For more than a decade the federal government has borrowed to pay for the rising cost of Medicare. Debt-financing of Medicare will increase sharply as the population over 65 doubles from 2010 to 2030 and the number of beneficiaries over 85—with the greatest medical needs—triples.

The origins of debt-financed Medicare

President Lyndon Johnson and congressional leaders who created Medicare never intended to use debt to fund the program. The original 1965 legislation raised payroll taxes to finance Medicare Part A (hospitalization insurance) and set premiums for Medicare Part B (physicians’ fees and outpatient services) at a level covering half of its costs. President Johnson assured Ways and Means Committee Chairman Wilbur Mills that budget priorities could be arranged to make room for sufficient general revenues to fund the other half of the cost of Medicare Part B. Yet soon it became difficult to fit Medicare’s cost within a balanced budget. The decision to escalate military intervention in Vietnam produced a deficit.

Medicare was popular from the outset, but Congress was alarmed by costs that rose far faster than originally projected. Congress frequently enacted laws intended to restrain the growth in reimbursements to providers. Though Medicare’s costs for various services did rise at a slower rate than those of private insurers, the program’s cost continued to rise faster than national income and general revenues.

Until 2003 federal leaders never considered using debt to expand Medicare services. In 1988, for example, Congress and the Reagan administration raised taxes on high income seniors to pay for coverage of certain expensive drugs and longer hospital stays. Congress promptly repealed both the taxes and benefits when seniors rebelled against those taxes.

Congress was also willing to raise payroll taxes for Medicare hospitalization. In the early 1990s it raised the payroll tax rate and eliminated the ceiling on earned income subject to the tax. Premiums charged to beneficiaries for Medicare Part B could not be raised, however, without pricing the program out of the range that millions of seniors could afford. In the mid-1990s, Democrats proposed to balance the Medicare budget by limiting fees paid to physicians for services, while Republicans sought to contain the costs by transferring the program to managed care insurers and capping the annual per capita rise in premium subsidies.

In 1997 the leadership in both parties agreed to a plan that would eliminate borrowing for Medicare, principally by limiting the growth in the level of fees paid to physicians. That Medicare reform, along with increasing general revenues paid by taxpayers in the highest bracket, led to a federal budget that balanced in fiscal year 2000.

The balance turned out to be short-lived. In 2001 and 2003 Congress passed debt-financed reductions in income tax rates. And in 2003 it also suspended the application of ceilings on fees set in 1997. Later that year Congress used debt to finance a new Medicare prescription drug benefit and higher payments to Medicare managed care plans.

As a result, the portion of Medicare paid for with dedicated taxes dropped from 73 percent in 2000 to 53 percent in 2010, the year that the first of the Baby Boom generation became eligible for Medicare. Debt was used to fund that extra expense, since all incremental expenses were paid with borrowed funds. The decision to use debt to fund recurring Medicare expenses was scarcely debated, or even explicitly acknowledged. Annual reports by the Medicare Trustees chronicled the system’s increasing dependence on “general revenues,” but in fact all tax revenues had long since been exhausted. Debt filled the funding gap.

After the election of President Obama Democrats sought to find Medicare “savings” for the purpose of expanding other medical services rather than balancing the budget for Medicare. In order to offset the cost of expanded medical services for families with low incomes, they placed restrictions on reimbursement rates, provided incentives for more efficient delivery of medical care, raised the Medicare tax paid by taxpayers with high earned incomes, and applied Medicare taxation to gains from investment.

Republican House Budget Chairman Paul Ryan exemplifies his party’s ambivalence toward Medicare reform. He ran as the vice presidential candidate on a ticket in 2012 that attacked the Affordable Care Act’s limits on Medicare reimbursements. Yet before and after that election he incorporated those very cost-saving measures into his own budget plans.

Federal incumbents in both parties find it awkward to even talk about the practice of borrowing to pay for Medicare. Obviously an extra layer of interest on debt simply increases the program’s long term cost. But any attempt to highlight that issue naturally invites the question of whether to cut Medicare costs or raise tax revenue dedicated to the program. No mainstream politician seeks to cut benefits by almost half, down to the level that could be paid for by revenues from premiums and payroll taxes. Democrats condemn any increase in payroll taxation as “regressive,” while most congressional Republicans have signed a pledge to oppose any tax increase.

Members of Congress are reluctant to argue with constituents who sincerely believe that they have “paid for” Medicare with payroll taxes and premiums. Most find it more convenient to tiptoe around the minefield of Medicare financings. Even the well-intentioned National Commission on Fiscal Responsibility—“Simpson-Bowles”—found it easier to diagnose the problem than prescribe any specific treatment. In 2010, in an effort to reduce future deficits, they called on the president and Congress to make “substantial structural reforms” to prevent the cost of Medicare from growing at anything close to its historical rate.

The road towards tax-financed Medicare

The math of balancing the budget for Medicare is fairly straightforward. Congress would have to dedicate new revenues—or revenues from a budget otherwise in surplus—in order to maintain the current level of services. A tax rate could be adjusted annually to reflect rising costs, much like the annual adjustment in the ceiling on earned income subject to Social Security taxation. Trustees for Medicare, or some other empowered panel, would be charged with adjusting benefits and reimbursement rates so that annual outlays did not exceed estimated revenues. Or Congress itself could specify the source of savings.

“Pay as you go” Medicare is consistent with both conservative and progressive principles.
Traditional conservatives can hardly expect to limit the size of government by using debt to disguise its cost. Republican voters have long advocated a constitutional amendment to balance the budget, and no one can balance the budget as a whole without using taxes alone to pay for Medicare. Most conservative leaders today publicly applaud the Federal Reserve’s announced intention to allow interest rates to rise, and federal interest expense will soar when that occurs. The public choice between those two federal functions should make defense-oriented conservative leaders nervous. Financing Medicare with greater payroll taxation would satisfy a goal long favored by conservative tax reformers—a broad-based tax, free of deductions, with two simple rates.

Progressives have much at stake in adopting a more sustainable system of Medicare financing. Social insurance—using contributions from workers to fund greater financial security for older Americans—was originally a progressive idea. Debt-financed Medicare turns that concept upside down, by shifting current medical costs to an aging population with growing medical needs. And Democrats now recognized that rising interest expense on debt incurred after 2000 already threatens future funding of all domestic programs. It is inconsistent for progressives fight to preserve the future by advocating policies to improve education and reduce climate change while defending deficits that cast a long shadow over the future.

Medical reformers should welcome a balanced budget for Medicare. A more explicit trade-off between Medicare taxation and services should create greater urgency in dealing with the costs imposed by excessive specialization and testing, inefficient hospital pricing, and a payment system based on effort rather than results. The prospect of reforms in the delivery of services—“bending the cost curve”—is no excuse for adding an extra interest expense onto Medicare services.

Leaders in each party can agree on the principal of “pay as you go” Medicare without agreeing in advance to the ultimate balance between taxes and services. The ensuing debate will likely be heated, similar to the debate over Medicare in the mid-1990s or the 1983 debate over balancing the budget for Social Security. But, as in those earlier debates, the non-partisan power of budget math is likely to enhance the possibility of compromise.

Medical care for older Americans rests on moral pillars that transcend party lines. All religious traditions honor the preservation of life and the gift of healing others. And paying with taxes rather than debt preserves opportunities for the next generation. For decades after World War II, the parents of Baby Boomers made enormous sacrifices in order to balance budgets and avoid mortgaging their children’s future. Their grandchildren deserve that same respect.

Bill White

Bill White , chairman of Lazard Houston, is the author of America's Fiscal Constitution: Its Triumph and Collapse. He was the mayor of Houston from 2004 to 2010 and the U.S. deputy secretary of energy from 1993 to 1995.