Republicans and Democrats have gotten into quite a tussle over Medicare, with Republicans claiming that President Obama’s health care law (i.e., ObamaCare) cuts Medicare by $716 billion (over 10 years). And Democrats are complaining that Republican vice presidential candidate Paul Ryan’s “premium support” Medicare reform would force seniors to pay more out of pocket.

Both sides are trying to use the mantra of “they’re cutting Medicare”-even though no one’s really cutting, just slowing the rate of growth-as a way to hammer the opposing party and drum up senior support.
But here’s the dirty little secret: Medicare spending could be cut, a lot, without doing any harm to seniors’ health. But that will only happen IF the right checks and balances as well as economic incentives are put into place. ObamaCare takes one good step by trying to reduce Medicare fraud, but it stops there. Ryan’s plan, by contrast, takes a much bigger step by creating the right economic incentives.
According to the Medicare Trustees, the Medicare program covered 48.7 million people in 2011 and cost $549 billion, or about $11,300 per Medicare beneficiary.

How much of that money is fraud and abuse? How much of it is internal inefficiencies? And how much of that is just plain waste due to the program’s perverse financial incentives? No one knows for sure, but we can guess.
Medicare Fraud. In 2011, the Government Accountability Office claimed Medicare spent $48 billion in “improper payments,” which include fraud but also waste, eligibility errors, miscoded claims and insufficient documentation. GAO determined that Medicare’s traditional fee-for-service plan had a 10.5 percent error rate.

Many people, including Attorney General Eric Holder, suggest there may be $60 billion in annual Medicare fraud, about 12 percent of Medicare spending. It’s a lot of money, but it may just be the tip of the iceberg.

The good news is that fraud is finally on Washington’s docket, but the jury is still out on how effective its efforts will be. For example, Congress gave the Department of Health and Human Services (HHS) $77 million to initiate a major antifraud push. The agency spent $3.6 million on a just-completed state-of-the-art antifraud command center.
But Republican Senators Orrin Hatch and Tom Coburn have raised questions about some of HHS’s antifraud initiatives. Though the agency launched its antifraud computer system last summer, by Christmas it had only identified one suspicious payment: for $7,591.

Internal Inefficiencies. Supporters of government-run health care often claim that Medicare is the most efficient health insurance program in the country, with just 2 to 3 percent administrative overhead. But that oft-cited admin cost just covers printing the Medicare checks [see here]. It doesn’t cover rent on the building, salaries, management, employee health coverage and pensions. So while the real cost is much higher, it could be much lower.
Besides overt fraud and abuse, the Medicare program is loaded with internal inefficiencies. In 2008 PricewaterhouseCoopers estimated there is between $21 billion and $210 billion of waste in health claims processing (all claims, not just Medicare). Claims that can be electronically adjudicated cost a health insurer around 85 cents to process. Claims needing personal attention can easily hit $2.05 or more, according to America’s Health Insurance Plans.

Many private sector health insurers are able to process about 80 percent of their claims electronically, but some companies have hit 90 percent or more. While insurers are increasingly contracting with companies that can help generate those efficiencies, the Medicare program has been slow to move.
Proper Financial Incentives. Perhaps the biggest problem facing Medicare is that it discourages consumers from being value-conscious shoppers in the health care marketplace. And Medicare will never really control spending until it does.

The PWC study mentioned above also asserted, “Our research found that wasteful spending in the health system has been calculated at up to $1.2 trillion of the $2.2 trillion spent in the United States, more than half of all health spending.” Of course, that figure is for the whole health care system, but if PWC is anywhere close to right, Medicare waste could approach $200 billion a year or more.

The best way to reduce that amount effectively is to give consumers a reason to bring their consumer skills to health care just as they do to every other sector of the economy. And that means consumer-driven health plans (CDHPs) that include health insurance for expensive accidents and illnesses along with a tax-free account to pay smaller and routine health care expenditures-similar to the kind of plans some 13.5 million people of under-age-65 Americans already have.

In the great debate over Medicare reform, ObamaCare tries to address the fraud problem, but it is still unclear how effective that effort will be. It tries to address efficiency by empowering panels-which will never see the patient-to decide what therapies and drugs doctors and patients have access to. The law does not empower patients because it doesn’t trust them.

Ryan’s premium support model, by contrast, tries to get the financial incentives right-by putting the money in the hands of consumers. People will have a reason to look for value for their health care dollar. That one change, if implemented correctly, would dramatically reduce Medicare spending while improving care rather than rationing it. It might not solve all of Medicare’s financial problems, but it’s a very good step in the right direction.

Originally posted at Forbes.

Merrill Matthews, Ph.D., is a resident scholar with the Institute for Policy Innovation, a research-based, public policy “think tank.” He is a health policy expert and weekly contributor at Forbes.com. He also serves as Chair of the Texas Advisory Committee of the U.S. Commission on Civil Rights.