A Note on Income Effects and Health Care Cost Growth in Medicare

This paper sets out a model of technical change and health care cost growth for a representative Medicare beneficiary facing a budget constraint. Derivation of an explicit expression for health care cost growth shows how technological change and preferences, including income effects, affect cost growth. The analysis highlights the role of the 76% percent subsidy from current taxpayers to Medicare beneficiaries for purchase of health insurance. This subsidy insulates beneficiaries from the income effects of cost growth by shifting the costs and income effects to taxpayers. Simulations show that over the next 10-20 years, income effects will have little effect on cost growth in Medicare.