How Is Medicare Financed

Medicare provides substantial support to older and disabled Americans in meeting their health care needs, and it is a key component of the U.S. health care system. Almost 98 percent of the population age 65 years or older is covered by Medicare. No doubt in large part due to the significant number of Americans covered by the program, public policymakers continue to debate how Medicare should be modified in response to the changing health care environment. A firm understanding of the way in which the current Medicare financing mechanisms operate is required to understand the likely impact of the different reform proposals, as well as the rationale behind them. Medicare consists of two parts, each of which is financed separately: Hospital Insurance (HI, or Medicare Part A) and Supplementary Medical Insurance (SMI, or Medicare Part B). Almost everyone is automatically eligible for Part A of Medicare upon reaching age 65 or because they are disabled and have met certain requirements. Individuals may participate in the Part B program if they enroll and agree to pay premiums. The Hospital Insurance program is intended to be self-supporting (i.e., financed entirely through designated sources of income rather than relying on general tax revenues), much like Social Security, and it is funded primarily through earmarked payroll taxes. The Supplementary Medical Insurance program is not intended to be self-supporting. Beneficiaries pay a monthly premium, intended on average to cover roughly a fourth of the cost. Federal general tax revenue finance most of the remaining cost of the SMI program. Under current law, the financing methods used for Medicare Parts A and B are very different, reflecting the political compromises struck when Medicare was created. This issue brief provides a basic description of the financing mechanisms used for each program. 1 The American Academy of Actuaries is the public policy organization for actuaries practicing in all specialties within the United States. A major purpose of the Academy is to act as the public information organization for the profession. The Academy is non-partisan and assists the public policy process through the presentation of clear and objective actuarial analysis. The Academy regularly prepares testimony for Congress, provides information to federal elected officials, comments on proposed federal regulations, and works closely with state officials on issues related to insurance. The Academy also develops and upholds actuarial standards of conduct, qualification and practice, and the Code of Professional Conduct for actuaries practicing in the United States.