Federal Reserve Bank of Cleveland
Press Release

For Release: August 6, 1997
Contact: John Martin, 216/579-2847 or June Gates, 216/579-2048

Incentives Needed to Curb Health Care Spending, Save Medicare

If implemented, proposals to stave off the impending bankruptcy of Medicare by widening cost controls are only likely to lower the quality of care for Medicare beneficiaries. Moreover, these measures will only extend the program's solvency by a few years. Despite recent attempts to control the costs of medical services, real spending on health care by Medicare beneficiaries has been expanding much more rapidly than for the total U.S. population. To save Medicare, says Federal Reserve Bank of Cleveland economist Jagadeesh Gokhale, it is necessary to implement structural reforms that maximize the incentives for consumers and health care providers to economize on their use of medical resources.

Writing in the Bank's Economic Commentary, Gokhale says Medicare's financial woes result from a health care system in which third parties - private insurers or the government - pay for health services instead of consumers. Such a system reduces both consumers' and providers' incentives to conserve on their use of health care resources.

Gokhale discusses current and proposed efforts to extend the life of Medicare, and concludes that they would do little to improve the efficiency and incentives of the system. Increasing Medicare deductibles and copays, for instance, would do little to encourage beneficiaries to economize, because most purchase Medigap policies that fill in where Medicare falls short.

Gokhale advocates a Medicare system that would provide a “defined contribution” (i.e., a fixed voucher) to each beneficiary for the purchase of private health insurance. Beneficiaries could opt for more expensive coverage by adding their own resources, or buy a cheaper policy and pocket the difference.

According to the author, this Medicare structure would force beneficiaries to pay for the last dollar of coverage, which in turn would require them to evaluate the benefit of spending that dollar. And, consumers' efforts to economize on their medical spending would likely heighten competition among insurers and health care professionals.

The Medicare strain on both the nation's health care resources and the budget will become especially severe when the baby boomers begin to retire in just over a decade. Ensuring the availability and quality of this important source of economic security, warns Gokhale, requires restoring beneficiary interest in using medical services wisely.

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