Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform

Published by the Government Accountability Office on 1999-03-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          United States General Accounting Office

GAO                       Testimony
                          Before the Committee on Finance, U.S. Senate

For Release on Delivery

Expected at               MEDICARE AND BUDGET
10 a.m.


March 10, 1999

                          GAO’s Perspective on the
                          President’s Proposal and
                          the Need for Reform
                          Statement of David M. Walker
                          Comptroller General of the United States

Mr. Chairman and Members of the Committee:

It is a pleasure to be here today to discuss the President’s recent proposal

for addressing Medicare and use of the projected budget surpluses over the

next 15 years. As you know, I testified last month on the implications of the

President’s surplus proposals for Social Security. Today, I will briefly

reprise our views on the overall fiscal consequences of the proposal,

discuss what it does and does not do for the Medicare program, and

examine the importance of and difficulty in making fundamental changes

to this complex program.

Regarding the President’s proposal:

•   It would significantly reduce debt held by the public from current levels,

    thereby also reducing net interest costs, raising national savings, and

    contributing to future economic growth. This element of the President’s

    proposal would have positive short- and long-term effects on the


•   It provides a grant (or in the President’s word, a gift) of a new set of

    Treasury securities for the Medicare Hospital Insurance (HI) program

    which would extend the life of the HI trust fund from 2008 to 2020. It is

    important to note, however, that these new Treasury securities would

    constitute a new unearned claim on general funds for the HI program--a

    marked break with the payroll tax-based financing structure of the

    program. This would be a significant change that could serve to

    undermine the remaining fiscal discipline associated with the self-

    financing trust fund concept.

•   It has no effect on the current and projected cash-flow deficits that have

    faced the HI program since 1992–deficits that taxpayers will continue to

    finance through higher taxes, lower spending elsewhere or lower

    paydowns of publicly held debt than the baseline. Importantly, the

    President’s proposal would not provide any new cash to pay for medical


•   It does not include any meaningful program reform that would slow

    spending growth in the HI program. In fact, the transfer of these new

    Treasury securities to the HI program could very well serve to reduce a

    sense of urgency for reform. At the same time, it could strengthen

    pressure to expand Medicare benefits in a program that is

    fundamentally unsustainable in its present form.

The current Medicare program is both economically and fiscally

unsustainable. This is not a new message--the Medicare Trustees noted in

Page 1                                                   GAO/T-AIMD/HEHS-99-113
                       the early 1990s that the program is unsustainable in its present form. They

                       also noted the need for dramatic and fundamental reform of the program to

                       assure its solvency.   With regard to Medicare:

                       •   The program’s continued growth threatens to crowd out other spending

                           and economic activity of value to our society. Even if we save the entire

                           surplus, Medicare is projected to more than double its share of the

                           economy by 2050.

                       •   Meaningful reform of this program is urgently needed and such reform

                           will require hard choices. The program changes enacted in 1997

                           illustrate how difficult even incremental reform is to adopt. Major

                           change requires reshaping the nation’s perspective on health care

                           consumption and drawing distinctions between what the nation needs,

                           wants, and can afford both at the national and individual level.

                       •   To be effective and sustainable, reforms must begin soon and be

                           comprehensive in nature. However, the history of entitlement reforms

                           tell us that, to be enduring, such reforms must be introduced gradually

                           after widespread public education in order to garner sufficient support

                           from the system’s multiple stakeholders.

Context: Long-term     It is important to look at the President’s proposal in the context of the fiscal

Outlook Is Important
                       situation in which we find ourselves. After nearly 30 years of unified

                       budget deficits, we look ahead to projections for “surpluses as far as the

                       eye can see.” At the same time, we know that we face a demographic

                       tsunami in the future that poses significant challenges for Social Security,

                       Medicare, and our economy as a whole. In this context, it is noteworthy

                       that the President has proposed a longer term framework for resource

                       allocation than has been customary in federal budgeting.

                       Although all projections are uncertain—and they get more uncertain the

                       farther out they go—we have long held that a long-term perspective is

                       important in formulating fiscal policy for the nation. Each generation is in

                       part the custodian for the economy it hands the next and the nation’s long-

                       term economic future depends in large part on today’s budget decisions.

                       This perspective is particularly important because our model and that of

                       the Congressional Budget Office (CBO) continue to show that absent a

                       change in policy, the changing demographics to which I referred above will

                       lead to renewed deficits. This longer term problem provides the critical

                       backdrop for making decisions about today’s temporary budget surpluses.

                       Page 2                                                   GAO/T-AIMD/HEHS-99-113
               Surpluses are the result of a good economy and difficult policy decisions.

               They also provide a unique opportunity to put our country on a more

               sustainable path for the long term, both for the nation’s fiscal policy and

               selected entitlement programs. Current decisions can help in several

               important respects: (1) current fiscal policy decisions can help expand the

               future capacity of our economy by increasing national savings and

               investment, (2) engaging in substantive reforms of retirement and health

               programs can reduce future claims, (3) by acting now, we have the

               opportunity of phasing in changes to Social Security and Medicare

               programs over a sufficient period of time to enable our citizens to adjust,

               and (4) failure to achieve needed reforms in the Social Security and

               Medicare programs will drive future spending to levels that will eventually

               “squeeze out” most or all discretionary spending, including national

               defense spending.   If we let the achievement of a temporary budget surplus

               lull us into complacency about the budget, then in the middle of the 21st

               century we could face daunting demographic challenges without having

               built the economic capacity or program and policy reforms to handle them.

The Proposal   Before turning to Medicare specifically, it is important to describe the

               President’s overall proposal for using the surpluses over the next 15 years.

               The proposal’s effects on Medicare are part of a broader initiative to save a

               major share of the surplus to reduce the debt held by the public and

               thereby enhance future economic capacity for the nation.

               The President proposes to use a significant portion of the total projected

               unified budget surpluses over the next 15 years to reduce debt held by the

               public. He also proposes to take some related steps to address the

               financing problems facing both the Medicare and Social Security programs.

               His approach to this, however, is extremely complex and confusing.

               Specifically, the President proposes to allocate about two-thirds of the

               projected surplus over the next 15 years to reduce publicly held debt. This

               portion of his proposal would increase our future economic capacity. At

               the same time, the President proposes to transfer a like amount to the

               Social Security and Medicare trust funds in the form of nonmarketable

               Treasury securities. In effect, the President’s proposal would trade debt

               held by the public for debt held by the Social Security and Medicare trust

               funds. The administration has defended this approach as a way of assuring

               both a reduction in debt held by the public and as securing a “first claim”

               for both Social Security and Medicare on what they call the “debt-reduction

               dividend” to pay future benefits for those two programs. The HI program

               Page 3                                                 GAO/T-AIMD/HEHS-99-113
would receive nearly $700 billion in additional Treasury securities                                 −
representing nearly 15 percent of total surpluses over the 15 years.                                     This

transfer is projected to extend the life of the HI trust fund from 2008 to


The President’s proposal has raised important questions about how the

federal government can promote long-term economic security by using

today’s surplus resources to “save for the future.” In the federal unified

budget, the only way to save for the future is to run a unified budget surplus

or purchase a financial asset. When there is a cash surplus it is used to

reduce debt held by the public. Therefore, to the extent that there is an

actual cash surplus, debt held by the public falls. This is exactly what

happened in fiscal year 1998 when the debt held by the public was reduced

by $51 billion.

In the federal budget, trust funds are not vehicles to park “real” savings for

the future. They are simply budget accounts used to record receipts and

expenditures earmarked for specific purposes. A private trust fund can set

aside money for the future by increasing its assets. State governments

similarly can “park” surplus resources in “real” pension funds and other

trust funds that are routinely invested in “assets” (e.g., readily marketable

securities) outside the government. However, under current law, when a

trust fund like HI ran a surplus of payroll tax revenues over benefit

payments, the excess was invested in Treasury securities and used to meet

current cash needs of the government. These securities are an asset to the

trust fund, but they are a claim on the Treasury. When a trust fund runs a

cash deficit, like HI has been doing since 1992, it redeems these securities
to pay benefit costs exceeding current payroll tax receipts.                                   Medicare will

be able to do this until 2008 under current law when its trust fund securities

will be exhausted. However, in order to redeem these securities, the

government as a whole must come up with the cash by either increasing

taxes, reducing spending, or raising borrowing from the public above the


Increasing the balances of Treasury securities owned by HI trust funds

alone would increase the formal claim that the trust funds have on future

general revenues since the trust fund’s securities constitute a legal claim

    With the additional interest these new securities would earn, total assets held by the HI trust fund
would go up by over $1 trillion.

    This may mean either using interest or the principal itself to cover the difference.

Page 4                                                                          GAO/T-AIMD/HEHS-99-113
                       against the Treasury. However, increasing the HI trust fund balances alone,

                       without underlying reform, does nothing to make the program more

                       sustainable. From a macro perspective, the critical question is not how

                       much a trust fund has in assets, but whether the government as a whole has

                       the economic capacity to finance the trust funds claims to pay benefits now

                       and in the future. From a micro perspective, trust funds can provide a vital

                       signaling function for policymakers about underlying fiscal imbalances in

                       covered programs. However, extending a trust fund’s paper solvency

                       without reforms to make the underlying program more sustainable can, in

                       effect, obscure the warning signals that trust fund balances provide.

Government Financing   The President’s proposals would enhance the nation’s future economic

                       capacity by significantly reducing debt held by the public from the current

                       level of 44 percent of gross domestic product (GDP) to 7 percent over the

                       15-year period. The President notes that this would be the lowest level

                       since 1917.        Nearly two-thirds of the projected unified budget surplus

                       would be used to reduce debt held by the public. Because the surplus is

                       also to be used for other governmental activities, the amount of debt

                       reduction achieved would be less than the baseline (i.e., a situation in

                       which none of the surplus was used), but nonetheless the outcome would

                       confer significant short- and long-term benefits on the budget and the


                       Our previous work on the long-term effects of federal fiscal policy has
                       shown the substantial benefits of debt reduction.                        One of these is lowering

                       the burden of interest payments in the budget. Today, net interest

                       represents the third-largest “program” in the budget, after Social Security

                       and Defense. Interest payments, of course, are a function of both the

                       amount of debt on which interest is charged and the interest rate . At any

                       given interest rate, reducing publicly held debt reduces net interest

                       payments within the budget. For example, CBO estimates that the

                       difference between spending the surplus and saving the surplus is

                       $123 billion in annual interest payments for debt held by the public by

                       2009--or almost $500 billion cumulatively between now and then.

                       Compared to spending the entire surplus, the President’s proposal would

                       also substantially reduce projected interest payments .                       Lower interest

                       payments lead to larger surpluses; these in turn lead to lower debt which

                           Budget Issues: Analysis of Long-Term Fiscal Outlook   (GAO/AIMD/OCE-98-19, October 22, 1997).

                       Page 5                                                                     GAO/T-AIMD/HEHS-99-113
leads to lower interest payments and so on: The miracle of compound

interest produces a “virtuous circle.” The result would be to provide

increased budgetary flexibility for future decisionmakers who will be faced

with enormous and growing spending pressures from the aging population.

For the economy, lowering debt levels increases national saving and frees

up resources for private investment. This in turn leads to increased

productivity and stronger economic growth over the long term. Over the

last several years, we and CBO have both simulated the long-term

economic results from various fiscal policy paths. These projections

consistently show that reducing debt held by the public increases national

income over the next 50 years, thereby making it easier for the nation to

meet future needs and commitments. Our latest simulations done for the

Senate Budget Committee, as shown in figure 1, illustrate that any path

saving all or a significant share of the surplus in the near term would
produce demonstrable gains in per capita GDP over the long run.                                   This

higher GDP in turn would increase the nation’s economic capacity to

handle all its commitments in the future.

    The “on-budget balance” path assumes that any surplus in the non-Social Security part of the budget is
“spent” on either a tax cut or spending increases or some combination but assumes the current law path
for the Social Security trust fund (SSTF). Thus, the surplus in the Social Security trust fund remains
untouched until it disappears in 2013 after which the unified budget runs a deficit equal to the SSTF
deficit. The “save the surplus” path assumes no changes in current policies and that budget surpluses
through 2024 are used to reduce debt held by the public. The “no surplus” path assumes that permanent
increases in discretionary spending and tax cuts deplete the surpluses but keep the budget in balance
through 2009. Thereafter, deficits reemerge as spending pressures grow.

Page 6                                                                       GAO/T-AIMD/HEHS-99-113
Figure 1: GDP Per Capita Under Alternate Fiscal Policy Simulations
Per capita 1998 dollars








30,000                                                           1998 level


            1998          2002   2006      2010         2014      2018        2022   2026       2030    2034   2038    2042      2046   2050

                                    On-budget balance                                Save the surplus                    No surplus

                                                        Source: GAO Analysis.

                                                        While reducing debt held by the public appears to be a centerpiece of the

                                                        President’s proposal—and has significant benefits—as I noted above, the

                                                        transfer of a portion of the unified surpluses to the HI trust fund is a

                                                        separate issue. The transfer is not technically necessary: Whenever

                                                        revenue exceeds outlays and the cash needs of the Treasury, debt held by

                                                        the public falls.

                                                        Page 7                                                        GAO/T-AIMD/HEHS-99-113
                     The President’s proposal appears to be premised on the belief that the only

                     the way to sustain surpluses is to tie them to Social Security and Medicare.

                     He has merged two separate questions: (1) How much of the surplus should

                     be devoted to reducing debt held by the public? and (2) How should the

                     nation finance these two programs in the future? The President has

                     proposed to save the surplus by, in effect, hiding it in the Social Security

                     and HI trust funds. The additional nonmarketable Treasury securities

                     transferred to the Social Security and Medicare trust funds are recorded as

                     a subtraction from the unified budget surplus–a new budgetary concept.

                     Accordingly, the surplus disappears under this novel scoring approach

                     since these transfers approximate the surplus the President is proposing to
                     save by reducing publicly held debt.

                     Let me turn now to the question of how the President’s proposal would

                     affect Medicare financing.

Impact on Medicare   The mechanics of the proposed transfer of surpluses to the Medicare

                     program are, like the transfers to Social Security, complex and difficult to

                     follow. In form they are similar, but the effects on Medicare would be

                     somewhat different. Unlike Social Security, Medicare’s HI program has

                     been experiencing a cash flow deficit since 1992–current payroll taxes and

                     other revenues have been insufficient to cover benefit payments and

                     program expenses. Accordingly, Medicare has been drawing on its special

                     Treasury securities, along with interest on those accumulated balances,

                     acquired during the years when the program generated a cash surplus. In

                     effect, these general fund payments can be viewed as repaying the loan of

                     cash that the trust fund provided the rest of government when the Medicare

                     program was in surplus. In fiscal year 1999, the HI program will run a cash

                     deficit of $8 billion. As noted earlier, in order to redeem these securities,

                     the government must either raise taxes, cut spending, or increase

                     borrowing from the public. In essence, Medicare has already crossed the

                     point where it is a net claimant on the Treasury–a threshold that Social

                     Security is not currently expected to reach until 2013. Stated differently,

                     the bleeding of the HI trust fund has already started based on the program’s

                     annual cash flow deficits.

                         The President also proposes to use about 13 percent of these surpluses to purchase stocks for Social

                     Page 8                                                                       GAO/T-AIMD/HEHS-99-113
The current financing flows for the HI program are depicted in figure 2

below. As the figure shows, to help pay benefits in fiscal year 1999, the HI

trust fund receives an $8 billion general fund payment for interest it earned

on its treasury securities from its past cash surpluses. The HI fund also

receives $5 billion for a portion of the income taxes paid on Social Security


Figure 2: Medicare Flows Under Current Law

                                     Unified Budget

            Payroll Taxes*                                               Other Taxes

                                       Claims for interest
                                    earned on past surpluses
      Hospital Insurance
                                                                  General Fund
         Trust Fund
                                         Cash for benefit
                                     payments and additional
                                        special treasuries
               Benefits                                          Spending

                                                                 Unified surplus would pay down
                                                                   the debt held by the public

*Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security
Source: GAO Analysis.

Under the President’s proposal, the above scenario would continue.

However, as shown in figure 3, at the point where total tax receipts are

allocated to pay for government activities, a new financing step would be

added to “transfer” a portion of the projected unified budget surpluses to

the Medicare HI trust fund. The Treasury would do this by issuing a new

set of securities for the HI trust fund. Unlike the current securities owed

the trust fund, these new securities are not supported by payroll tax

surpluses in the program; rather, they represent what amounts to a grant or

gift. However, it is important to remember that these new securities equal a

Page 9                                                                  GAO/T-AIMD/HEHS-99-113
portion of the excess cash that would be used to reduce the debt held by

the public. The administration argues that the new securities are, in effect,

supported by the enhanced economic resources gained by reducing

publicly held debt. Nonetheless, we should remember that under the

current law baseline—i.e., with no changes in tax or spending policy—this

would happen without crediting additional securities to either the Social

Security or Medicare trust funds.

Figure 3: Medicare Flows Under President’s Proposal

                                     Unified Budget

            Payroll Taxes*                                                Other Taxes

                                       Claims for interest
                                    earned on past surpluses
      Hospital Insurance
                                                                   General Fund
         Trust Fund
                                         Cash for benefit
                                     payments and additional
                                        special treasuries
               Benefits                                           Spending
                                       Transfer for
                                       Trust Fund
                                                                 Unified surplus would pay down
                                         New Special               the debt held by the public

*Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security
Source: GAO Analysis.

The financial consequences of this transfer are depicted in figure 4 below.

This graph first shows that by providing the additional Treasury securities,

the solvency of the Hospital Insurance trust fund would be extended from

2008 to 2020. However, the figure also shows that the President’s proposal

does nothing to alter the imbalance between the program’s tax receipts and

benefit payments. It has been in cash deficit since 1992 and remains in a

cash deficit even with the new Treasury securities. Thus, the President

Page 10                                                                 GAO/T-AIMD/HEHS-99-113
                                                proposes to provide additional claims on the Treasury, not additional cash

                                                to pay benefits.

Figure 4: Medicare Hospital Insurance Trust Fund Financial Outlook Under President’s Proposal



                Cash Deficit 1992













 - 100

 - 200

 - 300

 - 400

                                    Cash Surplus/Deficit      T rust F und Balance    T rust F und Balance with T ransfer

                                                Source: GAO Analysis.

                                                Notwithstanding the fact that no real cash is exchanged, the transfer of

                                                additional securities to Medicare is a discretionary act with major

                                                economic consequences for the future financing of the HI program. As

                                                with Social Security, this proposal represents a fundamental shift in the

                                                way the HI program is financed. It moves it away from payroll financing

                                                toward a formal commitment of future general fund resources for the

                                                program for the future. The general fund obligation would begin far earlier

                                                than for Social Security. Specifically, the HI trust fund would begin

                                                drawing on the general fund to redeem these new securities in 2008–well

                                                before the full reduction in publicly held debt and associated benefits to the

                                                general fund will have been realized under the President’s plan. In addition,

                                                Page 11                                                                GAO/T-AIMD/HEHS-99-113
this is 24 years before the Social Security Trust Fund would begin drawing

on the additional Treasury securities that the President is proposing to

grant to that program.

The transfer would constitute an explicit general fund subsidy for the HI

program–a subsidy whose magnitude is unprecedented for this program.

This is true because the newly transferred securities would be in addition

to any buildup of historical payroll tax surpluses. Securities held by the

trust fund have always represented the value of the loan of its surpluses to

the Treasury--annual cash flows in excess of benefits and expenses, plus

interest. Under the President’s proposal, the value of securities held by the

HI trust fund would exceed that supported by earlier payroll tax surpluses

and constitute a new and unearned claim on the general fund for the future.

In effect, the proposal would shift the financing of the HI Trust Fund to

look more like that for the Part B Supplemental Medical Insurance (SMI)

Trust Fund. The SMI portion of Medicare obtains 75 percent of its revenues

from a general fund subsidy, with the remainder supported by beneficiaries’


This is a major change in the underlying theoretical design of the HI

program. Whether you believe it is a major change actually depends on

what you assume about the likely future use of general revenues under the

current circumstances. For example, current projections are that the HI

Fund will exhaust its securities to pay the full promised benefits in 2008. If

you believe that this shortfall would—when the time came—be made up

with general fund moneys, then the shift embedded in the President’s

proposal merely makes that explicit. If, however, you believe that there

would be changes in the benefit or tax structure of the fund instead, then

the President’s proposal represents a very big change. In this case, less of

the long-term shortfall would be addressed through future changes in the

HI program itself and more would financed through higher taxes or

spending cuts elsewhere in the federal budget as a whole. Thus, the

question of bringing significant general revenues into the financing of the

HI program is a question that deserves full and open debate. The debate

should not be overshadowed by the accounting complexity and budgetary

confusion of the President’s proposal.

In our view, the proposal carries some significant risks that should be

carefully considered by the Congress. One risk is that the transfers to both

the Medicare and Social Security trust funds would be made regardless of

whether the expected budget surpluses are actually realized. The amounts

to be transferred apparently would be written into law as either a fixed

Page 12                                                 GAO/T-AIMD/HEHS-99-113
                      dollar amount or as a percent of taxable payroll rather than as a percent of

                      the actual unified surplus in any given year. These transfers would have a

                      claim on the general fund even if the actual surplus fell below the amount

                      specified for the transfers. However, it is important to emphasize that any

                      proposal to allocate surpluses is vulnerable to the risk that those projected

                      surpluses may not materialize. Proposals making permanent changes to

                      use the surplus over a long period are especially vulnerable to this risk.

                      The history of budget forecasts should remind us not to be complacent

                      about the certainty of these large projected surpluses. In its most recent

                      outlook book, CBO compared the actual deficits or surpluses for 1988-1998

                      with the first projection it produced 5 years before the start of each fiscal

                      year. Excluding the estimated impact of legislation, CBO says its errors

                      averaged about 13 percent of actual outlays. Such a shift in 2004 would

                      mean a surplus $250 billion higher or lower; in 2009, the swing would be

                      about $300 billion. Accordingly, we should consider carefully any

                      permanent commitments that depend on the realization of a long-term


The Compelling Need   A more significant risk of the President’s proposal is that by appearing to

for Fundamental
                      extend financial stability for Medicare, it could very well undercut the

                      incentives to engage in meaningful and fundamental reform of the HI

Program Reform        program—reform that is vital to making the HI program sustainable over

                      the long term. Unlike Social Security, the HI program is already in a

                      negative cash flow position—payroll taxes support 89 percent of spending

                      now and will cover less than one half 75 years from now. Even in the short

                      term, the HI program’s annual outlays grow by several times the rate of

                      general inflation. Although its growth has slowed in recent years, it remains

                      one of the most volatile and uncontrollable programs in the federal budget.

                      According to CBO, the growth of Medicare—both HI and SMI-- will

                      increase its share of the economy by nearly a full percentage point over the

                      next 10 years, from 2.5 percent to 3.3 percent of GDP in 2009. By contrast,

                      the share devoted to Social Security is projected to remain relatively flat

                      during this period rising from 4.4 percent of GDP in 1999 to 4.7 percent in


                      Over the long term, the program’s growth rates are more daunting. Absent

                      any changes, the combined Medicare program (i.e., HI and SMI) is

                      projected to more than double its share of the economy by 2050–from 2.7

                      percent now to 6.8 percent based on the Medicare Trustees’ most recent

                      best estimated assumptions. When coupled with Medicaid, federal health

                      Page 13                                                 GAO/T-AIMD/HEHS-99-113
                                           care costs will grow to nearly 10 percent of GDP by 2050, as depicted in

                                           figure 5. The progressive absorption of a greater share of the nation’s

                                           resources for health is, like Social Security, a reflection of the rising share

                                           of elderly in the population. However, health care growth rates also reflect

                                           the escalating cost growth of health care at rates well exceeding general

                                           rates of inflation. Increases in the number and quality of health services

                                           fueled by the explosive growth of medical technology has spurred much of

                                           this extraordinary cost growth in health care. Consequently, Medicare

                                           represents a much greater and more complex fiscal challenge than even

                                           Social Security over the longer term.

Figure 5: Medicare and Medicaid as a Share of GDP
Percentage of GDP












       1998   2002   2006    2010     2014      2018      2022      2026        2030    2034       2038      2042      2046      2050

                                    Medicare Part A           Medicare Part B              Medicaid

                                           Source: GAO’s “save the surplus” long-term simulation based on HCFA’s 1998 intermediate
                                           projections for Medicare spending and CBO’s May 1998 projections for Medicaid spending.

                                           The President’s proposal to strengthen the HI program is more perceived

                                           than real. Specifically, while the HI trust fund will appear to have more

                                           Page 14                                                             GAO/T-AIMD/HEHS-99-113
resources as a result of the President’s proposal, in reality nothing about

the program has really changed. The proposal does not represent program

reform but rather a supplemental means to finance the current program.

Stated differently, the reform proposed has more form than substance.

What is most alarming is that the President’s proposal could induce a sense

of false complacency about the financial health of the HI program. The

impending insolvency of the HI program sends important signals to

policymakers that the program needs to be made more affordable through

benefit changes, revenue increases, or both. The 2008 date has become an

important cue to policymakers that could provide the impetus needed to

make the hard choices necessary to promote the solvency and

sustainability of the HI program for the long term. Extending the life of the

HI trust fund without substantive program reform could be a recipe for

delay and denial that could increase the ultimate fiscal and social cost of HI

program reform. At a minimum, the President’s proposal is likely to create

a public misperception that something meaningful is being done to reform

the Medicare program.

Changes to the HI program should be made sooner rather than later. The

longer meaningful action is delayed, the more severe such actions will have

to be in the future. Since Medicare is the fastest growing sector of the

federal budget, early action to reduce its costs will have compounding

fiscal benefits. Even if the rate of growth is not changed, reducing the base

level of spending can produce outyear dividends for the program’s

finances. Moreover, acting now would allow changes to benefits and health

care delivery systems to be phased in gradually so that stakeholders and

participants can adjust their saving or retirement goals accordingly.

When viewed together with Social Security, the programs’ financial burden

on the future economy takes on daunting proportions. As figure 6 shows,

the cost of these two programs would nearly double as a share of the

payroll tax base over the long term. Assuming no other changes, these

programs would constitute an unimaginable drain on the earnings of our

future workers, even without including the financing challenges of the SMI


Page 15                                                GAO/T-AIMD/HEHS-99-113
Figure 6: Social Security and Medicare’s HI Program as a Percentage of Taxable Payroll








                                                       Current Level




































                                          Note: Taxable payrolls of the two trust funds are different. For analytic purposes, they have been
                                          combined by the Social Security Trustees.
                                          Source: 1998 Social Security Trustees’ Report.

                                          There is another reason to take early action to reform both Social Security

                                          and Medicare costs. Reducing the future costs of these programs is vital to

                                          reclaiming our nation’s future capacity to address other important needs in

                                          the public sector. To move into the future without changes in the Social

                                          Security, Medicare, and Medicaid programs is to envision a very different

                                          role for the federal government. Assuming no financing or benefit changes,

                                          our long-term model (and that of CBO) shows a world in 2050 in which

                                          Social Security, Medicare, and Medicaid absorb a much greater share of the

                                          federal budget. (See figure 7.) Budgetary flexibility declines drastically

                                          and there is increasingly less room for programs for national defense, the

                                          Page 16                                                                 GAO/T-AIMD/HEHS-99-113
young, infrastructure, and law enforcement—i.e., essentially no

discretionary programs at all. Eventually, again assuming no program or

financing changes, Social Security, health and interest consume nearly all

the revenue the federal government takes in by 2050. This is true even if

we assume that the entire unified budget surplus is saved and these

continued surpluses reduce interest from current levels. As shown in

figure 8, the picture is even more dramatic if we assume the entire unified
budget surplus is used.                 In that scenario, lower GDP and higher interest

payments lead to a world in which revenues cover only Social Security,

health, and interest in 2030. And in 2050 revenues do not cover Social

Security and federal health expenditures alone! Although views about the

role of government differ, it seems unlikely that many would advocate a

government devoted solely to sending Social Security checks and health

care reimbursements to the elderly.

    Our "no surplus" simulation is not a forecast but rather an illustration of the implications of taking
fiscal actions that eliminate projected surpluses and the fiscal pressures posed by the aging of the baby
boom generation. This simulation shows ever-increasing deficits that result in declining investment, a
diminishing capital stock, and a collapsing economy. In reality, these economic consequences would
inevitably force policy changes to avert such a catastrophic outcome.

Page 17                                                                         GAO/T-AIMD/HEHS-99-113
Figure 7: Composition of Spending as a Share of GDP Under “Save the Unified Surplus” Simulation
Percentage of GDP





30                        Revenue




                        1998                                   2030                               2050

      Social Security           Medicare & Medicaid                   Net Interest      All other spending

                                            Source: GAO Analysis.

                                            Page 18                                                  GAO/T-AIMD/HEHS-99-113
Figure 8: Composition of Spending as a Share of GDP Under “No Unified Surplus” Simulation
      Percentage of GDP









                             1998                                     2030                       2050

   Social Security                  Medicare & Medicaid                      Net Interest   All other spending

                                              Source: GAO Analysis.

                                              Page 19                                            GAO/T-AIMD/HEHS-99-113
Mounting Pressures on   It is clear that real and substantive reform of Medicare is essential to

Medicare Spending
                        achieving the long-term solvency and sustainability for the program itself–it

                        is not a question of whether, but when and how. However, multiple factors

Pose Challenges for     complicate and magnify the challenges involved in achieving such

Long-term Program       fundamental program reform.

Viability               Substantial growth in Medicare spending will continue to be fueled by

                        demographic and technological change. Medicare’s rolls are expanding

                        and are projected to increase rapidly with the retirement of the baby boom

                        generation. For example, today’s elderly make up about 13 percent of the

                        total population; by 2030, they will comprise 20 percent as the baby boom

                        generation ages. Individuals aged 85 and older make up the fastest growing

                        group of Medicare beneficiaries. So, in addition to the increased demand

                        for health care services due to sheer numbers, the greater prevalence of

                        chronic health conditions associated with aging will further boost


                        Compounding the cost pressures of serving a larger and needier Medicare

                        population are the costs associated with the scientific breakthroughs for

                        treating medical conditions and functional limitations. Technological and

                        treatment advances have resulted in more services being provided to more

                        beneficiaries. These services can restore health, reduce pain, increase

                        functioning, and extend lives. Medical miracles abound, such as

                        medications that reduce the permanent damage resulting from heart

                        attacks, hip replacements that improve the health and quality of life for

                        many, and therapy regimens that promote recovery from what previously

                        would have been debilitating strokes. The frequency and intensity of some

                        high-tech services, however, may be of limited clinical value or fail to

                        improve the quality of beneficiaries’ lives.

                        These technological advances feed the public’s expectations that more

                        health care is better. Some expect virtually unlimited services to treat any

                        condition. However, the actual costs of health care consumption are not

                        transparent. Third-party payers generally insulate consumers from the cost

                        of care decisions. In traditional Medicare, for example, the impact of the

                        cost-sharing provisions designed to curb the use of services is muted,

                        because about 80 percent of beneficiaries have some form of supplemental

                        health care coverage (such as Medigap insurance) that pays these costs.

                        The demographic spiral will increase health care needs over the

                        foreseeable future, while technological changes have begun expanding

                        Page 20                                                 GAO/T-AIMD/HEHS-99-113
                   health care demand. But of this demand, how much are “needs” and how

                   much are “wants”? The distinction is blurred by the effect of scientific

                   advances making available new treatments—which may not be universally

                   applicable or necessarily effective—while individuals continue to be

                   insulated from the full costs of care. At the same time, financial incentives

                   to expand service use fail to be held in check by reasonable assessments of

                   what society can afford.

                   While these financial questions loom, pressure is mounting to update

                   Medicare’s outdated benefit design. However, doing so carries with it the

                   potential to exacerbate Medicare’s spending trajectory. Consider the case

                   of prescription drug coverage. In 1965, when the program was first

                   established, outpatient prescription drugs were not nearly as important a

                   component of health care as they are now. Used appropriately,

                   pharmaceuticals can cure diseases, improve quality of life, and substitute

                   for more expensive services. Most private insurance options and Medicaid

                   programs recognize these advantages by including pharmaceutical

                   coverage in their benefit packages. Many seek to similarly modernize

                   Medicare’s benefits. However, this desired expansion comes at a time

                   when pharmaceutical companies are increasingly marketing their products

                   directly to consumers—raising the specter that wants will grow well

                   beyond actual needs. Thus, the question of whether to include prescription

                   drugs in Medicare’s benefit package illustrates the importance of

                   affordability counterweights to moderate notions of health care wants.

BBA Reforms        The kinds of reforms needed to put Medicare on a more sustainable footing

Overshadowed by
                   for the future will require hard choices. Real changes in providers’ incomes

                   and services to beneficiaries will undoubtedly be necessary. Substantive

Magnitude of the   reform, not simple financing shifts among funds within the budget--which

Problem            have been all too frequent in the past as a way to delay the inevitable day of

                   reckoning--will be required to address this daunting problem.

                   Let’s not kid ourselves--this will not be easy. The Balanced Budget Act of

                   1997 (BBA) illustrates how challenging reforms can be for this program.

                   BBA contains what are probably the most significant changes to Medicare

                   since its inception more than 30 years ago, yet it was never intended to

                   substitute for long-term reform. The changes will extend the HI trust fund’s

                   solvency to 2008 before the baby boomers even begin to draw on the

                   program. The changes will also result in an estimated $385 billion in lower

                   program expenditures over a 10-year period through a combination of

                   savings from constrained provider fees, increased beneficiary payments,

                   Page 21                                                GAO/T-AIMD/HEHS-99-113
and structural reforms. To make even these incremental changes to

Medicare required substantial effort on the part of the Congress.

Effective implementation of BBA has proved daunting to the Health Care
Financing Administration (HCFA), as we have recently testified.

Moreover, to the extent that these changes have produced new winners and

losers among health care providers, pressures to undo the related changes

are growing. Examples include the following.

•      Introduction of prospective payment for certain Medicare services :

       Prospective payment systems will alter how reimbursements are made

       to skilled nursing facilities, home health agencies, hospital outpatient

       departments, and rehabilitation facilities. Rather than paying largely

       whatever costs providers incur, the objective is to fix rates, giving

       providers incentives to deliver care and services more efficiently. Our

       work in this area shows that weaknesses in the design and

       implementation details could substantially erode the expected savings.

       Furthermore, over the past year, the Congress has faced intense

       industry pressure to revisit certain BBA provisions that constrain

       payments to particular groups of providers.

•      Creation of Medicare+Choice: BBA established this new program to

       encourage the expansion of managed care. It represents a first step

       toward the restructuring of Medicare from two perspectives. The first

       addresses cost growth through increased reliance on private sector

       expertise and resources to control costs. The Medicare+Choice

       provisions addressing health plan and beneficiary participation reflect

       in part the expectation that increased managed care enrollment will

       help slow Medicare spending. To date, Medicare managed care has

       failed to meet that promise and, owing to payment methodology flaws,

       has actually cost the government more than if enrolled beneficiaries had

       remained in traditional fee-for-service Medicare. BBA attempts to

       correct this problem by mandating several adjustments to Medicare’s

       payments to managed care plans. These are adjustments that industry

       representatives have sought to delay and that they claim will lead to less
       rather than greater plan participation in Medicare+Choice.

    HCFA Management: Agency Faces Multiple Challenges in Managing Its Transition to the 21st Century
(GAO/T-HEHS-99-58, February 11, 1999).

    See Medicare Managed Care: Better Risk Adjustment Expected to Reduce Excess Payments Overall
While Making Them Fairer to Individual Plans    (GAO/T-HEHS-99-72, February 25, 1999).

Page 22                                                                   GAO/T-AIMD/HEHS-99-113
              The second perspective touches on beneficiary expectations. In principle,

              managed care can reshape consumer behavior. The intent of

              Medicare+Choice is to provide beneficiaries a greater menu of plan choices

              that offer additional benefits, like prescription drugs, not covered in

              traditional Medicare. Simultaneously, however, plans will attempt to

              manage care, thus resulting in beneficiaries facing limits on both traditional

              and additional services. In this way, Medicare+Choice would demonstrate

              that resources are constrained and that expanding choice must involve


              BBA illustrates the temptation to proceed down the slippery slope of

              federal Treasury funding rather than sticking with the more difficult task of

              attempting meaningful program or financing reforms. The act calls for

              reallocating a portion of home health spending from the HI program to the

              SMI program. This is essentially an accounting exercise that moves

              obligations from the HI trust fund account to SMI. While this reallocation

              could position policymakers to develop additional structural reforms for

              this benefit, the movement of home health payments from HI to SMI alone

              generates little net savings. Similarly, 1993 legislation increased the taxable

              portion of Social Security benefits and, for all practical purposes, shifted

              this additional revenue to the HI trust fund. These two shifts illustrate a

              pattern of taking from Peter to pay Paul.

              The lessons learned so far from the BBA experience are twofold. First,

              passing the legislation is a bold first step, but remaining resolute and

              effectively implementing the provisions constitute an equally challenging

              second step. Second, relative to the reforms necessary to align Medicare

              spending with the nation’s priorities for all spending, BBA’s changes may

              represent only a minor excision when major surgery is required to assure

              the HI program’s solvency. BBA did result in reduced costs and cut the

              long-term actuarial imbalance significantly. Nonetheless, the HI and SMI

              programs together are still projected to grow by nearly a full percentage

              point of GDP over the next 10 years.

              The pressures that continue to drive health care spending upward are

              exacerbated by the undefined boundaries between what the nation and

              individuals want, need, and can afford.

Conclusions   Budget surpluses provide a valuable opportunity to capture significant

              long-term gains to both improve the nation’s capacity to address the

              looming fiscal challenges arising from demographic change and aid in the

              Page 23                                                 GAO/T-AIMD/HEHS-99-113
transition to a more sustainable Medicare program. The President’s

proposal should prompt a discussion about the importance of the trust

fund concept in disciplining spending for Medicare. The President’s

proposal is both wide-ranging and complex, and it behooves us to clarify

the consequences for both our national economy and the Medicare


A substantial share of projected budget surpluses over the next 15 years

would be used to reduce publicly held debt, providing demonstrable gains

for our economic capacity to afford our future commitments. Saving a

good portion of today’s surpluses can help future generations of workers

better afford the ballooning costs of these commitments, but we must also

reform the programs themselves to make these commitments more

affordable and sustainable over the long term.

The transfer of surplus resources to the HI trust fund, which the

administration argues is necessary to lock in surpluses for the future,

would nonetheless constitute a major shift in financing for the Medicare

program. However, it would not constitute real Medicare reform because it

does not modify the program’s underlying commitments for the future.

Moreover, the proposed transfer may very well make it more difficult for

the public to understand and support the hard choices necessary for the

program’s future viability.

While meaningful reform is urgently needed, it will require reshaping the

nation’s perspective on health care consumption and draw clearer

distinctions between needs, wants, and affordability. Complicating this

effort is the nation’s strong commitment to maintaining and even enhancing

the quality of and access to services. Further, we have a history of

technological development, which may in some cases make health care

delivery more efficient or effective, but sometimes has driven spending up

without contributing significantly to the quality or length of life.

Irrespective of whether the President’s proposal is enacted or not, the

Medicare program is in need of fundamental reform to assure its solvency

and sustainability over the long term. There will be many proposals to

modify Medicare and to implement fundamental change. I would suggest

the following five criteria for evaluating these proposals.

•   Affordability:   Changes should ensure that the Medicare program

    consumes a reasonable share of our productive resources and that it

    does not unduly encroach on other necessary public programs or

Page 24                                                  GAO/T-AIMD/HEHS-99-113
    private sector activities. Retaining the self-financing feature of the HI

    trust fund will help instill the necessary fiscal discipline that I fear could

    be eroded through general fund subsidies for the program. Shifting

    excess expenditures from one sector of the budget to another or

    transferring the burden to different payers or future generations should

    not be construed as actions that will make the trust fund solvent or

    future program commitments sustainable. Rather, there needs to be a

    fundamental rethinking of the incentives in the current program that

    promote increased intensity and utilization of services without

    sufficient consideration of their costs. Proposals that involve early

    action on modifications to the program to take advantage of the

    compounding fiscal dividends of savings that are achieved sooner

    should be preferred.

•   Equity:   Reforms should not impose a disproportionate burden on

    particular groups of beneficiaries or providers. It may be that correcting

    the distortions created by our current system requires substantial

    reductions in utilization by certain groups of beneficiaries or of certain

    types of services. Graduated implementation could make the burden of

    such shifts less onerous.

•   Adequacy:    Beneficiaries should have appropriate access to health care

    services, regardless of their individual ability to pay. Further, the

    tradition of technology development, which has contributed greatly to

    health and health care in this country, needs to be maintained in a

    manner that supports cost-effective and clinically meaningful

    innovations that enhance the quality and length of life.

•   Feasibility: Reforming an entitlement defined in specified benefits
    rather than dollar terms must involve changing the behavior of

    beneficiaries and providers. A proposal must contain the correct array

    of incentives to achieve necessary behavioral change. It must also

    involve mechanisms that an entity like HCFA can implement and

    monitor. There must also be provisions for a safety valve to recalibrate

    aspects when the intermediate goals are not achieved.

•   Acceptance:    Beneficiaries, taxpayers, and providers must reach a

    consensus on any major changes to ensure their long-term viability. The

    path for getting there must begin with steps that will make program

    costs, which today are barely opaque, much more transparent to the

    public. Sufficient beneficiary and provider education to the realities of

    the trade-offs involved may facilitate their acceptance. Further, a

    phased approach could help ease any disruptions in services or incomes

    while garnering public approval.

Page 25                                                    GAO/T-AIMD/HEHS-99-113
                   Applying such criteria will require a detailed understanding of the possible

                   outcomes and issues associated with the various elements of proposals.

                   We will be happy to work to provide the data, information, and analysis

                   needed to help policymakers evaluate the relative merits of various

                   proposals and move toward agreement on much needed Medicare reforms.

                   The time has come for meaningful Medicare reform. Delay will only serve

                   to make the necessary changes more painful down the road. We must be

                   straight with the American people--achieving the goal of saving Medicare

                   will require real options and tough decisions to increase program revenues

                   and/or decrease program expenses. There is no “free lunch.”

                   We have an historic opportunity to deal with the temporary surpluses

                   available today, and how we do so could position us better to deal with the

                   future. We also have an obligation to execute our fiduciary responsibilities

                   regarding the nation’s fiscal health. This involves demonstrating prudent

                   management of the projected unified surpluses. At the same time, we

                   cannot let the comfort afforded by these temporary surpluses lull us into

                   complacency. Instead, we must capitalize on this opportunity to engage in

                   serious entitlement reform.

                   We at GAO stand ready to help the Congress as you develop effective,

                   equitable, and affordable solutions for Medicare reform. Working together,

                   we can make a positive and lasting difference for our country and the

                   American people.

                   Mr. Chairman, this concludes my statement. I would be happy to answer

                   any questions that you or the Members of the Committee may have.

(935309)   Leter   Page 26                                               GAO/T-AIMD/HEHS-99-113
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