This paper develops an overlapping generations model to study the macroeconomic effects of an unexpected elimination of Medicare. We ﬁnd that a large share of the elderly respond by substituting Medicaid for Medicare. Consequently, the government saves only 46 cents for every dollar cut in Medicare spending. We argue that a comparison of steady states is insufficient to evaluate the welfare effects of the reform. In particular, we ﬁnd lower ex-ante welfare gains from eliminating Medicare when we account for the costs of transition. Lastly, we ﬁnd that a majority of the current population benefits from the reform but that aggregate welfare, measured as the dollar value of the sum of wealth equivalent variations, is higher with Medicare.
- Federal Reserve Bank of Minneapolis. Research Department
- Federal Reserve Bank of Minneapolis
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