Medicare and "present value"

by reader coberly

Andrew Biggs wrote that current Medicare recipients have not paid enough for the benefits they will recieve. He states that “since this is zero sum, it means that future taxpayers will get less than they pay for.” Here is an excerpt of what he said, followed by my comments.

Biggs said:

unlike Social Security benefits, which increase only to keep up with inflation, Medicare benefits grow in real terms. The Medicare Trustees project that health costs will grow around 1 percentage point faster than the growth of per capita GDP, which in turn they project will grow around 1.3 percent faster than inflation over the next 15 years. So I assume that real Medicare benefits will increase by 2.3 percent each year.

to make taxes and benefits comparable, I convert each to present value terms, assuming a real interest rate of 3 percent. This means that taxes paid in the past have 3 percent interest added each year, to account for the fact that these taxes could otherwise have been invested. Likewise, future benefits have 3 percent annual interest deducted, to account for the fact that retirees must wait to receive them.

So what do we get? This typical person paid around $64,971 in Medicare payroll taxes over his lifetime. Likewise, after netting out Medicare premiums, he’ll receive around $173,886 in lifetime Medicare benefits. The net? He can expect to receive around $108,915 more in benefits than he paid in taxes over his lifetime.

Alternately, let’s put this in terms of return on investment: the typical worker’s Medicare taxes produce an annual compound return of around 6.25 percent above inflation. This is comparable to the return on stocks, without any of the risk. A low-income worker with earnings at half the average wage would receive an 8.45 percent return on his Medicare taxes, while even a high earner at twice the average wage would receive a 4 percent real return—again, without any market=2 0risk.

While we can quibble about some of the assumptions and calculations, the scale of Medicare transfers to current beneficiaries is undeniably huge. And since Medicare’s pay-as-you-go financing is zero sum, these transfers, like similar overpayments to early participants in Social Security, will result in future Medicare beneficiaries receiving far less in benefits than they will pay in taxes.

My objections are below the fold.

My objections to Biggs’ main argument are first that “present value” is not a useful way to evaluate programs like Medicare and Social Security, which are insurance programs. As such they would need to be compared to otherwise similar insurance programs, not to imaginary “investments” with different risks.

Moreover, I question the logic of claiming that Medicare is “zero sum.” It seems to me that for this to be true there would have to be an endpoint at which all the taxes that are ever going to be collected, and all payments that are ever going to be made, have been.

It is easier for me to imagine that while the costs of medical care for each generation might increase so that under pay as you go each “paying” generation pays more than the last, and each “receiving” generation gets “more than it paid for,” this “profit” will continue for each generation in its turn as each subsequent generation lives longer than the last with the benefit of increasingly expensive medical care. It seems likely to me that this approaches a limit, and entirely possible that each generation does a little bit “less better” than the last, but that hardly seems a reason to abandon a program that provides badly needed insurance for each generation in turn.

“Generational equity” is a delusion. Each generation will face different problems like war, depression, inflation, the draft, better or worse weather, compared to which a small difference in the “return on investment” is not worth worrying about… especially an entirely imaginary, projected, difference based on an entirely arbitrary “present value” discount rate. and a complete misunderstanding of the difference between insurance and investment.

Medical care, like retirement costs, are consumed on a “daily bread” basis. Unless you can show that you have a better way to pay for it, with adequate guarantees, talking about it in “present value” terms is false precision and solving the wrong problem. This doesn’t mean that we ought to ignore projections of higher future costs, but it does mean we don’t need to cut off our own heads to avoid the future high cost of living.
by reader coberly