The health care elephant in the room: Medicare

If you want to read an article on the future of health care in America with a Hollywood ending, stop reading now because this isn't it.

Since we all know Medicare and its sibling Medicaid are financially precarious, perhaps we should fix these existing health care programs before launching any new ones.

Medicare is generally described as a social insurance program administered by the United States Government to provide health insurance coverage to people 65 and over. But it isn't really insurance, and here's why. Insurance is essentially protection against the lottery wheel of life: the cost of fire insurance on our homes is relatively low because only one in a 100 houses will burn down in any given number of years --odds which can be actuarially assessed.

But getting old and dying of some disease or illness is not something that only happens to a few unfortunates -- it happens to all of us. And with modern medicine's constant advances, there is almost always some test, treatment or procedure that can be administered to stem the disease or illness.
So Medicare is not insurance; it's akin to a community in which everyone's house burns down within about 20 years, and the costs of attempting to stave off the inevitable are rising three times faster than the overall economy, year in and year out.

Once we understand Medicare/Medicaid is not really insurance, then we can understand the system's fundamental problem. No matter what their wage level, marital status, or retirement date, a recipient will receive benefits that far exceed the taxes he or she paid into the system.

Let's run through some simple arithmetic. The average wage in the U.S. is about $40,000 a year. The Medicare tax is 2.9 percent --1.45 percent from employer and employee, and 2.9 percent for self-employed. Over 30 years (yes, some will work 40 years but others only 10 years, so let's take 30 as an average), that means the average wage earner (and his/her employer) will pay in about $36,000 in Medicare taxes.

The average benefits extracted from the system run from $393,000 to $525,000 (due to the benefits extended to non-working spouses, benefits for never-married people may be somewhat lower).

That means each of us who make it to 65 years of age -- which is the majority of us -- will take out 10 to 15 times more than we paid in. That is clearly a huge gap.

We can easily get lost in quibbling about details: What about all the unfortunates who lose their lives before reaching 65? Yes, in a cold actuarial sense, their contributions go to the survivors. But on the other hand, people who worked sporadically or part-time -- stay-at-home spouses, etc. -- will also be drawing full benefits even though they might have only paid in a fraction of our $36,000 average lifetime Medicare tax.

But Medicare/Medicaid is a "pay as you go" system, so there are several workers paying in for each retiree. True, but as the 60 million Baby Boomers start entering Medicare and structural issues in our economy sap long-term job prospects, this ratio is falling rapidly. Right now there are over 50 million people drawing Social Security benefits of one type or another, and about 130 million wage earners. So we should count on perhaps 2.5 workers paying Medicare taxes for each recipient.

If we multiply $36,000 by 2.5, we get $90,000--that's roughly the total amount paid in for each recipient. That's still only 20 to 25 percent of the average benefits paid out per retiree.

The Medicare recipient makes some co-pays: for most, it's about $100 a month plus another small sum for the drug plan. There's also about a $1,000 co-pay for a hospital stay, and various other fees. But over the course of 15 years-from 65 to 80 years of age-these co-pays add up to around $25,000.

Any way you slice it, the total taxes and co-pays paid into the system only add up to around $125,000-roughly a third to a fifth of expected benefits paid by the system.

We are talking about stupendous sums of money. The current tab for Medicare ($452 billion) and Medicaid ($290 billion) for this fiscal year is $742 billion--more than the entire Defense budget ($707 billion) including the cost of two hot wars and the Global War on Terror. Actuarially, Medicare grows by seven percent a year, decade after decade, even as the U.S. economy's long-term growth rate is about 2.5 percent.

This means the Medicare budgetary target is moving three times faster than wages, taxes or the economy as a whole. Previous attempts to limit costs have had little effect on this long-term growth rate.

If we are to close the gap between the Medicare taxes paid and the actual costs of the program, we have two choices: either raise the Medicare tax from three percent to 15 percent, roughly comparable to the total Social Security tax, or collect a 10% value-added tax (VAT) on everything from mints to Mercedes. Alternatively, we could choose to limit Medicare coverage to a population roughly 25 percent of the current beneficiary pool. One way to do this would be to raise the qualification age from 65 to 75 or perhaps even higher.

These are unpalatable choices to most Americans. Nobody wants to limit coverage or raise taxes. But without any substantive changes, the system's costs will soon exceed the Federal government's ability to borrow money from abroad to fund our $2 trillion per year deficit.

Before we legislate a complex multi-trillion dollar health care reform for everyone under 65, maybe we should address the looming crisis in Medicare/Medicaid first.

Charles Hugh Smith writes the Of Two Minds blog and is the author of numerous books, most recently Survival+: Structuring Prosperity for Yourself and the Nation.
Read Full Story