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How Medicare is Funded: The Intricacies of Government Health Care Financing

Medicare is the United States federal health insurance program. This program is designed to provide coverage for people who are 65 and older or for younger people with long-term disabilities.

As of October 2021, Medicare enrollment was just shy of 64 million people. That’s a lot of people and a significant expense. So, who pays for Medicare and how is it funded?

How Is Medicare Funded?

Because Medicare is a federally funded program, it falls under a few different government organizations. The Department of Health and Human Services (HHS) is the overarching body but Medicare more specifically falls under the oversight of the Centers for Medicare & Medicaid Services (CMS), which is a sub agency of HHS. The CMS is also responsible for monitoring the Medicaid programs offered by each state.

The U.S. Treasury has two different trust funds that hold all of the money that is used for Medicare. That money is collected from six primary sources:

  • General revenues
  • Payroll taxes
  • Premiums paid by beneficiaries
  • Taxes on Social Security benefits
  • Payments from individual states
  • Interest

There is an “other” category that collects from other areas but it is a much smaller amount.

Each part of Medicare is funded differently. Medicare Part A, designed for hospital stays and inpatient care, gets most of its funding from payroll taxes.

Medicare Part B, which includes doctor visits and other outpatient services, gets the majority of its funding from general revenue. Medicare Part D is an optional benefit for prescriptions and other drug expenses, and it also receives most of its funding from general revenue.

Medicare Part C, or Medicare Advantage, is a combination of all of your Medicare parts, so some of the funding comes through each of those programs. Medicare Advantage is also an optional program with premiums that help fund the costs.

Hospital Insurance (HI) Trust Fund

All of the money the government collects for Medicare is put into one of two Medicare Trust Funds. The U.S. Treasury holds these funds and the money is only available for Medicare – the government cannot tap it for special projects. 

One of those funds is the Hospital Insurance (HI) Trust Fund.

How Is It Funded?

HI Trust receives the majority of its funding from payroll taxes. These are paid by people who are working, their employers, and self-employed people. The rest of the money for this account comes from:

  • Income taxes paid on Social Security benefits
  • Interest earned on investments the HI Trust makes
  • Medicare Part A premiums (not everyone pays premiums, but some people do)

What Does It Pay For?

The HI Trust pays for Medicare Part A, which includes hospital care and charges. This can include inpatient hospital care, expenses from a skilled nursing facility, home health care for qualifying individuals, and hospice care.

HI Trust is also responsible for administrative costs such as costs related to paying benefits, collecting taxes, and fighting fraud and abuse.

Supplementary Medical Insurance (SMI) Trust Fund

The second Medicare Trust Fund that the government has created is the Supplementary Medical Insurance (SMI) Trust Fund. It’s designed to support Medicare Part B and Part D programs.

How Is It Funded?

SMI Trust Fund does not receive money from payroll taxes. Instead, its funding comes from:

  • Annual appropriation from Congress
  • Contributions from the general fund
  • Premiums paid for Medicare Parts B and D
  • Interest on the trust fund’s balance

What Does It Pay For?

The SMI Trust Fund pays for expenses related to care that fall under Parts B and D of Medicare. Part B covers outpatient care, physician services, medical supplies, and other expenses related to health care when you’re not hospitalized. Medicare Part D is the prescription drug program and is designed to cover prescription medications but may include some other drug necessities.

Medicare’s Financial Condition

Many people worry that Medicare’s funding will run out in the future. This is typically referencing the HI Trust Fund as it does not receive an annual appropriation from Congress and is more susceptible to economic conditions and increases in Medicare enrollment.

Currently, the spending is outpacing the revenues and funds are being depleted. The Congressional Budget Office (CBO) and the Medicare Trustees Board are responsible for looking at the amounts held in the HI Trust and at expenses and projections. Each group then determines when it is likely that the fund will no longer be enough to support Medicare Part A expenses. Both organizations have a projected date for insolvency of 2028 with no major changes to the current projections.

Medicare Trust Fund Solvency

Measuring solvency is a way to look at the financial status of Medicare. If it’s solvent, then there is enough money in reserves for the projected expenses. When it becomes insolvent, there isn’t enough in the reserves and the money will be depleted until it is gone. Currently, the HI Trust is being depleted and it’s expected to run out in 2026.

It’s not known exactly what would happen if the HI Trust became insolvent as it’s never happened. Since legislation was signed for Medicare in 1965 by President Lyndon B. Johnson, it has been within five years of insolvency only twice, in 1996 and 1997. At that time, Congress enacted legislation to reduce Medicare spending obligations to deal with the looming insolvency. It’s yet to be seen what will happen to manage the current deficit projections.

Future of Medicare Funding

One thing that is important to note is that if the HI Trust Fund becomes insolvent, Medicare Part A will not immediately cease to exist. The revenue sources that it is funded by will continue to funnel money into HI Trust. This means money will still be coming into the account, but it will not be enough to cover the predicted expenses.

This also brings into question how the money that’s there will be used, as there is no automatic process that prioritizes certain expenses or bills over others. How this will be handled and what the U.S. government will do to boost solvency is not known at this point. What is known is that this issue is one that only applies to Medicare Part A. Medicare Parts B and D are funded differently and automatically adjust to account for spending increases.

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