In the recent vice presidential debate, moderator Martha Raddatz prefaced a question by declaring Medicare "bankrupt." Rep. Paul Ryan agreed, and Vice President Joe Biden grinned and shook his head. Unfortunately, the use of the term "bankrupt" in this context is both inappropriate and misleading.
It has special meaning in business and economics, where it describes how the assets of a struggling private sector company can be legally and rationally reorganized or sold. Medicare's future obligations are underfunded; "bankruptcy" does not describe its financial condition.
As with all government programs, Medicare's existence depends on continued public support and funding by Congress. That support will erode only if there is a better substitute; the leading proposed alternative is the Medicare privatization plan put forth by Ryan, which includes "premium support" in the form of vouchers to assist the elderly with their purchase of private insurance.
Why the Confusion about "Bankruptcy"? Medicare relies on three revenue sources — a monthly premium paid by the recipient, a payroll tax paid by all workers and revenue from the sale of bonds in the Medicare Trust Fund. Thirty years ago, President Ronald Reagan foresaw that the retirement of the baby boom generation would place considerable financial strain on Medicare. To relieve it, he raised the payroll tax rate to force boomers to save more for their future Medicare benefits.
The surplus revenue produced by this tax increase was used to purchase government bonds, which were stored in the Medicare Trust Fund. These bonds were scheduled to be cashed in as needed when the revenues generated by monthly premiums and the payroll taxes were insufficient to meet expenses. Although these bonds were scheduled to last until 2060, unforeseeable escalation of health care costs and slower-than-expected economic growth led to slower accumulation and faster sales of those bonds. It is this looming early depletion of bonds — perhaps as early as 2024 — that leads to cries of "bankruptcy."
The Economics. The choice of the nation's health insurance coverage for its older citizens is constrained by a number of economic realities. First, because of the increasing size of the elderly population, their health insurance will require increasing revenue, whether the insurer is public or private. This requirement of increased funding as costs rise is not a sign of "bankruptcy." To survive, any enterprise facing increased costs must increase its funding. In the case of Medicare, failure to increase revenue, leaving the program underfunded, is a choice.
Second, public plans enjoy a considerable cost advantage as a large purchaser of medical services and drugs. According to the Congressional Budget Office, Medicare has a 30 percent cost containment advantage over private plans.
Third, when comparing private sector substitutes to Medicare, it is necessary that they be held to the same standards; for example, they must provide universal coverage. For this to occur, new regulations will be required to constrain the tendency of insurers to use experience rating when setting premium levels. Experience rating is a natural outcome of market competition, generally accepted as fair, as in the case of car insurance where poor drivers are charged more because they are more likely to have larger claims. However, applying experience rating in pricing health insurance will result in higher premiums and denial of coverage for sick people, frustrating the goal of universal coverage.
The Choice. The presidential candidates are aware of these realities and have designed their plans accordingly. When determining premium levels, the Massachusetts plan (Romneycare) and the Affordable Care Act (Obamacare) replace experience rating with community rating, the practice of offering health insurance coverage in a given geographic region regardless of an individual's pre-existing health conditions. They also require everyone to buy into the system (the individual mandate).
Both plans adopted these features from a health care proposal designed and promoted by the Heritage Foundation, a conservative think tank. Under that plan design, or Ryan's more privatized plan, costs will have to be paid by some combination of individual payments, bond sales, and government subsidy. Whether we end up with a highly regulated private system or with the current Medicare system, more resources will be required.
We all want lower health insurance costs; some want smaller government at any cost. The proponents of privatization are selling it as a lower cost program, but there is no evidence that this will be the case. The notion that Medicare is "bankrupt" has become accepted "fact" through frequent repetition, but it distracts from meaningful discussion.
William L. Holahan is emeritus professor of economics at the University of Wisconsin-Milwaukee. Charles O. Kroncke, retired dean of the College of Business at UW-M, also recently retired from USF. They are co-authors of "Economics for Voters." They wrote this exclusively for the Tampa Bay Times.