Medicare, the federal insurance program for Americans aged 65 or older, had an annual budget of $683 billion in 2016, making it the second largest health care organization in the U.S. (behind only Medicaid).  The annual outlay by Medicare is one-fifth of the entire U.S. health care expenditure. In 2016, almost 59 million Americans were covered by Medicare, but this number should grow to 64 million by 2020 and 81 million by 2030.

The enormous costs of funding Medicare and the rapid “greying” of the U.S. population forces the question, “What if Medicare runs out of money?”  This month the federal government issued an analysis of Medicare’s financial situation and concluded that Medicare will become insolvent by 2026—at least three years earlier than previously expected.

Any changes to Medicare could severely impact those seniors enrolled in the program. Of the 60 million with Medicare coverage, one in six is disabled; two in three have two or more chronic health conditions; and one in two is impoverished. Without this critical safety net, millions of seniors could fall further into poverty, lose access to needed medical care or suffer a shortened lifespan.

Current State of Medicare

Medicare has been one of the federal government’s most popular programs since its founding in 1965.  Almost 70 percent of the U.S. population is in favor of keeping Medicare as it is.  This huge public support is one of the primary reasons why politicians of any ideological background have resisted making any alterations to the program.

Medicare currently operates at 100 percent efficiency, meaning that it pays for all of its promised benefits for its enrollees. It is able to do this because funding by Congress and revenue generated by its programs including private insurer payments, payroll taxes and enrollee premiums are sufficient to cover its expenditures.

A closer look at the mechanism of Medicare funding reveals that Medicare Part A, which covers hospital services is funded by a hospital insurance trust fund.  This trust fund is replenished by a payroll tax of 2.9 percent on employers and 1.45 percent on each employee. Other Medicare program components are funded by premiums, state payments and general revenue.

Although it may not represent the entire program, the hospital insurance trust fund is the metric by which Medicare solvency is generally determined; in other words, when the hospital insurance trust fund becomes insufficient to cover all of its enrollee benefits, Medicare will be insolvent. Medicare Parts B and D are not dependent upon a trust fund but are allocated financing based on beneficiary premiums for an estimated annual budget.

Although the future of Medicare may appear bleak, there is some hope the government can enact changes that could forestall insolvency. One important example of this is the Affordable Care Act that was passed in 2010.  The ACA helped lower the annual growth in spending for beneficiaries from 7.4 percent between 2000 and 2010 to 1.4 percent between 2010 and 2015. These programs save Medicare almost $800 billion over ten years.

The Exploding Cost of Medicare

Programs like the Affordable Care Act have helped keep health care costs lower for Medicare in recent years, but more health care reforms are needed to rein in costs for the long haul. The annual growth in Medicare’s spending is projected to reach 7.1 percent every year between 2015 and 2025.  The per capita annual growth in spending will also accelerate rapidly during this period, from 1.4 percent to 4.3 percent.

The Congressional Budget Office predicts that by 2027, Medicare spending will double from the $592 billion in 2015 to $1.2 trillion. That means that almost one in six federal dollars will go towards funding Medicare.  Even if the economy experiences exuberant growth, that budgetary outlay will sap funding from other essential programs and place a heavy brake on economic growth.  There is almost no doubt that if health care costs continue to rise and the number of seniors enrolled in Medicare grows as expected, the cost will be unsustainable.

If current projections hold up, the number of working Americans supporting Medicare through payroll taxes will shrink dramatically in the coming years.  In 2014, the number of Medicare beneficiaries was at 54 million, but this number will balloon to 93 million by 2050.  While the U.S. workforce is also expected to grow, it will probably not keep pace with the senior population. In 2014, 3.2 workers contributed taxes to support each Medicare beneficiary, but this will fall to 2.3 by 2050, forcing Congress to find other funding or raise the payroll tax.

Consequences of Insolvency

If the hospital insurance trust fund should run at a deficit in 2026 as projected, then there will be some serious consequences, but Medicare won’t cease to operate. It is estimated that in 2026, Medicare will still be able to cover 87 percent of its hospital benefits. Medicare Parts B and D, the drug and private insurance programs, are funded independently of the trust fund, so they should continue to operate without much disruption.

However, insolvency of Medicare Part A will produce some uncomfortable changes for program beneficiaries or American taxpayers. As the trust fund becomes depleted, Congress will likely have to choose between paring down Part A benefits or raising payroll taxes.  Although it is unknown which option they will choose, in the past, raising taxes has been the more politically palatable; Congress has raised the payroll tax ten times since Medicare was enacted in 1966.

In the long term, raising payroll taxes is only a temporary solution. Unless the American population experiences a dramatic surge in growth that will boost the workforce, or the costs of covering a rapidly burgeoning senior population fall precipitously, Medicare will continue to grow at an accelerating rate.  Not only will this produce undue strain on the federal budget, but it will also increase the national debt which is currently 77 percent of annual gross domestic product, to 89 percent of GDP in 2027 and 150 percent in 2047.