A sense of entitlement: medicare's new expansion, and what to think.

THE recently enacted Medicare bill is being fiercely criticized from both the right and the left, but planted in this huge, and hugely expensive, legislation are seeds that can lead to transformative changes in the health sector.

Liberals are angry because the bill puts an end to their nearly 40 years of dominance over the program and injects some market competition into a system many of them still hope to use as a springboard for universal, single-payer government health insurance. And many conservatives are angry because they believe that a Republican Congress and White House have abandoned small-government principles to create a massive new entitlement projected to cost more than $400 billion in the first ten years and burden future generations with trillions of dollars in unfunded liabilities. They also feel cheated, because the plan to put Medicare on a track toward competing with private plans was reduced to six demonstration projects--starting in 2010.

Nonetheless, Congress narrowly passed the legislation, and President Bush is expected to sign it soon. The clincher that led to enactment was endorsement by the AARP, the 35-million-strong seniors lobby. The price of AARP's support was to scale back measures leading to competition with private plans. Chief GOP negotiator Bill Thomas, chairman of the Ways and Means Committee, stormed out of an eleventh-hour session when told of the deal, only to be coaxed back to fix and polish it.

For six long years, Congress had been debating how to add an outpatient-prescription-drug benefit to Medicare. The bill as finally enacted offers a benefit design that will be the subject of intense argument for years to come. Congress could have reduced the cost by making the benefit available primarily to the 22 percent of seniors who don't have drug coverage, but congressional leaders were determined to pass a drug benefit that was available to all. So, starting in 2006, all 40 million Medicare beneficiaries will be able to get a voluntary prescription benefit, delivered through private drug plans; the plans will be paid partly through government payments and partly by premiums from seniors, estimated at about $35 a month. Once enrolled, seniors will pay the first $250 each year in drug costs, and the drug plans will cover 75 percent of the next $2,000 in drug spending. Then, there is an infamous "doughnut hole" requiring seniors to pay all of their next $2,850 in drug costs before the coverage triggers again, when it will pay 95 percent once seniors' total drug costs reach $5,100. Lower-income seniors receive more generous subsidies, including reduced premiums, deductibles, and drug co-payments. Many observers are concerned that only seniors with high or moderately high drug expenses will enroll in the drug plans, leading to higher premiums for everyone.

But the legislation also contains important victories for reform--including Health Savings Accounts (HSAs) and incentives for private health plans to stay in Medicare, providing a base of participation for future modernization. HSAs have the potential to transform health-insurance arrangements for all Americans, including future retirees. Granted, the reform proposals came at a high price, but the reforms probably never would have been passed had they not been part of a larger bill.

HSAs build on Archer Medical Savings Accounts with a much more accessible system. Starting next year, 250 million Americans under age 65 will be able to make tax-free deposits to their own health accounts. Individuals will be able to deposit up to $2,600, and families $5,150, next year to pay for routine health expenses and to save for future medical needs; allowable deposits will be adjusted for inflation every year after that. Whatever isn't spent in one year rolls over to the next. The money stays tax-free as long as it is spent on IRS-allowable health care, and the interest that accrues on it is tax-free as well. The accounts must be coupled with high-deductible health insurance that covers major health expenses.

The average cost of an employer-provided family insurance policy is more than $9,000; HSAs give employers more options in allocating the money. The new system also gives consumers an incentive to seek the best value for their dollars--and can thus set in motion the essential change of putting doctors and patients back in control of medical decisions. Some forward-looking physicians already are starting to see the value of these new arrangements, with a few forgoing insurance altogether and offering their services for cash payments at fixed, posted prices.

The link between consumers and sellers has been broken in the health sector because third-party payment systems have led consumers to believe that someone else is paying the bill for their medical expenses. Federal, state, and local programs pay 45 percent of all health bills, largely through price-controlled programs like Medicare and Medicaid. And much of the remaining 55 percent is paid through private insurance that is circumscribed by rules set by government and by corporate bureaucracies. Health-insurance prices continue to rise at double-digit rates year after year while consumers complain about a lack of control over decisions.

Keeping private health plans in the program is essential if there is to be a base to create, eventually, a competitive Medicare. The incentives established by the new bill will encourage many more private health plans to participate in the Medicare market. In 2006, when the drug benefit kicks in, there will be a solid base of millions of seniors who will be able to choose from among competing private health plans offering an integrated drug benefit. In addition, the plans will have some flexibility in the design of the drug benefit, to make it more consumer-friendly.

Medicare-endorsed prescription-drug discount cards also will be available to all beneficiaries starting next spring, giving seniors access to privately negotiated drug discounts that the Bush administration estimates will provide savings of 15 to 25 percent on prescription drugs. Lower-income seniors will receive a temporary subsidy on the drug discount card of up to $600 in 2004 and 2005; this is a defined contribution that gives government certainty over its costs and seniors an incentive to make the dollars go as far as possible, putting down a good marker for future programs.

For conservatives, then, there is much to like in this bill. But liberals are getting ready for the next round. Senate minority leader Tom Daschle has introduced legislation to repeal what he considers to be the worst provisions of the legislation. Topping the list will be filling the "doughnut hole," repealing the six demonstration projects, allowing Americans to import price-controlled drugs from Canada and Europe, and insisting that the federal government use its bulk-purchasing power to "negotiate" lower drug prices. But that's tomorrow's fight. As it stands, the 2003 Medicare bill is an important starting point for reform. It cracks the door by engaging consumers and competition in a sector of the economy dominated by government-fixed prices and bureaucratic control. The challenge for lawmakers will be to build on these reforms, not revert to greater political control over the health-care economy.

Grace-Marie Turner is president of the Galen Institute in Alexandria, Va.