Hiding the costs of cutting

(Very long post. The take home point is that the Republican plan to modify/replace Medicare will result in massive increases in out-of-pocket expenses for beneficiaries, because private insurance is just straight-up indisputably more expensive than Medicare. In order to be able to cover these increased costs, each of us would have to start saving thousands of dollars a year starting today to make up the difference. So why not just pay more in Medicare taxes, the increase of which would be less than the amount we would have to set aside should Republicans get their way?)

In my previous post, I discussed that, since most voters don't know how the federal government spends money, Tea Partiers were able to get into office on a vague pledge to "cut spending", without ever being specific about what spending would be cut. After they got into office, besides some invectives hurled at budgetarily-trivial organizations like Planned Parenthood and NPR, their main budgetary proposal was Wisconsin Rep. Paul Ryan's "Path to Prosperity". Its main cost savings come from changing traditional Medicare into a system oddly enough quite similar to Obamacare. Instead of being a government-run, subsidized health insurer, Medicare would give seniors vouchers with which they could purchase private insurance on government-run exchanges, just like Obamacare. While it would decrease government expenditures on health care, it would increase health care expenditures overall and vastly increase costs for seniors. That means that current workers, who of course are tomorrow's seniors, would have to immediately start paying thousands of dollars a year in a hidden "tax" to make up for the supposed "savings" Republicans want to impose.

As currently constituted, Medicare offers subsidized insurance. The total cost of insurance is made up of both government subsidies and seniors' out-of-pocket expenses. The Republican plan, which all but 4 Congressional Republicans voted for, would not change anything for anyone already on Medicare or anyone 55 or above. That is, if you're 65 years old and get into Medicare before 2022, it doesn't change anything. According to the Congressional Budget Office (.pdf) and the Kaiser Family Foundation (.pdf), the average Medicare beneficiary, under current law, would get about $8,000 in subsidies in 2022 and have to pay about $6,200 out-of-pocket every year, for a total cost of about $14,000 a year.

Under the Republican plan, seniors would instead get a voucher for $8,000, the same as the government's cost in 2022 under current law, and purchase private insurance via a government-run exchange. The CBO estimates that a plan providing similar benefits to Medicare via a private insurer would cost a bit over $20,000 a year, or over $6,000 more than a traditional Medicare plan. This is because, with Medicare's bargaining power, they are able to pay lower reimbursement rates to doctors and hospitals. Because the federal government's contribution stays at $8,000, the out-of-pocket cost for a senior in 2022 would be over $6,000 higher than they would pay out-of-pocket with traditional Medicare.

The savings for the government come via limiting the rate at which the voucher's value increases over time, as well as by pushing back the age at which citizens qualify for the voucher (going from 65 in 2022 to 67 in 2033). Instead of the current system, where the government's cost increases in step with the rise of health care costs, the Republican plan would index increases in the govenment's cost to overall inflation, which historically is well below inflation in health care costs. This means that the percentage of seniors' health care costs which are paid by the government will decrease over time, as the voucher increases in value more slowly than health care costs go up. The CBO also projects that the difference in price between a traditional Medicare plan and a similar private plan will continue to increase over time. So people younger than 55 would get an even worse deal than today's 55 year olds.

So let's look at how much a 55 year old today would have to save in order to cover the increased costs in their retirement. All the calculations are my own, and I'd be happy to share more details if anyone cares:

-The Social Security Administration projects that a person who turns 65 in 2022 can expect to live 19 years.

-In order to pay $6,240 more out-of-pocket, per the Kaiser projection, for each of those 19 years (which is a very kind assumption, as the actual out-of-pocket cost will increase faster than inflation), assuming a 5% return on investment, would require a nest egg of $77,764 at age 65, which would be spent down to $0 over the next 19 years

-In order to have a nest egg of $77,764 by age 65, again assuming a 5% return on investment (which is also very kind and very close to the average 5.3% rate of increase of the Dow over the 20th century, given the current return on a 10 year government bond of about 2%), a current 55 year old would have to save just over $5,200 a year, or $100 a week, starting today to not lose ground.

-If you drop the expected rate of return on investment to 3%, which again relative to the 10 year T-bill is kind, a current 55 year old would have to save just over $7,000 a year, starting today, to not lose ground.

-When you consider that health care costs have increased by 4.9% in real terms over the past 4 decades, which means that health costs have gone up faster than the Dow increased in the 20th century (4.9% real is actually more than 5.3% nominal, which doesn't include inflation), it is likely that younger workers will get an even worse deal than current 55 year olds. They'll have more time to save up their nest egg, but in real terms they will have to save/deposit even more to make up the difference.

All of this boils down to the fact that Medicare, due to its massive, bordering-on-monopsony power to control reimbursement rates, is more effective at limiting costs than private insurance. If your goal is to limit health care costs for the government, the Republican plan is one way to go. But if your goal is to limit overall costs, which at the end of the day is what matters, then it's a big step in the wrong direction. Instead of paying thousands more a year into individual accounts to pay increased out-of-pocket costs in our retirement, we would be better off to pay more than we currently do into the Medicare system.

In the next post, we'll discuss why Republicans' claims that privatization will actually decrease costs, which seem to be largely based on their misinterpretation of the effects of Medicare Part D (Medicare prescription coverage), are flawed.