What If Technology Never Stops Improving? Medicare's Future Under Continuous Cost Increases

Washington and Lee Law Review, Fall 2003 by Pauly, Mark V

Voluntary premiums paid by or on behalf of beneficiaries will not finance the great bulk of this increased spending.33 Rather, about 90% of funding will come from compulsory taxes, either in the form of payroll (actually non-capital) income taxes for Part A or general revenue taxation for Part B.34 Although the Part A taxes are earmarked for hospitalization insurance, at the individual level (in contrast to Social Security) they bear no direct relationship to the benefits the individual would expect to collect.35 In the case of general revenue taxation, the disconnect is complete.

Economists argue in theory, and empirical research shows, that this disconnect has a cost. Because a person's tax burden rises in relation to the higher values of the tax base (more aggressively so if the tax is progressive), people have an incentive to make choices that reduce their share of the tax base.36 There is a whole panoply of distortions, ranging from excessive do-it-yourself repairing to sophisticated financial manipulations, that only occur because of the taxes on financial income that behavior can alter. Of course, if total tax collections are set in a budget, these distortions do not, in the aggregate, reduce taxes; rather, they add an additional cost to any funds collected through taxation.

Economists term this phenomenon the "excess burden" or "deadweight loss" of taxation.37 It is well documented that taxes do affect behavior, although the magnitudes are sometimes measured imprecisely. Measures of this excess burden (or "tax on taxes") are known to be positive and thought to be relatively large (if also imprecise).38

Not only is it more costly to raise funds for the public sector through compulsory taxation than through voluntary purchases in the private sector, but the excess burden per dollar of tax collected multiplies with the tax rate.39 A 1% increase in the tax rate costs much more at high overall tax rates than at low rates; therefore, the excess burden of a tax increase for something specific like new technology for Medicare beneficiaries depends on the mix of taxes Congress uses and the level of tax rates overall. Nevertheless, recent research suggests that the excess burden as a percentage of taxes collected in the United States with today's level of tax burden (which rose during the 1990s) is probably at least 30% and perhaps more.40

Although the research on the existence of the excess burden of taxes is definitive, research on what it should or does mean for tax-financed spending decisions is much more ambiguous. The common-sense intuition-if something costs more, it should be bought less-may still come through, but must this happen, and if it must, how will it happen? And if the excess burden cost per dollar of revenue collected rises over time as Medicare and Social Security tax rates rise, how would and should public spending respond to this ever-growing price?

IV. Financing New Medical Technology in Old Age

Although the significant intergenerational redistribution Medicare accomplishes somewhat attenuates its precision, the fundamental question is simple: How do or should people pay for what they want and need in their old age when one important component of consumption-medical care-will be increasing in both quality and cost? For private goods (retirement housing is a good example), the economically-motivated agent knows what to do: forecast the cost and consequent amount you want to spend after retirement, consume less and save more to accumulate funds for that expense, and then dissave and consume after you retire.