Starting in 2007, a new surcharge on upper-income retirees will require them to pay more for their Medicare Part B coverage based on their income as reported for federal tax purposes. Medicare Part B is the optional plan that pays for doctor bills and outpatient services, and requires a premium.
Adopted in the mammoth 2003 Medicare Act that created the Medicare Part D program covering prescription drugs, this new policy marks a first for this component of Medicare.
Due to the information tsunami concerning the Medicare drug program, this so-called “means-testing” provision has received almost no attention and is likely to surprise most of the Medicare enrollees who will be affected by it.
Most retirees know they pay a monthly premium for Medicare Part B. Currently, this premium is $88.50, and it is commonly deducted from the retiree’s monthly Social Security benefit.
Most recipients do not realize, however, that this premium covers only 25 percent of Medicare’s projected costs for doctors’ fees, ambulance charges, outpatient diagnostic procedures, and certain other expenses. The other 75 percent comes from general tax revenues. But starting in 2007, the 25-75 ratio will be altered for retirees whose “adjusted gross income” plus their “tax-free” interest income exceeds $80,000 ($160,000 for married couples).
The change is being phased in over three years and will apply to retirees according to their income.
For some time, a debate has simmered over whether taxpayers ought to shoulder 75 percent of Part B’s cost. As a group, Americans aged 65 and older have more disposable income and greater unencumbered wealth than Americans under 65.
Such generalizations, of course, gloss over considerable variations in both age groups, but a policy question has persisted about whether Medicare enrollees should pay more for Medicare Part B coverage based on their annual income.
Some enrollees effectively do pay more for their Medicare Part A coverage, because that program is funded by a payroll tax that is based on earnings from employment. Part A pays for hospital benefits and skilled nursing home care.
Given this situation, it is somewhat anomalous, some people have argued, that Medicare Part B makes no distinction among retirees on the basis of income or wealth.
Proposals to differentiate Medicare Part B premiums according to a retiree’s annual income are nothing new.
One was made during President George H.W. Bush’s administration and was subsequently incorporated into President Bill Clinton’s ill-fated “Health Security” proposal of 1993.
Variations on the theme were included in many of the alternative plans that appeared during the health care reform debate of 1993-94.
In fact, the concept of means-testing Medicare Part B was actually adopted, with somewhat different income thresholds and cost-sharing formulae, in the Balanced Budget Act of 1995 that Clinton vetoed–an act that precipitated the famous federal government “shutdown” of 1996.
Means-testing Medicare made another appearance in the version of the Balanced Budget Act of 1997 that passed the United States Senate, but the provision was eliminated in the conference committee that reconciled the House and Senate versions of that legislation.
Social Insurance or Welfare
Means-testing’s checkered history with Medicare Part B reflects some major philosophical divides in American politics.
Some politicians, especially House Democrats, opposed means-testing Medicare because they thought the concept contradicted the social insurance role they wanted Medicare to play. Democrats wanted everyone to be in the Medicare risk pool, and for the program’s benefits to be shared as broadly as possible.
Moreover, House Democrats opposed means-testing Medicare Part B because they were concerned that if it took on certain characteristics of a welfare program–e.g., fewer benefits (or higher costs) for persons with greater income–Medicare might become vulnerable to the sort of attack that federal welfare programs had endured in 1996.
Interestingly, House Republicans also opposed means-testing in Medicare Part B, but for a very different reason. They believed calibrating Medicare Part B premiums according to income was a back-door tax on retirees who had invested conscientiously throughout their working lives.
In other words, means-testing Medicare was just one more penalty on effort, or “success tax,” in their view.
Risk of Opt-Outs
Apart from these political assessments, the basic notion of means-testing a medical insurance program like Medicare Part B is somewhat problematic.
Most studies show that folks with higher incomes are generally healthier than folks with fewer financial resources at their disposal, and this relationship applies to retirees as well. Thus, the upper-income retirees who would be paying the most under a means-testing scheme are likely to be among those who receive the least direct benefit from the program.
Taken to the extreme, if upper-income enrollees are asked to pay the full cost of their coverage, some retirees might opt out of Medicare Part B and obtain private health insurance to cover the same services Medicare provides. Medicare Part B, after all, is a voluntary program, albeit one with heavily subsidized premiums.
Adverse Selection Problem
To the extent that high-income non-enrollees represent lower-than-average health care risks, Medicare Part B could face an adverse selection problem. That is, as lower-risk enrollees leave the program, Medicare Part B’s expenditures net of enrollee premiums would increase, and premiums going forward would necessarily rise.
In other words, means-testing Medicare Part B might actually boomerang and result in higher premiums being paid by the remaining, mainly lower-income enrollees, and higher costs borne by all taxpayers.
“Soaking the rich” in a voluntary health insurance program could thus become a singularly ineffective strategy.
The prospect of means-testing Medicare Part B runs into another problem relating to income distribution.
Among Americans 65 years and older, the majority have annual income of less than $35,000. So if means-testing Medicare Part B premiums is to have any noticeable impact on government expenditures, it must apply at a fairly low income threshold. But at a low income threshold, the plan is politically disastrous, because too many people would be directly affected.
Congress learned that lesson in 1988, when it imposed a broadly applicable income-based tax increase on older Americans to help finance Medicare. Enraged senior citizens literally attacked congressmen in their cars for enacting this additional tax, and they forced its complete repeal the following year.
On the other hand, if the income threshold is raised high enough to avoid a political backlash, the means-testing mechanism will affect relatively few older Americans and therefore bring in less revenue.
As a result, means-testing’s significance will be more symbolic than economic.
Financial Pain, Little Gain
Projected to reduce government expenses for Medicare by less than $2 billion per year when fully implemented, the mechanism for means-testing Part B will increase health care costs for some upper-income retirees by several thousand dollars annually.
As Medicare Part B premiums continue to rise over time, some affected retirees may find a private insurance plan more appealing. Choosing that alternative will be ill-advised in most cases, but even if few retirees abandon Medicare Part B, the new law creates fresh planning dilemmas and associated financial pain, all for relatively little government gain.
Richard L. Kaplan ([email protected]) is the Peer and Sarah Pedersen Professor of Law at the University of Illinois. This article is adapted from “Means-Testing Medicare: Retiree Pain for Little Governmental Gain,” which appeared in the May-June 2006 issue of The Journal of Retirement Planning. A longer version of this article is available online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=918100.