its savings by efficiency or by skimping on quality–but for almost everybody it is inevitable. The only question is how we get there.

The preferred route of many–including the American Medical Association, the conservative Heritage Foundation, the moderate-liberal Progressive Policy Institute and (according to heavily dropped hints) the Republican congressional leadership–is so-called managed competition. Managed care is a type of health insurance; managed competition is a system for choosing among types of health insurance, including managed care.

In its purest form, managed competition would replace Medicare with a voucher good for the purchase of the health insurance of your choice. The government would lightly supervise the available choices. You could choose an HMO, a PPO, traditional fee-for-service medicine or whatever. If your choice cost more than the value of the voucher, you would pay the difference. If it cost less, you might get a rebate. Competition to sign you up is supposed to restrain prices and guarantee quality. The health-care system for federal employees works roughly like this, and it works well. Last year premiums actually went down.

There is irony in Republicans’ and conservative groups’ pushing managed competition as the free-market solution to Medicare, since it is more or less exactly what President Clinton proposed last year as a general health-care reform, which these same voices denounced as “socialized medicine.” And their specific objection was precisely that the arrangement would drive people into managed care.

Speaker Gingrich has promised that any Medicare reform will merely expand the options available to seniors and will not force them against their will into new arrangements like managed care. Whether that promise is kept depends, of course, on the cash value of the vouchers. Will it be enough to buy private insurance equal to today’s Medicare benefits?

The seniors lobby is understandably skeptical on this point. Once the government’s guarantee is defined as a certain amount of money rather than a certain set of benefits, that amount becomes subject to adjustment. Even if the payment starts off fully adequate, it can be allowed to drift down in value as health costs escalate.

Certainly it is hard to see how a voucher system can save Medicare much money unless it pushes people, subtly or otherwise, away from fee-for-service and into managed care (or gets them to pay for the difference out of their own pockets). Leaked reports about the Republican plan for Medicare say that it might impose caps on Medicare’s annual cost, and that if costs exceed the caps, the difference would be taken out of the government’s payments for fee-for-service insurance only. That is one way to drive people into managed care.

In the coming Medicare debate, beware of the word choice. It can mean two different things. One is freedom to choose your own doctor and services. The other is freedom to choose among different medical plans. Managed competition expands the second type of choice, but by inevitably tilting that choice toward managed care, it reduces the first type of choice. On the other hand, beware of excessive moaning from the seniors lobby about loss of choice. As the private sector has discovered, reducing that choice is the one sure way of bringing costs under control.

The other tricky issue about vouchers is that the cost of private insurance naturally will vary depending on a person’s age, health condition and so on. The current Medicare system actually performs two functions. One is subsidizing seniors’ health care. The other is “risk pooling”: spreading costs evenly among the healthy and the sick, the old and the very old. With vouchers, who will perform that second function?

Under the Heritage Foundation proposal, the government’s annual payment would vary based on age and sex but not medical condition; Medicare-qualified insurance plans, though, would be forbidden to discriminate against sicker people. This puts much of the burden of risk pooling on private insurers. There would be a tremendous incentive for insurers to “cherry pick”–to try to sign up healthier people–as is happening in a small way now with Medicare’s HMO option. Even without purposeful discrimination, healthier people will naturally drift toward the cheaper, less elaborate plans, making them cheaper still–not because of greater efficiency but because of what is known as “adverse selection.” The consequence? To avoid punishing sick people–simply for being sick–will require far more government regulation than free-market enthusiasts for managed competition care to admit.

Managed competition and managed care are not the only ways to bring free-market discipline into Medicare. In fact, by retaining the basic principle of insurance, they preserve health care as a salad bar where you can eat as much as you want at no extra cost. The Cato Institute, a libertarian think tank, wants to go further: arrange it so that people pay for most normal medical expenses out of their own pockets. Cato would gradually increase Medicare’s deductibles and copayments–currently $716 for the first 60 days of a hospital stay, and $100 a year plus 20% of doctors’ bills and outpatient services–until the first several thousand dollars of seniors’ health-care expenses each year would be uninsured. (“If necessary,” Cato says grudgingly, there could be a subsidy for lower-income elderly folk.) In essence, this would convert Medicare into an insurance program for very large, “catastrophic” health-care expenses only. The theory is that people will watch every penny when they are paying the bills themselves.

The theory is undoubtedly correct. But there are problems too. As mentioned, there are limits on people’s ability and inclination to be rational consumers when it comes to health care. Furthermore, the worst health-care inflation is occurring in big-ticket items, such as major surgery, which cost more than the annual out-of-pocket threshold. The big savings to the government would come not from any triumph of market-based efficiency but simply from making seniors pay more of the cost. And the government would lose some of that money again if, as proposed, people are encouraged to set up tax-free “Medisave” accounts to pay for the annual out-of-pocket expenses.

President Clinton argued last year that you can’t reform Medicare without reforming the whole health-care system. That is partly right and partly wrong. It’s true that the real problem is the rising cost of health care in general, not Medicare per se. But Medicare is now behind the rest of the health-care system in health-cost management innovation. And Medicare, as the country’s largest single health-care financing system by far, can and ought to lead the way in finding solutions (since general reform appears out of the question for now).

No one seriously believes that $270 billion can be pruned from Medicare through efficiency alone. If that–or anything close to it–is the goal, it will require reforms from all the categories discussed above. It is fair to ask seniors who can afford it to pay a bit more for what will remain a very sweet deal. It makes sense to move seniors into managed care, along with the rest of the country, and managed competition is the least coercive and most efficient way to do that–provided the politicians are honest about what is going on. And it is worth trying to make people more sensitive to the real cost of the health care they consume.

The seniors lobby is worried that if Medicare is turned into a cash payment or voucher, it will become indistinguishable from food stamps. It will be seen more like a welfare program, and people may start to wonder why we are financing gold-plated health-insurance welfare for the elderly, many of whom don’t need it, when we do nothing for 41 million Americans–mostly workers and their families–who have no health insurance at all. The worry is reasonable. But so is the question.