Philadelphia Reflections

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Why not Medical IRAs?

It's not big news that Medicare could run out of funds by the early 1990s. And government solutions are no revelation, either. They go from price-fixing capping payments at the hospital bed or at the stethoscope to making users pay more through higher deductibles or larger copayments. The only tired old scheme that hasn't been trotted out yet is to raise payroll tax beyond the increases scheduled.

There is talk, however, about one new and sensible solution: return a great potion of retirement medical insurance to the private sector. This majestic idea comes from a team gathered by the National Center for Policy Analysis, a Dallas-based think tank. Its benefits are many, its costs slight, and its chances not as bad as might be imagined.

Under the current system, Medicare is funded by a payroll tax equally divided between employer and employee. The Tax now totals 2.6%, with workers paying 1.3% on income up to $37,800. Rates are scheduled to rise to 2.9% of payroll in 1986, with another bump up to 5.08% by 1995.

That's a considerable tax bite revenues this year are estimated at $51.3 billion and it's not nearly enough. The problem, along with overgenerous benefits and the waste and inefficiency engendered by the payments system, is that Medicare funding borders on check-kiting.

The tax revenues go into a trust fund, sure, but most of the money goes right back out again to pay the bills for current beneficiaries. This pay-as-you-go arrangement makes for a peculiar kind of trust fund: The money doesn't stay put long enough to earn investment returns. What's more, since individuals don't accumulate their own discrete piles, they can't pass anything to their heirs if they die before "their" contributions are used up.

The National Center for Policy Analysis goes to the heart of that funding problem. The scheme, brainchild of economists John Goodman, Richard Rahn, George Musgrave, and Peter Ferrara, calls for the establishment of individual retirement accounts to cover medical expenses. In short, medical IRAs. Each year workers could contribute up to $500 tax-free. Workers with no taxable income could receive a refundable tax credit. The money would constitute an actual trust fund, thus throwing off investment returns that would, in turn, accumulate tax-free. And, of course, those who die without exhausting their funds could assign the money to their heirs.

Under the NCPA plan, people would have two options upon retirement: use their funds to purchase insurance from a private company or withdraw the money to pay for medical expenses as they arise. How much would a typical worker have on retirement? The NCPA team calculates that a worker entering the labor force at age 20 would have just under half a million at age 65 and over $500,00 by age 67. That's assuming an initial contribution of $464.10, with contributions thereafter (see chart, p. 72) rising apace with wages at 5% a year (the postwar historical rate) and 9% investment returns. The initial contribution of $464.10 is what workers now pay to Medicare on average.

The NCPA plan does leave room for the government to play a role, however, a most important one. A payroll tax would be retained to do what it should do now and doesn't provide coverage for catastrophic, or high costs illness. The government also would provide vouchers on retirement for workers electing to remain in the Medicare system. Even with this government role, the NCPA figures that Medicare expenditures would decrease and that the payroll tax could be lowered gradually.

There is, of course, a cost to this scheme. According to Peter Ferrara, if medical IRAs were used at twice the rate of regular IRAs, the tax revenue loss would be $12.5 billion in 1985. But that revenue drain, Ferrara says, would be gradually offset by lower Medicare bills as workers relied less on the Medicare system.

Now for the benefits. Privatization of retirement health insurance would create powerful incentives to hold down costs. Currently, a third party the government pays most of the bills. Thus, users have little reason to scrutinize, let alone constrain, their bills. Moreover, absent patients paying attention to costs, doctors and hospitals have no check on how many services they provide, or even on how necessary those services are. With both users and providers spending other people's money, waste and inefficiency are practically guaranteed.

Now consider the two options people would have on retirement with the NCPA's medical IRA plan. Under the self-insurance option, the incentives to avoid unnecessary surgery and seek low-cost treatment are straightforward. The money comes out of one's own pocket. Says NCPA President John Goodman: "This is a wild guess, but if people had the option of operation, you would see the number of medical procedures cut in half".

Under the purchased insurance option people would surely search for the insurance company offering the best deal. Since the best deals can be offered only by companies that are cost-effective, you can bet that insurance companies would be policing the providers of health care.

There are also more intangible benefits to the medical IRA idea. People would have control over their money. They could tailor their insurance coverage to fit their insurance needs. Substituting IRA funding for Medicare funding for also would boost savings.

Sounds good, but does it sound likely? Well, the American Medical Association, for one, is interested. While it doesn't want to see Medicare phased out entirely why sever the hand that feeds? it looked at the NCPA idea as a "promising long-term alternative." At its December 1984 meeting, the AMA House of Delegates called for a continuing evaluation of the proposal.

Other powerful groups, such as the Conference Board, Business Roundtable and Health Insurance Association of America, have yet to be heard from. But Willis Goldbeck of the Washington Business Group on Health says, "We've supported medical IRS+As privately and publicly, to no avail. Nonetheless, it's an idea that's going to grow."

And that brings us back to Washington. Goodman reports that the members of Congress he has talked with admit the proposal makes sense. But, he says, "The initiative will have to come from outside of Washington. When politicians see this idea mentioned in a publication like FORBES, they'll say, 'My God, it must be important.' Congress does not lead. It follows."

Originally published: Tuesday, November 13, 2018; most-recently modified: Wednesday, June 05, 2019