11/06/2014 11:33 am ET Updated Jan 06, 2015

Modernizing Medicare


Modernizing Medicare is the most important domestic policy challenge facing the United States. Medicare is at the heart of the spending explosion built into the federal budget over the next decade, rising from $603 billion in 2014 to $1.04 trillion in 2024 -- a rise of 72 percent, or an average annual growth rate of 5.6 percent.

The spending explosion, in turn, is the core source of the projected additional $7.8 trillion in federal debt held by the public, bringing the total to $20.8 trillion, or 77.2 percent, of Gross Domestic Product (GDP) -- and rising.

The unchecked rise in spending and debt sends the signal that the U.S. is willing to entertain a future consisting of a steady diet of tax hikes, flirting with a sovereign debt crisis -- or both. Neither is a pro-growth strategy on behalf of a citizenry that is weary of too-weak job growth and anemic real wage increases.

To top it off, the expensive, debt-inducing, growth-threatening Medicare program is not delivering top-quality medicine to its deserving beneficiaries. Fee-for-service Medicare pays doctors, hospitals, and other providers to do things to patients, instead of rewarding those that deliver quality outcomes through prevention, coordination, and acute care. Because Medicare is the largest payer of medical bills in the United States, the poor incentives embedded in fee-for-service set the (subpar) standard for care throughout the health sector at all ages.

The most important first step in modernizing Medicare is repealing the so-called Sustainable Growth Rate mechanism (SGR).

The SGR dates to the 1998 Balanced Budget Act. The SGR sets targets for Medicare Part B services (doctors, outpatient care, office-administered drugs) on the basis of past spending, modified for increases in costs (inflation), income growth (GDP), and beneficiary growth. If spending exceeds the target, subsequent reimbursements are cut.

Spending always exceeds the targets. As a result, doctors are faced with increasingly large potential cuts to their reimbursements (most recently, the automatic cut would have been 24.4 percent), leading Congress to override the SGR formula. We have witnessed the Groundhog Day-like pageant of excessive spending, proposed draconian cut, and Congressional override 14 times since 2001.

Clearly, the SGR is not working as a budgetary control mechanism. Even worse, it is exacerbating the worst health policy aspect of Medicare. It is well-documented that when faced with lower reimbursements, providers increase their activity to offset the cut with additional volume. (The Congressional Budget Office estimates that increased volume offsets 28 percent of a reimbursement cut.) Fee-for-service becomes fee-for-more-service. In effect, the existence of the SGR makes real reform of Medicare harder.

Eliminating the SGR would remove the commitment to trying to make the fee-for-service model work in either a medical or budgetary sense. It does raise the question of what would replace it, but after years of study and negotiation this past year witnessed an agreement on the shape of an SGR replacement in both parties and in both the House and the Senate. Unfortunately, the bill did not become law.

It is essential that Congress finish the job as soon as possible. SGR repeal is the key to beginning the process of real modernization of Medicare. Medicare modernization is, in turn, an essential element of coming to grips with poor growth, big debts, and an underperforming social safety net.