Payroll Taxes Cover About a Third of Medicare Costs

By :: June 15th, 2012

I get the impression that many Americans believe Medicare is financed like Social Security. They know that a portion of payroll taxes goes to Social Security and a portion goes to Medicare. So they conclude workers are paying for Medicare benefits the same way they are paying for Social Security benefits.

That isn’t remotely true, as new data from the Congressional Budget Office demonstrate.

In 2010, payroll taxes covered a little more than a third of Medicare's costs. Beneficiary premiums (and some other earmarked receipts) covered about a seventh. General revenues (which include borrowing) covered the remainder, slightly more than half of total Medicare costs.

If you prefer to focus on just the government's share of Medicare (i.e., after premiums and similar payments by or on behalf of beneficiaries), then payroll taxes covered about 40% of the program, and other revenues and borrowing covered about 60%.

In contrast, payroll taxes and other earmarked taxes covered more than 93% of Social Security's costs in 2010, and that was after many years of surpluses.

The difference between the two programs exists because payroll taxes finance almost all of Social Security, but only one part of Medicare, the Part A program for hospital insurance. Parts B and D (doctors and prescription drugs) don't get payroll revenues; instead, they are covered by premiums and general revenues. But that distinction often gets lost in public discussion of Medicare financing.

As recently at 2000, general revenues covered only a quarter of Medicare’s costs. That share has increased because of the creation of the prescription drug benefit in 2003 and because population aging and rising health care costs have pushed Medicare spending up faster than worker wages. Over the next decade, CBO projects that premiums will cover a somewhat larger share of overall costs, while the general revenue share will slightly decline.

Note: For simplicity, I have focused on the annual flow of taxes and benefits. The same insight applies if you want to think of Social Security and Medicare as programs in which workers pay payroll taxes to earn future benefits. That's approximately true for workers as a whole in Social Security (but with notable differences across individuals and age cohorts and uncertainty about what the future will bring). But it's not true at all for Medicare.


  1. AMTbuff  ::  8:00 pm on June 15th, 2012:

    If the premiums were higher, would healthier seniors drop out of Part B? Is that why the premiums are set so far below the average cost?

  2. Ralph H  ::  6:51 am on June 16th, 2012:

    This bar graph should be widely published. It is obvious we need to increase the payroll tax, the premiums or both to bring this more in balance. In general there is wide support for Medicare, but we need to reign in the net cost to the treasury. How much of the unfunded amount is due to the addition of “D” benefit?

  3. David  ::  8:36 pm on June 17th, 2012:

    OK, we see the symptoms of the patient. Medicare costs are huge; payroll taxes don’t pay for it all. What is making this so is the outrageous rents that our private sector healthcare system is imposing on citizens (and thus on Medicare). Get healthcare costs in line with the rest of the civilized world’s healthcare costs, and we’d be OK.

    Another thing hidden in this data is that workers have been not getting any of the increases in productivity that has occurred since about 1980. So while healthcare costs have skyrocketed, salaries have pretty much stuck where they were, or even gone done for the ones who use Medicare the most. There is absolutely nothing wrong with Medicare itself; so of course their FICA can’t cover these cost increases that the private sector healthcare industry is imposing on the citizenry.

    What’s wrong is having doctors that heal for money instead of the public good (salaries far above their counterparts in Germany etc.), drug companies that make drugs cost ten times what they should (here’s were you could solve the deficit problem), and all the other sundry unnecessary costs (advertizing, and administrative bloat, to name only two).

  4. Michael Bindner  ::  11:59 am on June 18th, 2012:

    The only way to raise premiums and copays is to also increase the base benefit. That will require more revenue to do. I would actually lower the income cap on the employee payroll tax (limiting the upper end on benefits) and decouple it from the employer contribution, which I would shift from a payroll tax to some kind of consumption tax. A VAT would be used if there were no offsets, while if offsets were preserved and expanded (like the health insurance exclusion or employer funding of retiree health costs)a VAT-like Net Business Receipts Tax would be created (and would also replace the corporate income tax and reporting of business income on personal income taxes). Obviously, if employers took over funding of retiree health costs, they would set their own premium and copays or avoid them entirely – especially if they employed the doctors directly rather than paying for third party insurance.

  5. Michael Bindner  ::  12:06 pm on June 18th, 2012:

    They should be employed directly by business rather than be private providers.

  6. Michael Bindner  ::  12:07 pm on June 18th, 2012:

    Medicaid should be covered by these consumption taxes as well. If you include senior Medicaid in these tables, the amount coming from general revenues is even higher.

  7. Renewing America » Morning Brief: Congressional Leaders Try to Save Transportation Bill  ::  9:46 am on June 19th, 2012:

    […] Since 2008, most states have cut Medicaid benefits and reimbursements (Stateline). Some are launching innovative programs to crimp costs and improve patient outcomes. Oregon’s “coordinated care organizations” will charge a fixed fee per customer to cover medical, dental, behavior health, and substance abuse services. New Jersey and Nevada are preparing similar programs for those with certain chronic illnesses and behavioral health problems. Health care costs are a significant burden to the federal government. More than half of all Medicare spending comes from general revenues; payroll taxes only supply a third (TaxVox). […]

  8. Michael Bindner  ::  3:06 pm on June 28th, 2012:

    Today’s finding on Medicaid means federalization is necessary to ensure reform. The likely stock market reaction to the decision means that a subsidized public option is necessary. Take this all together and a consumption tax is needed to fund it all plus Medicare as part of comprehensive tax reform.

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