Fixing Medicare

by Laurence J. Kotlikoff

There's a way to curb costs without giving people substandard care.
We're now spending $572 billion a year on Medicare and Medicaid. These programs are critically important to millions of Americans. But they're also driving our country into bankruptcy. We're already broke, if you consider future outlays as a liability and future tax receipts as an asset. Measured in present value as of this year, the gap between the two is an astronomical $51 trillion, and Medicare and Medicaid are responsible for a large portion of this total.

So our country has a choice. We can either radically restructure Medicare and Medicaid to limit their growth, or we can go the way of Argentina, Brazil and other fiscal malfeasants.

Or we can adopt an approach called the Medical Security System. We can't change the fact that 77 million baby boomers are moving inexorably from changing diapers to wearing them. And we've tried controlling growth by doing such things as capping the amounts doctors and hospitals receive and enrolling participants in health maintenance organizations. Yet real expenditures per recipient, now $6,000 a year, have grown roughly two and a half times faster than real wages over the last 25 years.

The problem lies in the fee-for-service structure under which Washington pretty much agrees to pay the fees for whatever medical services Medicare and Medicaid participants demand.

We should eliminate fee-for-service and introduce a voucher system. In the fall of each year the government would provide all Medicare and Medicaid participants with vouchers to purchase health insurance for the following calendar year. But unlike other voucher schemes, these vouchers would be individual-specific, with the amount based on the participant's medical condition. A perfectly healthy 85-year-old might get $8,000, whereas an 85-year-old with pancreatic cancer might get $75,000. These vouchers would be used to pay the insurance premiums for a year of coverage. If the cancer patient needed more than $75,000 in care, the insurance company would make up the difference. If he needed less, the insurance company would pocket the difference.

Because those in the worst medical shape would have the largest vouchers, insurance carriers would be as happy to sign them up as they would their healthy contemporaries. The key cost element is that the government could set total expenditures at an affordable level and then allocate this amount to participants such that those with the greatest medical need get the largest vouchers.

For example, the government could set a total medical expenditure budget so that spending per beneficiary grew only as fast as wages. This would slice roughly $17 trillion off the fiscal gap without any of the program participants feeling they'd been hurt. Indeed, they wouldn't be hurt. Their real medical benefits would continue to rise, just not as fast as in the past. And they could rest assured that their medical care system was solvent.

The government would, of course, have to collect up-to-date electronic records about participants' medical conditions. But doing so seems straightforward. And because the government would maintain this information, it would be kept confidential and be provided only to an insurance carrier from which a participant wanted to buy coverage.

All insurers who wished to enroll participants would provide a basic set of benefits, including prescription drug coverage. There would be little incentive for individuals to try to get their doctors to falsify their medical conditions, because it wouldn't provide them with any better insurance protection. But the insurers would be free to sell additional out-of-pocket coverage for additional premium payments.

Competition among insurers would ensure that participants got the best care per voucher or dollar spent. And the insurers would have an incentive to keep their customers from overusing the health care system, which would help restrain the growth in health care costs throughout the country.

No system is perfect. But this one is worth a try. It's our best hope to restore fiscal sanity.

Laurence J. Kotlikoff, Chairman of Boston University's Economics department and coauthor of The Coming Generational Storm