Means Testing Federal Health Entitlement Benefits

Recent federal legislation has linked the price paid for health insurance benefits to current income. Under the Patient Protection and Affordable Care Act of 2010, individuals and families with income as high as 400% of the federal poverty level are eligible for premium tax credits that limit their health insurance premiums to under 10% of their income. Under the Medicare Modernization Act of 2003, higher-income beneficiaries face income-related premiums over three times the standard premium for Part B coverage. For workers at or near retirement age, means testing based on current income provides an incentive for early retirement, dissaving, and income manipulation, raising concerns about the efficiency of such means testing. Further, current income is subject to short-term fluctuations, making it a noisy predictor of ability to pay. Using the Health and Retirement Study and linked Social Security earnings histories, this paper introduces a measure of lifetime income that compares favorably to current income as a basis for means testing. It offers less short-term variation in premiums while improving incentives for preretirement work and saving.