In his budget due to be released tomorrow, President Biden will propose major changes in the way Medicare’s Part A hospital insurance program is funded. To ensure the program’s solvency, he’d shift hundreds of billions of dollars in tax revenues and allocate $200 billion in cost savings from other parts of Medicare to the hospital insurance (HI) trust fund. Biden’s proposals won’t become law in the near future but may open a critical discussion into how to fix the nation’s health system for older adults and younger people with disabilities.

Biden’s package, which the White House previewed yesterday, combines cost savings with tax increases. Here are the key elements:

  • Raise the Affordable Care Act’s Net Investment Income Tax (NIIT) rate from 3.8 percent to 5 percent for people making $400,000 or more.
  • Broaden the tax base for the NIIT so it includes nearly all non-wage income. The tax already applies to most investment income and passive business income. Biden would include active business income, such as income received by owners of S Corporations and real estate developers.
  • Transfer NIIT revenue from the federal government’s general fund to the HI Trust Fund.
  • Expand and accelerate Medicare’s ability to negotiate drug prices and use the cost savings to shore up the HI Trust fund. Last year’s Inflation Reduction Act allowed Medicare to negotiate drug prices, but it applies only to a handful of drugs and would not begin until 2026.

Biden also proposed to lower some out-of-pocket costs for Medicare beneficiaries, but we can look at them another time.

How Medicare Is Financed

To understand what Biden wants to do, remember how Medicare is financed today.

About 90 percent of the HI trust fund is financed with payroll taxes. Most of the rest comes from the income tax on Social Security benefits for those making more than $25,000 annually. But that income tax contribution represents only about 7 percent of HI revenue.

The rest of Medicare is financed very differently. General tax revenues pay for about three-fourths of the costs of Part B, which covers physician visits and other care, and the Part D drug benefit. Income-related premiums fund most of the rest.

Biden would expand the tax that funds Medicare Part A so that it looks more like an income tax than a payroll tax, at least for high-income households. He’d add at least $500 billion in  general tax revenue over the next 10 years to the HI pot. That would fundamentally change the funding system that has been in place for nearly 60 years. And, perhaps, alter public perceptions of the program.

A Not-Simple NIIT

Explaining the tax is not simple. Today, all wages are subject to the 1.45 percent Medicare payroll tax (employers also pay 1.45 percent). Single filers with income in excess of $200,000  and joint filers making more than $250,000 also must pay an additional Medicare payroll tax of 0.9 percent (not matched by employers), for a combined rate of 2.35 percent. All those revenues go to the HI Trust Fund.

Investment and some business income are subject to the current 3.8 percent NIIT but none of those revenues go to Medicare. Under Biden’s proposal, nearly all investment and business income of high-income households would be subject to the 5 percent NIIT and all revenue would go to Medicare. It appears the maximum tax on wage income would remain at 2.35 percent, even for those with incomes of more than $400,000.

Papering Over A Problem

At the same time, Biden would shift dollars from Medicare’s Part B and Part D to Part A. It would be a bookkeeping change, but an important one. Until now, funding for each part of Medicare largely has been kept separate. Because Parts B and D are pay-as-you-go programs that have no trust funds, they don’t face insolvency, which the HI Trust Fund faces as soon as 2028.

But Parts B and D still are spending vastly more than their premiums support. When Congress passed a modest attempt to reduce Medicare drug costs last year, it did so largely to slow the growth of Part B and Part D costs, and decelerate the increases in government spending and premiums.

But by shifting cost savings from Parts B and D, Biden would fail to reduce the financial stress on the other two Medicare programs, even as he relives pressure on Part A.

It would be a little like someone in financial distress using the rent money to buy food. It may paper over one problem for a while but it is not a sustainable fix.

While Biden’s plan won’t become law over the next two years, it could kick off a serious debate about how the US is going to pay for the inevitable cost increases that come from an aging population and growing per-capita health care costs. And that would be a good thing.