The politics and realities of Medicare

Public Interest, Summer, 2004 by Eric Cohen

How Medicare works

To understand the implications of the new Medicare bill and the political disagreements surrounding it, one needs to understand how Medicare works as a whole. This is no easy task, but a few salient points are worth noting.

First, Medicare is primarily a federally funded, third-party payer, fee-for-service program. In other words, when seniors get sick, they go to the doctor and the government pays most of the bill. Beneficiaries pay some premiums: an $876 deductible for major hospital visits under Part A; $66.60 per month, a $100 annual deductible, and 20 percent co-payments for most outpatient treatment under Part B. But the value of the government subsidies rises the more care one uses. Seniors who participate in traditional Medicare (roughly 88 percent) have the freedom to see any doctor who will see them. This is generally wonderful for beneficiaries: They have access to all the care they desire. But it is problematic for society as a whole, since there are limited incentives for seniors to cut their own health-care costs, and there is limited room within the heavily regulated system for private insurers to improve efficiency by creating health-care networks or tailoring services to individual needs. This economic problem will only get worse, many believe, as expensive new medical technologies become available, as the percentage of the national population on Medicare increases, and as the average age of Medicare beneficiaries rises and their health deteriorates.

Second, Medicare is a major part of the "hidden subsidy" and "price control" system that now shapes American health care. The government sets the prices by fiat for all the medical services covered under Medicare--with different physician groups lobbying constantly for increases to the reimbursement rate for their own specialties, and the government trying constantly to keep up with ongoing changes in the nature of medical care. This system allows government to exert some control over Medicare costs--though reimbursement cuts in the past have often resulted in reduced access to care, reduced quality of care, or increased billing for a larger volume of services. And of course, government doesn't get the prices right. This means the system only works because those services that are over-reimbursed subsidize those services that are under-reimbursed--for example, over-payment for cancer drugs subsidizes under-payment for cancer treatment. This system of cross-subsidizing exists both within Medicare and between Medicare and private-sector health insurance.

Third, Medicare's system of government-controlled pricing also shapes how patients are treated, and not always for the better. In some cases, people seek not the best or cheapest treatments for a given condition but those treatments that are covered by Medicare. In other cases, avoiding inexpensive but uncovered therapies leads to expensive but covered emergencies in the future. As Joseph Antos, an analyst for the American Enterprise Institute (AEI), explains about cancer therapy: "There is widespread agreement that Medicare overpaid for Part B drugs, although oncologists argued that those overpayments helped compensate for the extra costs of administering the drugs and caring for patients that were not reflected in fees paid by Medicare for office visits." The problem is that when the federal government reduced payments for cancer drugs, as it did in MMA, there was "a shift of patients out of the doctor's office and back to the inpatient hospital care, which reduces patient satisfaction and could increase federal outlays."