Medicare’s Supplementary Medical Insurance Fund: A Growing Burden On Taxpayers

The two trust funds tracking Medicare income and outgo—for Hospital Insurance (HI) and Supplementary Medical Insurance (SMI)—are supposed to help policy makers see and address financial problems before they escalate into more difficult challenges. However, because Congress designed SMI so that, unlike HI, it can never become insolvent, the construct is weak. The risk now is that Medicare spending is pushing the federal government toward a debt crisis, which in turn may lead to abrupt and indiscriminate cuts in program benefits and other vital programs.

Indeed, Medicare’s trust funds as currently constituted are so flawed that they could be impeding, rather than facilitating, sensible reforms. As has been the case for several years, the 2022 Medicare trustees report, just released by the administration, will generate understandable concerns about the projected depletion of HI reserves. While solving that problem is necessary, it is far from sufficient, as HI finances less than half of Medicare’s annual expenditures. An excessive focus on HI may lead policy makers to assume that SMI spending requires no changes because projections show its trust fund with a positive balance well into the future.

With Medicare now in its second half century, it should not be surprising that many aspects of its original design need updating and modernization, including the framework used to enforce financial discipline across generations. Reform should ensure total Medicare expenditures are matched with sources of funding that do not presume ever-increasing levels of federal debt.

Origins Of The Dual Trust Funds

When Congress approved Medicare in 1965, Social Security served as a partial template. The basic idea was to append a new publicly run health insurance plan to the cash benefits provided to the elderly and disabled through the Old Age and Survivors Insurance and Disability Insurance programs. As with Social Security, Congress opted to use trust funds to align Medicare’s outgo with income over time; a projection spanning 75 years can provide early warning of impending problems.

There was one important difference with Social Security, however; not all of Medicare’s expenses would be financed from payroll taxes collected from current workers and their employers and held in a single trust fund. Instead, Congress created two trust funds for Medicare, only one of which—for HI, or part A—conforms to the Social Security model, with revenue from payroll taxes on current workers. The other, for SMI, which pays for parts B and D of the program, gets its revenue from premiums paid by current beneficiaries, and, importantly, from the Treasury’s general fund as needed to fully finance all spending. Consequently, the SMI cannot become insolvent, while the HI can.

The use of two trust funds to finance Medicare is a reflection of the political and market dynamics of the 1960s. At that time, the dominant insurers were the Blues plans, with “cross” policies identified historically with hospital expenses and “shield” versions with physician care. Congress wanted to mirror what many Americans were experiencing in the private market.

There was another political consideration, too; organized physician groups were suspicious of an expanded government role in financing medical care. A separate Medicare trust fund dedicated to non-hospital care, with funding that was reserved for physician services and other ambulatory care and was partially subsidized out of general funds, was a factor in securing the profession’s support.

The Hospital Insurance Trust Fund Shortfall

The 2022 Medicare trustees report, released on June 2nd, provides updates projections of the pace of depletion of HI reserves.

The new projections are likely to be viewed in Congress with some relief because HI insolvency is modestly delayed. In the 2021 report, the trustees estimated that HI would run through its reserves in 2026, after which its annual obligations would exceed incoming revenue on a permanent basis. Over 75 years, the trustees projected HI had a deficit of $4.9 trillion, measured in present value terms. In this year’s forecast, HI will deplete its reserves in 2028, and its shortfall over 75 years is projected to remain as it was in last year’s forecast — $4.9 trillion.

Perpetual SMI Solvency

The SMI trust fund faces no such shortfall because, as described above, it can be fully financed from general funds as needed. Thus, the same 2022 report that tags HI with a multitrillion dollar deficit shows SMI with steady reserves over the next 75 years even though it accounts for about 60 percent of total program spending.

And yet the Treasury’s contributions to SMI are not costless; they expand the government’s annual budget deficits, and thus also add to federal debt. The general fund works as a catch-all for government tax receipts, borrowed money, and spending. Taxes dedicated to specific purposes come into the general account and then are credited to the separate ledgers tracking those activities; spending is assigned in a similar fashion. When total federal spending exceeds revenue, as it does today and will for many years in the future, the deficit is covered with borrowing. Consequently, when the general fund makes its required payments to SMI, the money comes either from existing, non-dedicated taxes (such as individual and corporate income taxes) or from amounts lent to the government by creditors. Because money is fungible, assuming that SMI has first call on income taxes only means that other necessary federal activities must be financed with more debt.

None of this would matter if the amounts involved were trivial, but that is not the case with SMI. The 2022 trustees’ report estimates the general fund contribution to SMI would be $413.9 billion in 2022 and $6.0 trillion over the period 2022 to 2031, reaching the equivalent of about 30 percent of all individual and corporate income tax receipts at the end of 75 years.

Congress hoped beneficiary premiums would serve as a check on SMI cost growth because rapid inflation would fuel political complaints. Initially, the premiums were set to cover half of program expenses. As costs soared in the program’s early years, Congress backed off the policy and allowed premiums to grow more slowly than part B spending. Eventually, a new benchmark was set, with beneficiary contributions covering 25 percent of program costs. When the prescription drug benefit was created in 2003, it also was financed with a 25/75 split between beneficiary premiums and general fund contributions.

With the general fund covering most of the added costs, SMI spending has risen rapidly even as beneficiaries pay more too. In 2022, the standard beneficiary part B premium is $170.10, which is $21.60, or 15 percent, above what it was in 2021 (there is a separate premium for part D coverage, which varies by the plan selected; the base premium is $33 in 2022). Since 2000, the nominal value of the Part B premium has gone up at an average annual rate of 6.4 percent, more than 4.0 percentage points faster than the general inflation rate.

General fund support for SMI is now one of the most consequential line items in the entire federal budget, as shown in exhibit 1. Shortly after enactment, in 1970, it totaled 0.2 percent of gross domestic product (GDP). By 2020, it was 2.0 percent of GDP. The trustees estimate it will reach 2.8 percent by 2050.

Exhibit 1: General fund payments to the supplementary medical insurance trust fund as a percentage of GDP

Source: 2022 Medicare Trustees’ Report (Expanded and Supplementary Tables and Figures).

Medicare And Federal Debt

Spending on Medicare, along with Social Security and Medicaid, is central to the nation’s fiscal challenge. All three have rising obligations tied to population aging, and spending on Medicare and Medicaid is also sensitive to the cost pressures unique to the health sector. Together, their combined spending has become the dominant force in fiscal matters over the past half century. In 1970, the combined federal expenditure on them was equal to just 3.7 percent of GDP; by 2020, it had reached 11.7 percent, with Medicare growth jumping 3.8 percentage points of GDP during that period (exhibit 2).

The Congressional Budget Office (CBO) expects the pressure to intensify over the next three decades as the full baby boom generation moves out of the workforce and into retirement. By 2050, Medicare spending will have reached 7.3 percent of GDP, or 5.2 percentage points of GDP above the level of spending in 2000. The combined spending on the big entitlement programs (now including the Children’s Health Insurance Program and Affordable Care Act subsidies) will reach 16.5 percent of GDP in 2050.

Exhibit 2: Gross Medicare spending and total federal debt as a percentage of GDP

Source: Congressional Budget Office (Historical Tables and The 2021 Long-Term Budget Outlook).

While federal revenue has risen and fallen over the years, it has never reached a level that would support the spending that is now occurring, and which will only grow in the future. CBO’s projections assume tax receipts will be determined by the requirements of current law and reach a maximum of 19.1 percent of GDP, even as total federal spending (driven by Medicare and other entitlement commitments, along with interest payments on debt) will rise to more than 30 percent of GDP by 2052. Consequently, in the agency’s long-term forecast, deficits soar, as does cumulative federal debt, which would exceed 175 percent of GDP by 2050 (exhibit 2). It is unlikely the federal government could borrow such sums without causing serious damage to the broader economy.

Ignoring The Medicare Trigger

In 2003, Congress, with Republicans in the majority, was concerned about the growing burden SMI’s general fund payments were creating for taxpayers. To compensate, it created a “trigger” tied to the percentage of total program spending covered by general revenue payments to the trust funds. When the Medicare trustees determine in consecutive annual reports that general revenue will exceed 45 percent of program costs in the current year, or during one or more of the subsequent six years, then the president and Congress are required to develop, and consider under expedited procedures, legislative amendments to eliminate the breach.

The scheme has not worked as planned. One problem is that the law creating the trigger, which was focused on standing up the prescription drug benefit, was passed mainly by Republicans, which means the trigger was never embraced by Democrats as a legitimate modification to the program. Indeed, there has been strong objection to the trigger among Democrats from the first years of its implementation.

Furthermore, presidents of both parties have balked at being told by Congress to develop a remedy for consideration in the legislative process; administration lawyers have consistently argued that this requirement is unconstitutional. Consequently, although the trustees have determined that the threshold has been breached fairly regularly since 2006 (and every year since 2018, including in the 2022 report), only President George W. Bush, in 2008, submitted a plan to bring the general revenue share back below the 45 percent threshold.

Sustaining All Of Medicare

Medicare’s two-part insurance and trust fund design may have made sense in the mid-1960s, but it no longer does. Modern coverage is not bifurcated in this way, and imposing stricter financial control over facility spending than clinician and outpatient services can distort the policy-making process, and thus also patient care.

Congress should enact reforms to prevent a near-term HI crisis, but it needs to go much further, too. Its primary focus should be on modernizing the program and creating a system of financing that is reliable and sustainable (modernizing the benefit by creating a single plan of coverage is long overdue too). If a trust fund is still the preferred tool for spending discipline, then its tap on the general fund must be strictly limited. For instance, these payments could be tied to growth in the economy irrespective of how fast Medicare spending escalates.

Trust funds are accounting devices that assist policy makers in the financial management of important federal activities. They are always imperfect. Medicare’s trust funds have proven to be particularly defective. Most of Medicare now appears fully solvent even as program spending pushes the entire federal government ever closer to a debt crisis. The coming discussion of HI’s shortfall offers an occasion for revisiting, and fixing, this flawed construct.

Author’s Note

Capretta serves on the advisory board of the National Institute for Health Care Management, which is a forum for the executives of Blue Cross/Blue Shield insurers to discuss major policy questions. He also serves as a senior adviser to the Bipartisan Policy Center and on the policy advisory board of Free the Facts, which sponsors campus educational programs on the nation’s long-term fiscal challenges.