The sources of revenue in the US health care system have changed considerably over the past 40 years. In 1970, 33% of funding was from OOP payments but that has fallen dramatically to 11% in 2016 (Table3.4). There has been a concurrent growth in the portion paid by most of the other sources: private health insurance, Medicare, Medicaid and CHIP (in 2016, 34%, 20% and 17% respectively).[4] As noted earlier, when combined, federal, state and local governments provided 45% of national health care expenditures in 2016, with the remainder paid for by businesses, households and other private revenues. The actual amount allocated to public coverage programmes in the United States is determined through the general budgetary process that begins early each fiscal year (see Box3.1).
| Table3.4 | Box3.1 |
| |
4. CHIP, the Children’s Health Insurance Program, is a joint federal state initiative that finances health insurance to low-income families with children. It is discussed more in section 3.3.2. ↰
Financing in the US health care system originates from employers, employees and individuals. From them, financing flows to private insurers and health plans (see Box3.2 for definitions of insurers and health plans), as well as to state and federal governments. Private and public purchasers then transfer dollars to providers through a variety of payment mechanisms. Fig3.7 depicts financial flows in the US health care system.
| Box3.2 | Fig3.7 |
 |  |
Beginning with the left-hand side of the figure, employers, employees, individuals and charities pay into the health care system through various taxes, premiums and other OOP expenses, and donations. Health care financing by employers includes payments in the form of corporate taxes to general federal and state revenue funds. Corporate tax rates were historically progressive, varying from 15% at the lowest levels of corporate income up to 35%, but as of 2018 face a flat 21% tax rate. Firms also contribute to private health insurance by paying all or part of employee health insurance premiums. Both employers and employees contribute equally through a mandatory payroll tax to fund the Hospital Insurance part of Medicare (Part A). In 2018 employers and employees each paid 1.45% of an employee’s income – in addition to a larger contribution to fund Social Security retirement income. The ACA increased this contribution for wealthy individuals (see subsection Revenue collection in section 3.3.1). The self-employed are responsible for the entire 2.9% share of the Medicare payroll tax.
Employed persons and their families contribute to private employer-sponsored insurance through premiums and cost-sharing. Individuals may also purchase non-group coverage outside the employment market. In addition to payroll taxes, individuals contribute to general federal and state revenue funds to finance public health care coverage through income, (and sometimes) sales and property taxes (depending on state of residence). Federal tax rates on individuals and families are progressive, ranging from 12% to 37% of taxable earnings. State income tax rates vary considerably across the United States. Seven of the 50 states levy no income tax, and two states tax only dividend and interest income. Several states have flat income tax rates while others, such as California, similar to the federal government, tax the wealthier more (the rate for the wealthiest Californians is 13.3%). Furthermore, some cities, such as New York City, also levy income taxes. Similarly, sales taxes, which are levied by states, also vary, with five states having no sales taxes and the remainder having rates varying from 2.9% to 7.3%. Some states exempt food or other necessities from sales taxes. There is no value added tax (VAT) in the United States, and proposals to enact a VAT have never been seriously considered by Congress. Property taxes, the rates of which also vary across the country (and average about 1% of home value), are generally collected on a sub-state (county) basis and are used to fund local programmes, which include public primary and secondary education, as well as safety-net health care services. The wide variation in public financing for coverage programmes between states contributes to the discrepancy in populations and services covered by state-sponsored and state/federal-sponsored public programmes, particularly Medicaid (see section 3.3.2).
Care for low-income and uninsured individuals is financed through a variety of mechanisms. Private charities, with monies from donations and endowments, assist individuals without health insurance and some special needs populations to purchase health care services. As discussed further in Chapter 5, health services for the uninsured are often provided by a safety-net system of public and community clinics, as well as by hospitals and physicians. Some funding comes from general tax revenues but in many cases the care received is uncompensated and therefore is borne by providers. It is estimated that of the US$ 84.9 billion in uncompensated care expenditures in 2013, hospitals contributed 60% and physicians 14%, with the remainder coming from a variety of community organizations (Kaiser Family Foundation, 2017b). In 2016 hospitals provided US$ 38 billion in uncompensated care, only 65% of which was covered by government funding (Khullar, Song & Chokshi, 2018). However, increased access to health insurance as a result of the ACA has reduced the burden of uncompensated care for hospitals, with states that chose to expand Medicaid experiencing the largest benefits. Between 2013 and 2015 the uninsured dropped from 14.5% to 9.4%, and hospitals experienced a 30% drop in uncompensated care costs as a share of hospital operating expenses (Schubel & Broaddus, 2018). Patients can also pay for services directly (e.g. self-pay or uninsured) or may be insured but have co-payments to make at the time services are received.
Revenues from the sources described above are paid to federal and state government, insurers and health plans, or directly to providers. Payroll taxes flow to the Hospital Insurance Fund at the federal level. Revenue from this fund finances Medicare Part A and the Part A component (mainly hospital care) of Part C coverage. Federal general revenue funds allocate dollars to Medicare (Parts B, C and D) and both federal and state general revenues are used to fund Medicaid programmes or other federal, state and local health agencies. Revenues from Medicare, Medicaid and insurers and health plans are transferred to providers through a variety of payment mechanisms. Payments from Medicare and Medicaid are made directly to providers or indirectly through insurers and health plans that provide managed care coverage to beneficiaries (e.g. Medicaid managed care organizations or Part C Medicare Advantage plans). The following paragraphs briefly describe the payment mechanisms by which revenues are transferred to providers (more detail on provider payment mechanisms is provided in section 3.7).
Medicare Part B insurance pays primary care physicians and specialists on a FFS, or retrospective, basis using a predetermined fee schedule. Conversely, Medicare hospital payments (Part A) are prospective and based on DRGs.
Medicare Part D subsidizes premiums for prescription drug coverage provided by private insurance organizations. Each of the private prescription drug plans establishes its own formularies determining which drugs will be paid for by the plans, subject to certain Medicare restrictions.
Depending on the state Medicaid programme, Medicaid may pay primary care doctors and specialists directly on a FFS basis. Alternatively, Medicaid may pay private managed care organizations a capitated rate and the managed care organizations then pay primary care doctors and specialists on either a capitated or FFS basis. Medicaid payments for hospital services vary by state and fall into three groups: DRGs, per diem and cost reimbursement (CR). Hospitals serving a large proportion of Medicaid and uninsured patients can be designated as disproportionate share hospitals (DSHs) and receive additional payments from states. Under the ACA, DSH allotments to states were reduced beginning in 2014. Medicaid pays for prescription drugs based on negotiated discounts. Among the services falling under “other providers”, Medicaid is the primary source of funding for long-term care services, paying for more than 51% of all long-term care (Kaiser Family Foundation, 2015).
Health plans transfer payments to primary care physicians and specialists on a FFS, capitated or salary basis (i.e. salaried physicians employed by a health plan). Hospital services are paid for by insurers and health plans using primarily per diem payments typically negotiated between each hospital and insurer on an annual basis. Similar to private health plans in Medicare Part D, insurers and health plans pay for prescription drugs based on formularies. Subsequent sections in this chapter provide greater depth on the sources of revenue in the US health care system, financing as it relates to Medicare, Medicaid and private insurers, the scope of OOP costs and payment mechanisms to providers.
How funds and risk are pooled varies widely across types of insurance coverage in the United States: Medicare, Medicaid, employer-based insurance, the VA, the independent insurance market, etc. Revenue flows from collection agencies and individuals to pooling agencies but, depending on the type of coverage, this may involve transfers from a taxing agency to a public statutory programme or from individuals to a private insurance company.
Risk pooling is defined here as the formation of a group so that the costs of individual health risks can be shared among everyone in the group. For some types of insurance coverage in the United States (individual insurance market and markets for small and medium-sized businesses) there was little pooling of risk at all prior to implementation of the ACA, while in others it has been substantial (Medicare). This is because private insurers, upon which the individual and employer-group health insurance markets rely, generally use experience rating, where different groups and individuals are charged premiums based on their expected costs (based on the individual’s health status or the overall health status in the group), while Medicare charges the same premiums to everyone (except for some of the very wealthy, who pay more, and the poor, who are subsidized) irrespective of health status and costs.