Fiscal Policy

Medicare’s Trust Fund Is Not Worth Much

(Mohammed Haneefa Nizamudeen/Getty Images)
Lawmakers use Medicare's trust fund to kick the can down the road on entitlement reform.

In 2020, the federal government for the first time spent more on Medicare than on national defense. Absent legislative reform, Medicare funding as a share of GDP is projected to increase by another 50 percent over the next 20 years.

Medicare’s trustees recently surprised nobody by projecting that the program’s trust fund will run out of money within five years. Most observers have rolled their eyes at the news, accepting that Medicare’s costs are out of control and no one is willing to address the looming insolvency. In recent decades, Congress has repeatedly acted to rein in Medicare costs. But this has typically been motivated by broader fiscal considerations and the desire to use resources for other purposes. The trust-fund device by itself achieves little other than legitimizing regressive tax increases that otherwise would not be possible.

Medicare’s “trust fund” is an accounting convention established by Congress in 1965 to ensure that payroll-tax revenues cover the expected cost of Medicare Part A (which pays for hospitalizations) over the long term. Medicare Parts B (which pays for outpatient and physician services) and D (which covers prescription drugs) are funded out of general revenues, such as income taxes.

When Medicare was first introduced, it paid hospitals according to the costs they incurred in delivering care to beneficiaries — which caused the program’s expenses in its first year of operation to exceed its anticipated level by more than three times. To make up the shortfall, Congress voted to increase the basic Medicare tax gradually from 0.35 percent to 2.90 percent of payroll. Nonetheless, in 1982 federal actuaries predicted that the trust fund would be depleted within five years, and the following year Congress and the Reagan administration agreed to fix reimbursement rates for hospital procedures. Since then, trust-fund accounting has appeared to offer a way of forcing Congress to address the program’s constantly rising cost.

But this misinterprets the politics of entitlement reform. Cuts to Medicare have typically happened because the program uses a lot of money that both parties would prefer to use for other things.

Throughout the 1980s, bipartisan legislation repeatedly cut Medicare hospital payments to reduce the deficit and finance expansions of Medicaid. For similar reasons, Congress later fixed physician fees, even though these reduced Part B costs and did nothing to improve the solvency of the Part A trust fund. The two most recent improvements to the Medicare trust fund’s solvency were similarly incidental: The 2010 Affordable Care Act raised the Medicare payroll tax and cut Medicare payments to hospitals in return for increasing their Medicaid revenues, while the 2011 Budget Control Act’s cuts to Medicare were just a small element of a larger sequester that hit Parts A and B equally.

The Balanced Budget Act of 1997 had the largest impact — extending the projected solvency of Medicare’s Trust Fund from 2001 to 2030. Yet this was also the product of general fiscal concerns, and cut Parts A and B similarly. Leading House Democrat Henry Waxman protested that “the only reason that deep cuts were made in the Medicare program” was “to satisfy the Republicans who wanted the tax cut and the Clinton administration that wanted to say they passed legislation” to get the “balanced budget issue off the table.” Indeed, trust-fund solvency concerns did nothing to stop the cuts being partially rolled back in 1999 and 2000, as economic growth created an unanticipated budget surplus.

Although the rising cost of Medicare is a big problem, trust-fund solvency is largely beside the point. From 1980 to 2020, the share of Medicare spending accounted for by Part A has slumped from 69 percent to 38 percent. Over the next 30 years, Medicare’s trustees predict that the costs of Medicare Part B will increase by more than three times those of Part A.

The lack of concern for trust-fund solvency is clear from contemporary politics. Congressional Democrats are currently trying to add a dental benefit to Medicare Part B, which would cost $60 billion more per year when fully phased in. They are hoping to fund it by cuts to payments for prescription drugs under Part D, which would do nothing to improve the solvency of Medicare’s trust fund.

So, what purpose does the trust fund serve?

Initially, the direct link with Medicare Part A benefits helped to justify a regressive payroll-tax increase, which otherwise would have been highly unpopular, and that remains the case today. In 2019, Americans with incomes below the median paid more than three times as much in payroll taxes as they did in property and income taxes combined.

The main effect of an insistence on the principle of trust-fund balance is therefore to place the most popular potential tax cut beyond policy-makers’ consideration.

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