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Since the creation of Medicare in 1965, the program’s basic structure has caused spending to grow rapidly decade after decade. Even aside from the role of general inflation and demographic factors in rising health costs, there are at least four additional cost drivers built into Medicare’s current design.

• First and foremost, Medicare allows enrollees and health care providers to spend other people’s money. That all but eliminates any incentive for either party to economize and invites waste, fraud, and abuse. Researchers at the Dartmouth Atlas Project and elsewhere estimate that about 30 percent of Medicare spending does nothing to make patients healthier or happier.¹⁸ That estimate does not include Medicare spending that provides some value, but whose benefits are smaller than the costs. This research suggests that Medicare wastes well over $100 billion per year. A study by health economists Amy Finkelstein and Robin McKnight found that “in its first 10 years, [Medicare] had no discernible impact on elderly mortality.”¹⁹ Crudely put, the $300 billion (in today’s dollars) that Medicare spent between 1966 and 1975 may not have saved a single life.²⁰

• Second, Medicare spending grows because the government keeps expanding the list of goods and services that Medicare subsidizes. Congress created the huge Part D prescription drug program in 2003, which has added hundreds of billions of dollars to the federal debt because legislators provided no funding source. Other expansions occur, without any congressional action or approval, when Medicare officials deem new procedures eligible for subsidies. In 2004, the Bush administration unilaterally announced that Medicare would begin subsidizing obesity treatments.

• Third, Medicare overpays for many items because it often sets prices higher than a free market would. In the 1990s, for example, ambulatory surgical centers (ASCs) increased their productivity. A competitive market would have quickly translated those gains into lower prices for consumers. Yet Medicare took 16 years to lower the prices it paid ASCs. Those artificially high prices encouraged excessive use of ASC services with taxpayers footing the bill.²¹ Medicare sets prices too high in many other areas of medicine, including cardiovascular care.²²

• Fourth, Medicare’s fee-for-service structure—based on price and exchange controls—encourages providers to deliver too many services because that is what the structure rewards. That fact does not imply any greediness on the part of providers. Medicine entails considerable uncertainty, and Medicare encourages providers to respond to that uncertainty by delivering more services.

These factors help explain why actual Medicare spending usually surpasses projections. When Congress created Medicare in 1965, officials projected Part A would cost $9 billion by 1990; it ended up costing $67 billion. In 1967, official estimates projected the cost of the entire Medicare program would reach $12 billion in 1990; it cost $110 billion that year. When Congress created Medicare’s home-care subsidies in 1988, official estimates projected it would cost $4 billion in 1993, but it ended up costing $10 billion.²³

So when the Congressional Budget Office projects that Medicare spending will grow at an annual rate of 7.0 percent during the next decade, it is important to take that projection with a grain of salt, given that Medicare grew at an average annual rate of 9.3 percent over the past decade.²⁴

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