The Medicare Monster, A cautionary tale-Part IIIby admin on 07/26/2016 7:03 AM
The deliberations about the cost of the hospital-insurance program make for a fascinating and almost comical story. Because it is hard to predict changes in medical technology and hospital costs, it was decided that the program could only be projected out 25 years, instead of the 75-year horizon that is used for Social Security projections. Even with this shorter time horizon, the projections turned out to be wildly inaccurate.
The most serious error the planners made was the assumption that hospital costs wouldn’t rise faster than wages. Hospital costs had been rising 2.7 percentage points a year faster than wages over the previous decade. But the House Ways and Means Committee said it was a “reasonable” and “conservative” assumption that the difference between the rates of increase for wages and hospital costs would disappear by 1975, after which wages and hospital costs would rise at the same rate. Obviously, if hospital costs rose faster than wages, there would have to be a sharp increase in either the payroll-tax rate or the wage base against which it was levied.
A 1965 House Ways and Means Committee report on the actuarial basis for the hospital-insurance program proudly declared that “Congress has very carefully considered the cost aspects of the proposed hospital insurance system” and that “Congress very strongly believes that the financing basis of the new hospital insurance program should be developed on a conservative basis.” The report acknowledged that hospital costs were rising faster than wages. But it dismissed the alternative scenarios that have turned out to be closer to what has in fact happened.
“It is inconceivable,” the committee report says, “that hospital prices would rise indefinitely at a rate faster than earnings because eventually individuals—even currently employed workers, let alone older persons—could not afford to go to a hospital under such cost circumstances….Quite obviously, it is an untenable assumption that there can be a sizable differential between the increase in hospitalization costs and the increase in earnings levels that will continue for a long period into the future.” This airtight logic didn’t consider the effect of the increased demand that Medicare set off.
Anticipating a 3.5-percent annual inflation rate, government actuaries predicted that the cost of a day’s hospital stay by 1985 would be $155 and that the hospital insurance portion of Medicare would cost $9 billion by 1990. The actual average cost of a hospital day by 1985 was over $600; instead of $9 billion, the hospital-insurance program cost $63 billion in 1990.
By the time Medicare passed the cost assumptions had been a subject of controversy for several years, especially with Ways and Means Chairman Mills. In a 1963 Ways and Means hearing, Mills clashed with the Social Security Administration’s chief actuary, Robert Myers, about the accuracy of cost estimates made for previous Medicare proposals. Mills pointed out that if any of the previous bills had been passed in the late 1950s or early 1960s, they would already be underfunded. A few excerpts from the transcript tell the story:
“The Chairman: I am concerned about your estimates of the cost of the present  program as I look back to see what happened to your estimates of cost with respect to these other programs….Isn’t it a fact that it would be about 100 percent underfunded today if we had enacted it in 1958 and provided exactly the tax then suggested as appropriate…?
“Mr. Myers: Mr. Chairman, I can’t answer that question exactly now. [A week later Myers submitted a memorandum to Mills concluding that the program would have been about 50-percent underfunded.]
“The Chairman: What would be the situation had we enacted the so-called Kennedy-Anderson program in 1960 and continued the payroll tax then suggested as being appropriate….l think today you would find it would be about one-third underfinanced.
“Mr. Myers: It is possible that that is right. [Myers’s subsequent memorandum confirmed Mills’s view on this second bill as well.]
“The Chairman: What do you do with hospital costs? Do they remain constant, or do you contemplate in your estimates an increase in those costs?
“Mr. Myers: The cost estimates really can be looked at in either of two ways.
“Either it is assumed that hospital costs will remain level in the same way that wages do, or that, if they rise, eventually wages will catch up with them….[A]lthough in the past, hospital costs have been rising faster than wages, it seems reasonable to me to assume that over the long run these two elements will move at about the same rate.
“The Chairman: What is there in the program to give us any assurance that hospital costs can be so contained that they will not continue to rise by 3 or 4 percent more rapidly than earnings levels in these future years?
“Mr. Myers: This, as you point out, is matter of judgment.”
Mills continued to press Myers on the subject, with a series of questions aimed at preventing Myers from wiggling out of the issue with bureaucratic equivocations. Myers finally had to admit that a doubling of the projected payroll tax rate was possible.
“Mr. Myers: My difficulty [with Mills’s scenario] is that if the increase continued indefinitely, hospital costs would pyramid so high that they would be eventually as much as the total of all wages [i.e., the wage base against which the payroll tax would be levied], but let me try to make an assumption that is a little more finite in this respect.
“The Chairman: All right.
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