America’s finances are in a mess, and Medicare is one of the main reasons. But the good news—just confirmed by the Congressional Budget Office—is that there’s a way to save money for Medicare patients and taxpayers.

Our health care spending crisis is largely due to the structural deficiencies and demographic challenges of the Medicare program. The CBO’s new report estimates significant potential savings from a much-needed Medicare reform.

The reform is on the basis of a “premium support” (defined contribution) system of financing. This means that seniors would receive government support for their health insurance, but they would have more choices in health coverage on a competitive basis. Heritage has long supported this reform, but it is not the only one. There is wide support for this approach to reforming Medicare, and CBO’s report is the latest addition to a rich and growing professional literature.

Premium support would bring competition into the Medicare program, which would help bring down costs. In its latest analysis, CBO modeled two different premium support options. In the first option, the payment for health plans (including traditional Medicare) would be set at the second-lowest bid among competing plans in a region. This is the method proposed by Congressman Paul Ryan (R-WI) and Senator Ron Wyden (D–OR) and separately by former CBO Director Alice Rivlin of the Brookings Institution and former Senator Pete Domenici (R–NM). The second option is to base Medicare plan payments on a “weighted average” of health plan bids, broadly similar to what is done today in the popular and successful Federal Employees Health Benefits Program (FEHBP) that serves federal employees and retirees and their families. In both cases, CBO finds, this major financing reform achieves serious program savings.

Three key CBO findings:

1. The reform reduces Medicare spending.

“CBO estimates that the second-lowest-bid option would reduce net federal spending for Medicare by about $45 billion in 2020 and that the average-bid option would reduce such spending in that year by about $15 billion.” CBO scoring is, of course, conducted on the basis of current law. So, CBO’s savings estimates are conservative, since they are based on the untenable assumption that Obamacare’s massive Medicare payment reductions (estimated at $716 billion over the next 10 years) and the statutorily required 25 percent cut in Medicare physician payments in 2014 go into effect. But these draconian cuts will likely be overridden.

Thus, if these provisions are overridden, the more realistic Medicare spending base would be substantially higher, meaning that the potential for additional savings from premium support would also be proportionately higher.

2. Medicare beneficiaries could secure premium savings.

Under the average bid option, average beneficiary premiums would be reduced by 6 percent in 2020. Under the second-lowest bid benchmark, the CBO estimates that premiums would increase. But CBO makes a counterintuitive assumption in both estimates: It assumes that about half of beneficiaries would stay in traditional Medicare, despite paying much higher premiums than they would under a competing private plan.

The CBO estimates that under the second-lowest bid option, average nationwide premiums would be $1,800 in private plans and $2,500 for traditional Medicare. Under the average-bid option, average premiums would be $1,000 for private plans and $2,000 for traditional Medicare. This means that under these scenarios, about half of all beneficiaries would choose to pay nearly 40 percent and 100 percent more, respectively. The idea that seniors are somehow uniquely price insensitive is intriguing if not fanciful, but the CBO report actually underscores a fundamental truth: Competing private plans in a Medicare premium support program, with the same actuarial value as traditional Medicare, would cost less.

3. In choosing private plans, seniors could also reduce their out-of-pocket costs.

According to the CBO analysis, “In 2020, beneficiaries’ total payments would be about 11 percent higher, on average, under the second-lowest-bid option and about 6 percent lower, on average, under the average bid option than they would be under current law.” CBO indicates that total payments would be higher under the second-lowest bid option because CBO assumes many people won’t switch out of higher cost traditional Medicare into cheaper health plans. Nonetheless, the CBO says, “out-of-pocket costs [i.e. deductibles, copayments, etc.] generally would be lower than under current law because more beneficiaries would enroll in lower-bidding private plans, which would tend to reduce the total costs of care while maintaining the required actuarial value.” [Emphasis added].

A better deal for both taxpayers and seniors. As CBO states, “The sum of net federal spending for Medicare and beneficiaries’ total payments as discussed above would be about 5 percent lower in 2020 under the second-lowest-bid option than under current law, CBO estimates. Under the average-bid option, combined payments would be about 4 percent lower than under current law.”

CBO’s report comes at a critical time. The Medicare Part A trust fund is projected to be exhausted by 2026 and under the most realistic scenario, the Medicare program has a long-term unfunded obligation of approximately $36 trillion.

Medicare is unsustainable in its current form. Reform based on “premium support” is the best option. It would reduce costs while increasing quality and guaranteeing real consumer choice.