Who Should Pay for Medicare?


"Dan Shaviro is that rare scholar who can blend legal and economic thinking in designing social reform. In this masterpiece of logic, he takes us outside the narrow debate over what we get and asks the fundamental question of who should pay for it. Only with approaches like Shaviro's are we ever going to face up to the types of Medicare—and broader health care—reforms that sooner or later we must undertake."—Eugene Steuerle, Urban Institute

"Sprightly, opinionated, and entertaining. This book attempts, with considerable success, to explain what the questions and issues are, both for overall efficiency and for the distribution of the burden of paying for the program. Shaviro is especially strong in his ability to capture in a few sentences what takes most policy analysts paragraphs of turgid prose."—Mark Pauly, The Wharton School of the University of Pennsylvania

See also:
"How Tax Cuts Feed the Beast," an op-ed by Daniel Shaviro

An excerpt from
Who Should Pay for Medicare?
Daniel Shaviro


Suppose a car dealer were to approach you and ask, "Would you like a new car?" If you were to answer the question literally, you would almost have to say yes. After all, there is bound to be something nice about having a new car.

You surely would realize, however, that the dealer was actually asking you something rather different: "Do you want to buy a new car from me?" Here, even if the dealer had the right car and could be talked into a reasonable price, it is possible that your answer would be no. It all depends on whether you happen to want a new car badly enough to be willing to pay the price.

Unfortunately, in the context of Washington politics, this elementary point, which every consumer understands, verges on being a revelation. We give deserving or politically powerful groups, and above all seniors, huge and costly benefits that they do not have to pay for, rationalized on the ground that the benefits are nice. We do not seriously ask whether the benefits are worth their cost, or whether it is fair to transfer wealth from the payers—and there always must be payers, even if we simply run up the federal debt rather than identifying them promptly—to the beneficiaries.

This book seeks to lend balance and perspective to the discussion of Medicare—already the second-largest government program, after Social Security, and potentially on a path toward becoming the largest. The question the book asks—who should pay for Medicare or, more precisely, for seniors' healthcare—could hardly be more timely. On November 25, 2003, Congress passed the biggest new entitlement in nearly forty years, since Medicare itself was enacted, by adding an unfunded prescription drug benefit to the program.

Should seniors get prescription drugs? Surely it's desirable that they, and also younger people, receive necessary healthcare without being wiped out financially. Should Medicare include a prescription drug benefit? Surely any well-designed healthcare program that spends more than $200 billion per year would carry such a benefit in its package, since prescription drugs are a vital part of modern medical treatment. But should we have added an unfunded benefit that is conservatively projected to cost $400 billion in the first ten years after enactment, and probably more than $1 trillion in the ten years after that? That is a very different question, just as in the case of the car dealer.

There are two big problems with passing such a benefit at this time in our history, even assuming for the moment that the benefit is otherwise well designed. The first problem is that it is Robin Hood in reverse, giving money to affluent seniors at the expense, in many cases, of poorer workers. It vastly increases the already huge wealth redistribution through our fiscal system from younger to older generations, in violation of the age-old covenant urging beneficence by each generation toward its children and grandchildren. We have passed, with scarcely any discussion of what we were doing, what Republican Senator Judd Gregg calls "the largest tax increase one generation has put on another generation in the history of this country," contrived simply to "get us through the next election."

The second big problem is that our current budgetary policy does not even remotely suggest how this benefit can be paid for. Annual budget deficits that already are projected to reach half a trillion dollars per year will only continue to grow as baby boomers retire, life expectancies rise, and expensive new wonder drugs (wonderful at least in their marketing) are discovered. Yet the George W. Bush administration, which gave us (through its control of Congress) the new prescription drug benefit, keeps on slashing taxes and raising government spending almost across the board without the slightest concern about our fiscal future. Democrats, meanwhile, complain that the new prescription drug benefit is not generous enough.

The design of the new prescription drug benefit almost ensures that it will soon be expanded. True insurance provides people with coverage against worst-case scenarios, such as having to pay a lot for healthcare when they become gravely ill. It does not offer first-dollar coverage of routine expenses; this would merely encourage waste and be a handout to anyone who received the coverage without having to pay for it. But true insurance is not politically popular, because if you lose your insurance "bet" by not actually having a catastrophe that would trigger its coverage, you may complain, after the fact, that you didn't get anything out of it.

So the prescription drug benefit has been given, in common with preexisting Medicare, a partly upside-down insurance structure whereby, after paying a $250 deductible, enrollees without other prescription drug coverage get the following government payments:

—75 percent coverage for the first $2,000 (above the deductible) that they spend on covered prescription drugs,
—no coverage for the next $2,850 that they spend, and
—95 percent of everything they spend beyond that.

The last of these three coverage brackets admittedly is true insurance. But the first really is not, and once it has been granted the second stands out like a sore thumb, already dubbed the "donut hole" by Washington insiders. You can bet that efforts to eliminate it and offer at least 75 percent coverage throughout will commence immediately.

Some seniors have begun to complain that the new benefit is stingy. Implicit in this complaint is the expectation that, whenever seniors face financial difficulty, they will receive a well-deserved handout. This expectation is encouraged both by the genuine financial and medical challenges that many of them face and by decades of political pandering to seniors, both affluent and needy. So the expansion of this benefit is already beginning to seem like water running downhill.

Now, perhaps the handout is well deserved, although so would be handouts to needy younger people who will be helping to pay for the benefits. Lots of us, perhaps all of us, would like more than we can realistically have without unfairly depriving others. But Medicare should not be thought of as a handout. The real point of Medicare is to provide universal health insurance coverage at a certain stage in life. And, like any insurance system, it must have enough funds coming in to pay for the benefits that it metes out.

The recent budget policies of the president and Congress, including enactment of the prescription drug benefit in its current form, are so irresponsible that they verge on fiscal treason. If we do not change course, these policies are highly likely to cause, within ten to fifteen years, a fiscal meltdown like those that have recently plagued nations such as Brazil and Argentina, complete with hyperinflation, rising unemployment, and recurrent bank failures. We like to think that our economy is too strong for this to happen, but if our policies are foolish enough for long enough, it can and will happen.

Recent estimates of the fiscal gap—that is, the amount, in today's dollars, by which we fall short of being able to meet our future commitments—range from $44 trillion to $74 trillion. To get a sense of what this means, suppose that the U.S. Treasury tried today to sell from $44 trillion to $74 trillion worth of bonds on world capital markets, while cheerfully announcing that taxes should still be cut and that no significant government spending cuts were imminent. The main difference between this and our actual present situation is simply that, as things stand, the bond markets haven't fully caught on yet to the fact that this is where we are headed, or else are hoping against hope (and against the evidence) that grown-ups will soon take the helm.

Can we grow out of the fiscal gap if the economy takes off again? Unfortunately, no. Social Security and Medicare, which together are responsible for more than 100 percent of the fiscal gap (since everything else is roughly in long-term budgetary balance), are both effectively pegged to the size of the economy. The bigger it gets, the bigger they get. So, while economic growth is certainly something to hope for, it does not actually make the fiscal gap go away. Indeed, the opposite happens. At some point, the fiscal gap is likely to start choking off economic growth, by requiring tax increases on current workers so as to keep the benefits to seniors flowing. This will reduce our already low national saving rate, possibly making it negative, and make the prospects for vigorous economic growth a lot dimmer than they would otherwise be.

What can we do to stave off the misfortunes toward which our political leaders, in response to the evident demands of our voters, are leading us? In this book, I offer both recommendations and a more pessimistic set of predictions. The former include tax increases and such changes to Medicare as reduced coverage of routine expenditures and greater use of income-related charges to enrollees. The latter include price controls and increased queuing, which would make Medicare a second-class program, and a real possibility of Weimar Germany–style hyperinflation. One big difference between the recommendations and the predictions has to do with timing. Current seniors ought to share the burden with younger generations, which requires acting sooner rather than later, but our distorted politics makes it unlikely that they will.

More important than my specific recommendations and predictions is the way of looking at Medicare and other government programs that I suggest. A public economics perspective, rooted in the understanding that there is no free lunch, that every distributional winner implies a distributional loser, and that incentives matter, is hardly novel in the academy, but it has been too little heard in public policy debate. If nothing else, I hope to do my bit, through this book, to improve our political discourse and thus help to create the preconditions for a more rational policy. Even seniors and ardent "social insurance" advocates—whose sympathies, in many respects, I share—will, I hope, get the message that the time for being fair and responsible without grave disruption of our political and economic life is rapidly growing short.


Copyright notice: Excerpt from pages ix-xii of Who Should Pay for Medicare? by Daniel Shaviro, published by the University of Chicago Press. ©2004 by the University of Chicago. All rights reserved. This text may be used and shared in accordance with the fair-use provisions of U.S. copyright law, and it may be archived and redistributed in electronic form, provided that this entire notice, including copyright information, is carried and provided that the University of Chicago Press is notified and no fee is charged for access. Archiving, redistribution, or republication of this text on other terms, in any medium, requires the consent of the University of Chicago Press.

Daniel Shaviro
Who Should Pay for Medicare?
©2004, 184 pages
Cloth $25.00 ISBN: 0-226-75076-0

For information on purchasing the book—from bookstores or here online—please go to the webpage for Who Should Pay for Medicare?.

See also: