Medicare in USA: Present and Future

3. Medicare’s Tax on Work

Medicare’s current rules are also a deterrent to long careers and continued work. This tax occurs because of Medicare’s complex interaction with the dominant employer-based insurance arrangements for the American workforce.
Under current law, Medicare becomes the ‘secondary payer’ when a person age 65 and older continues to work for a firm with at least 20 employees and a company-sponsored health insurance plan. In those cases, the company’s health insurance for workers pays for medical care for the workers first (the ‘primary payer’) and Medicare only pays for those portions of the bills not covered by the company plan.
This rule was put in place to reduce Medicare costs and allow a focus on insuring those without access to an employer-sponsored plan.
But this approach is short-sighted because it imposes an onerous tax on work for those Medicare-eligible people who choose to continuing working. Most economists assume that, when an employer pays for health insurance for a worker, those costs reduce what can be paid in cash wages. Consequently, when an employer must assume primary responsibility for the health insurance premiums of an older worker, that means there is less funding available for that worker’s wages.
A 2007 analysis by economists at Harvard, Stanford, and Occidental College shows this ‘tax on work’ to be quite considerable. These researchers found that, at age 65, Medicare’s ‘secondary payer’ rule imposes a 15 to 20% tax on wage income, and this implicit tax rises to 40 to 75% for those approaching 80 years old. Such high marginal tax rates are a significant disincentive to work.
The problem is compounded by Medicare payroll tax financing. Workers age 65 and older who are already getting Medicare benefits must nonetheless continue paying Medicare’s payroll tax (2.9% of wages, for the combined employee-employer tax) even though they get no additional benefit for paying it.
The authors of the 2007 paper suggest that reforming these anti-tax provisions of Medicare could provide much strong incentives for continued work. One approach would be to make the Medicare program the primary payer for all workers, even though with access to an employer-sponsored plan, and repeal of the payroll tax for workers who have already worked for forty years. The authors estimate that this kind of reform would increase the total labor supply from the eligible population by over 1%.

4. The Challenge

The federal government is taking on substantial new debt in response to the crisis in the financial sector. Even so, these costs, though high, are likely to be temporary, which cannot be said of rising costs for Medicare.
Federal government spending on Medicare increased from 1.0% of GDP in 1975 to 3.1% in 2008, according to CBO. Projections indicate the U.S. will be facing public expenditures on Medicare that are double and triple the rate of today’s spending, and these additional costs would occur every year, not once.
To find a solution to this problem, it’s important to understand that Medicare is really two programs. The most important feature of Medicare is that it is guaranteed-issue, community-rated insurance. Everyone age 65 and older gets their insurance for the same premium, and they cannot be denied coverage based on their health status. These features of Medicare are highly valued by beneficiaries, and for good reason. Without a regulatory structure putting all seniors into the same risk pool, insurance would naturally move to cover healthier seniors at lower premiums than the unhealthy.
But Medicare is also a large tax-and-transfer program. And it is this feature of Medicare that is substantially out of balance.
Medicare’s unfunded liability could be contained with a simple change in program structure. The program could continue to provide guaranteed issue, community-rated insurance, but future retirees would be eligible for premium subsidization commensurate with tax contributions during each generation’s working years (a large exception would be made for seniors in the lowest fourth or fifth of the wealth distribution). This change would ensure that program spending rose in tandem with the program’s revenue base. And it could be designed to be more neutral toward continued work by the elderly, thus providing a strong incentive for higher labor force participation among Medicare enrollees.
Opponents would immediately argue that this kind of reform would be dangerous for future retirees because health-care costs might rise faster than the premium subsidies. But it does not make good sense for the government to pre-commit health entitlement spending twenty-five and fifty years from today that is unaffordable. It would be better to build a program that is solvent by definition, with ample room for future policymakers to make adjustments if evidence indicates that seniors need more subsidization to secure appropriate health care.
The country can provide generous health insurance coverage for seniors in the future, even coverage that costs much more than it does today. But the program can’t double or triple in a generation. The sooner U.S. policymakers face up to this reality, the better.


Congressional Budget Office (2007): The Long-Term Outlook for Health Care Spending, Congressional Budget Office, November.

Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (2008): Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, March.

Finkelstein, A. (2006): “The Aggregate Effects of Health Insurance: Evidence”, from the Introduction of Medicare, April.

Shah, G., Shoven, J.B. and Slavov, S.n. (2007): A Tax on Work for the Elderly, National Bureau of Economic Research Working Paper, August.

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