How Medicare and Medicaid Contribute to Budget Deficits

The steady rise of cumulative federal debt relative to the U.S. economy over the past half-century is a consequence of many decisions, some made by Congress and others by a succession of presidents from both parties. Tax cuts, benefit expansions, responses to financial crises, pandemics, natural disasters, and wars have all been factors. However, acknowledging these many varied contributors to the problem should not prevent the identification of Medicare and Medicaid as particularly important factors. Without their growth, the country’s fiscal challenge would be more manageable than it is, both today and in the future.

The severity of the fiscal challenge posed by these programs was not fully understood when the programs began. There were concerns about costs when President Johnson pressed Congress to approve Medicare and Medicaid in 1965 as part of his ambitious Great Society agenda, but what has occurred has been well beyond the warnings of even those who were the most skeptical about what was being set in motion.
Part of the problem has been a straight underestimation of the spending that would occur based on the provisions included in the original bill. The primary estimates used in 1965 to guide Medicare’s design came from Robert Myers, the long-time chief actuary of the Social Security program. In 1994, he acknowledged that the actual outgo from the Medicare Hospital Insurance (HI) trust fund in 1990 was, after making needed adjustments to ensure comparability, 165 percent higher than the forecast he submitted to the House authors of the original program. Medicare coverage increased the demand for services among the nation’s elderly far more quickly and dramatically than what was predicted, which in turn led the nation’s hospitals and physicians to provide more care to Medicare-eligible patients, and at higher prices, than what was assumed in the official forecast.

An even more important, and also more subtle, factor was the change in the federal government’s budgetary practices and norms that occurred when the programs were enacted and also shortly thereafter.

Up until 1965, there was an expectation that federal programs would be controlled either through the appropriations process, with Congress overseeing annual spending decisions, or through trust funds that would restrict what could be spent to the amounts raised from dedicated tax sources. Either way, there would be political barriers to paying for expenditures from borrowed funds.

In 1965, the primary model for spending authority outside of the annual appropriations process was the Social Security program. Social Security benefits are paid from a permanent appropriation tied to the amount of funding available from two trust funds (for retirement and disability, respectively). The only funds credited to the trust fund are those tied directly to payroll tax receipts (along with a smaller amount of income tax payments) and the investment returns on unspent reserves.

This accounting construct is supposed to ensure that, when considered over a number of years (or perhaps decades), Social Security does not add to total federal borrowing because its spending cannot exceed its dedicated tax receipts, at least not indefinitely. To date, that expectation has been met (although it is in doubt for the future).

Medicare was built upon the same budgetary construct but with a crucial distinction: one of its two trust funds, for Supplementary Medical Insurance (SMI), is partly financed from “general revenue,” not dedicated payments from taxpayers or program participants. In other words, the federal government sends funds to the SMI trust fund that could be obtained from borrowing instead of tax receipts. Indeed, the transfers from the general fund are calculated to ensure the SMI trust fund never becomes depleted.

Perhaps inevitably, once the availability of general funding was made automatic and contingent only on how much medical care costs, the political process and the health care system became ever more reliant on it to cover Medicare’s expenses. In 1970, the annual general fund transfer to SMI was the equivalent of 0.2 percent of GDP. By 2000, it had grown to 0.7 percent, and then, with the addition of the drug benefit to SMI in 2003, it reached 1.4 percent in 2010 and 1.7 percent in 2022. In the most recent Medicare trustees report, the program’s actuaries expect the general fund payment to Medicare to continue to rise relative to GDP and reach 2.8 percent in 2050 and 3.0 percent in 2075.

Medicaid also represented a new way of conducting government business. Along with a few other programs enacted in the same era, it was written as an entitlement program without a source of dedicated tax receipts or even a trust fund. All of its funding comes from the general fund of the Treasury, which in turn gets some funding from borrowing in public markets.

Medicaid is one of the largest of several “mandatory” programs that notionally require funding approval through the annual appropriations process but in practice, are governed by the legal entitlements to benefits their statutes provide to program participants. In other words, Congress can cut Medicaid spending but only by changing its benefit rules and not by imposing a cap on appropriated funds.

With funding that is not constrained by the reluctance of taxpayers to part with their personal resources, Medicare and Medicaid have been given fuel to continue growing on a nearly uninterrupted basis for a half-century. The combined cost of SMI’s annual general fund subsidy and total Medicaid expenses grew from 0.5 percent of GDP in 1970 to 4.1 percent in 2022 – a jump of 3.6 percentage points of GDP. This is a cost the federal government incurs every year. The growing combined expenditures of these programs is an important reason total federal debt grew from 27 percent of GDP to 97 percent over this same period.

It is not possible to secure a dramatic break with the budget practices that finance Medicare and Medicaid because the nation’s entire medical care system has been built up around them. It was also inevitable that the U.S. would devote more resources to health care one way or another (all advanced economies have during this era). The best that can be hoped for at this point is the adoption of reforms that ease the pressure for ever more federal borrowing, which most likely will come from bringing cost discipline to the entire system and not just to Medicare and Medicaid.

Mr. Capretta is a senior fellow at the American Enterprise Institute. He served as associate director for health programs at the Office of Management and Budget in 2003 when adding a Medicare drug benefit to SMI was recommended by the Bush administration and approved by Congress.