Overview. Medicare was created in 1965 with a social contract: workers would contribute to a trust fund to pay for basic health care for the elderly, with an understanding that when they turn 65, the next generation of workers will help pay for their care. This arrangement has worked successfully in the 20th century, with demonstrated improvements in health and security of the nationís elderly.

However, the 21st century brings new challenges. Like Social Security, Medicare enrollment will double between 1999 (39 million) and 2032 (78 million) as the baby boom generation retires. Not only will there be more elderly in the future, but the elderly will live up to 6 years longer on average by the middle of the next century. Compounding the demographic challenges are the unique factors that affect health spending – changing disease patterns, technological advances, and a high value placed on health. As a result, health spending growth has historically exceeded that of general inflation. These trends are expected to continue into the next century. Private health spending growth per person is projected to be 7.3 percent between 1999 and 2007 – more than twice as high as general inflation.

In addition to its demographic and financial challenges, Medicare approaches the next century without a basic tool needed to improve quality of care and the health of its beneficiaries: prescription drugs. Coverage of medications is absolutely essential to preventing, treating, and curing diseases. Its potential is even greater as advances in genetics and molecular biology translate into pharmaceutical therapies.

1.  Extending the Life of the Medicare Trust Fund

Policy: This plan includes the Presidentís commitment to dedicate part of the surplus to strengthen the Medicare trust fund and, indirectly, buy down the publicly held debt. The planís contribution to solvency (in combination with Part A savings) would be $328.5 billion over 10 years, which has the effect of extending the life of the Trust Fund through 2027. For the amount that is being transferred from the surplus, the Treasury would buy down debt and then convey to the Medicare Trust Fund special purpose bonds (above and beyond the amount called for under current law). Legally binding procedures – a Medicare "Lock Box" – would prevent the government from using these funds for any other purpose. These bonds would guarantee that Medicare will get the benefits that result from the fiscal improvement that debt reduction and lower net interest costs. By reducing debt held by the public, the framework would dramatically reduce the amount of net interest that the government would have to pay to service debt in the future. This reduction in net interest costs will help free up the resources to allow the government to meet its existing Social Security and Medicare commitments.

Background/rationale: The President has an unparalleled record of strengthening and improving Medicare. When he took office, the Medicare Hospital Insurance (HI) Trust Fund was projected to be bankrupt this year – 1999. Today, the Trust Fund is projected to be solvent through 2015 and Medicare spending growth rate per beneficiary is below that of private health spending.

However, Medicareís HI Trust Fund will become insolvent about 20 years earlier than Social Security and shortly after the baby boom generation starts to retire. Even with reforms that substantially slow cost growth, the revenues coming to the Medicare Trust Fund will not support the doubling of the number of beneficiaries that will occur by 2035. For these reasons, the President has proposed a framework for dedicating part of the surplus to Medicare.

As described earlier, sheer demographic changes alone will require that new financing be found for Medicare. Dedicating part of the surplus to the Medicare is both fair and forward-thinking. The unprecedented budget surplus was in part created by the actions and policies of the baby boom generation. Reductions in Medicare spending alone contributed to 40 percent of the overall spending declines resulting from the BBA. Additionally, the baby boom generation has spearheaded advances in technology and productivity that have contributed to increased economic growth and revenue. As such, dedicating part of the surplus to Medicare to prepare for their retirement is a fair approach to averting the fiscal crisis that would occur otherwise. It also prevents future generations from having their taxes raised to support their parents.

Dedicating part of the surplus for Medicare solvency not only assures the financial health of the Trust Fund through at least 2027 (in combination with the reform proposalís savings), but it will also reduce the need for future excessive cuts and radical restructuring that would be inevitable in the absence of these resources.

2.  Responsibly Financing the New Prescription Drug Benefit

Policy: This plan would use $45.5 billion over 10 years in funds from the amount of the surplus dedicated to strengthening Medicare ($374 billion over 10 years, $794 billion over 15 years) to help finance the new prescription drug benefit. This amount would remain in general revenues since this is a source of financing for the SMI Trust Fund, from which this benefit would be run.

Background/rationale: The new drug benefit would cost about $118 billion over 10 years. It would be fully financed, mostly by savings from competition and efficiency. About 60 percent of the $118 billion Federal cost of the new Medicare prescription drug benefit would be offset through these savings.

A small portion of the cost of the drug benefit would be offset by $45.5 billion over 10 years from the surplus. There is a strong rationale for using part of the surplus dedicated to Medicare for the prescription drug benefit. The 15 percent allocated from the surplus to Medicare is now higher than it was when the President made this commitment in January. The higher projections of the surplus in part result from lower Medicare spending under current law.

Policy experts advising the Congress (MedPAC, CBO, and the Medicare Trustees) have consistently stated their belief that much of the recent decline in Medicare spending beyond initial projections is due to our success in combating fraud and waste. Reinvesting the savings that can be reasonably attributed to our anti-fraud and waste activities into a new prescription drug benefit is completely consistent with the past actions of the Congress and the Administration utilizing such savings for programmatic improvements. This means that the plan could both achieve solvency through 2027 and help offset the costs of the new drug benefit. The amount going to the drug benefit is about one-eighth of the entire amount of the surplus committed to Medicare (and less than 2 percent of the entire surplus) and represents only about 40 percent of the 10-year total Federal benefit costs.

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