Medicare Reform: Observations on the President's July 1999 Proposal

Published by the Government Accountability Office on 1999-07-22.

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 2:00 p.m.
Thursday, July 22, 1999
                          MEDICARE REFORM

                          Observations on the
                          President’s July 1999
                          Statement of David M. Walker
                          Comptroller General of the United States

Medicare Reform: Observations on the
President’s July 1999 Proposal

              Mr. Chairman and Members of the Committee:

              I am pleased to be here today to discuss the President’s recent proposal to
              reform Medicare. According to the President, his proposal is intended to
              make Medicare more efficient, modernize the benefit package, and extend
              the program’s long-term solvency.

              When I last testified before you to discuss this topic in March,1 there
              appeared to be an emerging consensus that substantive financing and
              programmatic reforms were necessary to put Medicare on a sustainable
              footing for the future. The long-term cost pressures facing this program
              remain today. Fundamental program reforms are vital to reducing the
              program’s growth, which threatens to absorb ever-increasing shares of the
              nation’s budgetary and economic resources. Modernizing and upgrading
              Medicare’s benefit package may be important, but such initiatives need to
              be considered in light of the broader financial challenges facing this
              program and the nation.

              Against this backdrop, I want to acknowledge this Committee’s efforts on
              Medicare reform over the past several months. The Committee has been
              diligent in exploring difficult issues pertaining to proposed options as well
              as the impact of reforms included under the Balanced Budget Act of 1997
              (BBA). To date, this Committee and the Congress as a whole have remained
              steadfast in the face of intense pressure to roll back BBA’s payment reforms
              and are waiting until strong evidence demonstrates the need for
              modifications. The President also deserves credit for looking out over a
              15-year period in formulating budget proposals and proposing an historic
              reduction in publicly held debt that will help future generations better
              afford future commitments.

              These initiatives are important because we must be especially prudent
              during this period of prosperity, even as recent estimates of budget
              surpluses have been increased. At the same time, we must remember that
              these are projected budget surpluses, and we know that the business cycle
              has not been repealed. Current projected surpluses could well prove to be
              fleeting, and thus we should exercise appropriate caution when creating
              new entitlements that establish permanent claims on future resources.
              While I don’t relish being the accountability cop at the surplus celebration
              party, that’s part of my job as Comptroller General of the United States.

              See Medicare and Budget Surpluses: GAO’s Perspective on the President’s Proposal and the Need for
              Reform (GAO/T-AIMD/HEHS-99-113, Mar. 10, 1999).

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    Medicare Reform: Observations on the
    President’s July 1999 Proposal

    Moreover, while the size of future surpluses could exceed or fall short of
    projections, we know that demographic and cost trends will, in the
    absence of meaningful reform, drive Medicare spending to levels that will
    prove unsustainable for future generations of taxpayers. Accordingly, we
    need to view this period of projected prosperity as an opportunity to
    address the structural imbalances in Medicare, Social Security, and other
    entitlement programs before the approaching demographic tidal wave
    makes the imbalances more dramatic and meaningful reform less feasible.

    As the foregoing suggests, the stakes associated with Medicare reform are
    high, for the program itself and for the rest of the federal budget, both now
    and for future generations. Current policy decisions can help us prepare
    for the challenges of an aging society in several important ways:
    (1) reducing public debt to increase national savings and investment,
    (2) reforming entitlement programs to reduce future claims and free up
    resources for other competing priorities, and (3) establishing a more
    sustainable Medicare program that delivers effective and affordable health
    care to our seniors.

    In this context, I’d like to make a few summary points before delving into
    the specifics of Medicare’s financial health and the President’s July 1999

•   The President’s proposal contains programmatic reforms that reflect a
    good faith effort to advance the reform debate. It provides a baseline for
    further debate and consideration of reforming Medicare. As such, it is an
    important step in the goal of reaching a national consensus about how we
    are going to deal with the explosive cost of medical care for our elderly
    population in the decades to come. We understand that several Members
    of Congress, including Members of the Senate Finance Committee, plan to
    introduce their own reform proposals later in this session.
•   The Congress and the President may ultimately decide to include some
    form of prescription drug coverage as part of Medicare. Given this
    expectation and the future projected growth of the program, some
    additional revenue sources may in fact be a necessary component of
    Medicare reform. However, it is essential that we not take our eye off the
    ball. The most critical issue facing Medicare is the need to ensure the
    program’s long-range financial integrity and sustainability. The 1999
    annual reports of the Medicare Trustees project that program costs will
    continue to grow faster than the rest of the economy. Care must be taken
    to ensure that any potential expansion of the program be balanced with

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                                          Medicare Reform: Observations on the
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                                          other programmatic reforms so that we do not worsen Medicare’s existing
                                          financial imbalances.
                                      •   Given the size of Medicare’s unfunded liability, it is realistic to expect that
                                          reforms to bring down future costs will have to proceed in an incremental
                                          fashion. The time to begin the difficult but necessary steps to reclaim our
                                          fiscal future is now when we have budget surpluses and a demographic
                                          “holiday” where retirees are a far smaller proportion of the population
                                          than they will be in the future.
                                      •   Ideally, the unfunded promises associated with today’s program should be
                                          addressed before or concurrent with proposals to make new ones. To do
                                          otherwise might be politically attractive but not fiscally prudent. If
                                          additional benefits are added, policymakers need to consider targeting
                                          strategies and fully offsetting the related costs. They may also want to
                                          design a mechanism to monitor these and aggregate program costs over
                                          time as well as establish expenditure or funding thresholds that would
                                          trigger a call for fiscal action. Our history shows that while benefits are
                                          attractive, fiscal controls and constraints are difficult to maintain. In
                                          addition, any potential program expansion should be accompanied by
                                          meaningful reform of the current Medicare program to help ensure its
                                          sustainability, and the President’s package of reforms provides a useful
                                          starting point.
                                      •   To qualify as meaningful reform, a proposal should make a significant
                                          down payment toward ensuring Medicare’s long-range financial integrity
                                          and sustainability. As we testified before this Committee in March and
                                          again in June, proposals to reform Medicare should be assessed against
                                          the following criteria: affordability, equity, adequacy, feasibility, and
                                          acceptance. (See table 1.)

Table 1: Criteria for Assessing the
Merits of Medicare Reform Proposals
                                          Affordability                 A proposal should be evaluated in terms of impact on the
                                                                        long-term sustainability of program expenditures.
                                          Equity                        A proposal should be fair across groups of beneficiaries
                                                                        and to providers.
                                          Adequacy                      A proposal should include the resources to allow
                                                                        appropriate access as well as provisions to foster
                                                                        cost-effective and clinically meaningful innovations that
                                                                        address patient needs.
                                          Feasibility                   A proposal should incorporate elements to facilitate
                                                                        effective implementation and adequate monitoring.
                                          Acceptance                    A proposal should be transparent and should educate
                                                                        beneficiary and provider communities about its costs and
                                                                        the realities of trade-offs required when significant policy
                                                                        changes occur.

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                          Medicare Reform: Observations on the
                          President’s July 1999 Proposal

                      •   People want unfettered access to desired health care, and some have
                          needs that are not being met. However, health care costs compete with
                          other legitimate claims in the federal budget, and their projected future
                          growth threatens to crowd out future generations’ flexibility to decide
                          which of these competing priorities will be met. Thus, in making important
                          fiscal decisions for our nation, policymakers need to consider the
                          fundamental differences between wants, needs, and what both individuals
                          and our nation can afford. This concept applies to all major aspects of
                          government, from major weapons system acquisitions to domestic
                          program issues. It also points to the fiduciary and stewardship
                          responsibility that we all share to ensure the sustainability of Medicare for
                          current and future generations within a broader context of providing for
                          other important national needs and economic growth.
                      •   The President’s latest proposal is projected to virtually eliminate the
                          publicly held debt by 2015—this would be a significant accomplishment.
                          Such an initiative would provide a substantial fiscal dividend by reducing
                          interest costs, raising national savings, and contributing to future
                          economic growth. This initiative would help us better afford our future
                          commitments, but it would not alone be sufficient. Even if all future
                          surpluses were saved, we would nonetheless be saddled with a budget
                          over the longer term that at current tax rates could fund little else but
                          entitlement programs for the elderly population. Reforms reducing the
                          future growth of Medicare as well as Social Security and Medicaid are vital
                          under any fiscal and economic scenario to restoring fiscal flexibility for
                          future generations of taxpayers.

                          At this time, I would like to discuss the competing concerns at the crux of
                          Medicare reform, in general, and issues to consider in assessing the
                          President’s proposal, in particular.

                          The current Medicare program, without improvements, is ill-suited to
Competing Concerns        serve future generations of seniors and eligible disabled Americans. On the
Pose Challenges for       one hand, the program is fiscally unsustainable in its present form, as the
Medicare Reform           disparity between program expenditures and program revenues is
                          expected to widen dramatically in the coming years. On the other, the
                          program is outmoded in that it has not been able to adopt modern,
                          market-based management tools, and its benefit package contains gaps in
                          desired coverage. Compounding the difficulties of responding to these
                          competing concerns is the sheer size of the Medicare program—even
                          modest program changes send ripples across the program’s
                          39-million-strong beneficiary population and the approximately 1 million

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                             health care providers that bill the program. Balancing the needs of these
                             interests requires hard choices that this Committee, the Congress, and the
                             National Bipartisan Commission on the Future of Medicare have had
                             brought before them in their deliberations.

Medicare Is Already in the   Unlike private trust funds that can set aside money for the future through
Red                          investments in financial assets, the Medicare Hospital Insurance (HI) Trust
                             Fund—which pays for inpatient hospital stays, skilled nursing care,
                             hospice, and certain home health services—is essentially an accounting
                             device. It allows the government to track the extent to which earmarked
                             payroll taxes cover Medicare’s HI outlays. In serving the tracking purpose,
                             annual Trust Fund reports show that Medicare’s HI component, on a cash
                             basis, is in the red and has been since 1992. (See fig. 1.) Currently,
                             earmarked payroll taxes cover only 89 percent of HI spending and,
                             including all earmarked revenue, the Fund is projected to have a $7 billion
                             cash deficit for fiscal year 1999 alone. To finance this deficit, Medicare has
                             been drawing on its special issue Treasury securities acquired during the
                             years when the program generated a cash surplus. Consequently, Medicare
                             is already a net claimant on the Treasury—a threshold that Social Security
                             is not currently expected to reach until 2014. In essence, for Medicare to
                             “redeem” its securities, the government must raise taxes, cut spending for
                             other programs, or reduce the projected surplus. Outlays for Medicare
                             services covered under Supplementary Medical Insurance, or SMI
                             (physician and outpatient hospital services, diagnostic tests, and certain
                             other medical services and supplies), are already funded largely through
                             general revenues.

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Figure 1: Financial Outlook of the Hospital Insurance Trust Fund

200           Dollars in Billions



           Cash Deficit 1992
                                                                                      20            20            20
                                                                                        15            20            25
         19               19            20                20              20
           90               95            00                05               10




                 Cash Surplus/Deficit

                 Fund Balance

                                             Without meaningful reform, the long-term financial outlook for Medicare
                                             is bleak. Together Medicare’s HI and SMI expenditures are expected to
                                             increase dramatically, rising from 12 percent in 1999 to more than a
                                             quarter of all federal revenues by mid-century. Over the same time frame,
                                             Medicare’s expenditures are expected to double as a share of the
                                             economy, from 2.5 to 5.3 percent, as shown in figure 2.

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                                         Medicare Reform: Observations on the
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Figure 2: Composition of Medicare Funding as a Percent of Gross Domestic Product (GDP)

        Percent of GDP























       General Revenue or Other
       Payroll Tax

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Medicare Reform: Observations on the
President’s July 1999 Proposal

The progressive absorption of a greater share of the nation’s resources for
health care, like Social Security, is in part a reflection of the rising share of
elderly in the population. Medicare’s rolls are expanding and are projected
to increase rapidly with the retirement of the baby boom. 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 and the ratio of
workers to retirees will have declined from nearly 4 to 1 today to roughly 2
to 1.

However, Medicare growth rates also reflect the escalating growth of
health care costs at rates well exceeding general rates of inflation.
Increases in the number and quality of health services have been fueled by
the explosive growth of medical technology. Moreover, 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. For these reasons, among
others, Medicare represents a much greater and more complex fiscal
challenge than even Social Security over the longer term.

When viewed from the perspective of the entire budget and the economy,
the growth in Medicare spending will become progressively unsustainable
over the longer term. GAO’s updated budget simulations shows that to
move into the future without changes in the Medicare, Social Security, and
Medicaid programs is to envision a very different role for the federal
government. Even assuming that all projected surpluses are saved and
existing discretionary budget caps are complied with, our long-term model
shows a world by 2030 in which Social Security, Medicare, and Medicaid
increasingly absorb available revenues within the federal budget. (See fig.
3.) If none of the surplus is saved, the long-term outlook is even more
daunting. (See fig. 4.) Budgetary flexibility declines drastically and there is
little or no room for programs for national defense, the young,
infrastructure, and law enforcement—i.e., essentially no discretionary
programs at all.

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Figure 3: Composition of Spending as a Share of GDP Under “Save the Unified Surplus” Simulation

60       Percent of GDP



30               Revenue



                1998                          2030                                  2050                            2070

       Social Security
       Medicare and Medicaid
       Net Interest
       All Other Spending

                                         Note: In 2030, all other spending includes offsetting interest receipts.

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Figure 4: Composition of Spending as a Share of GDP Under “No Unified Surplus” Simulation

60    Percent of GDP



30                Revenue



                1998                         2030                               2050

       Social Security
       Medicare and Medicaid
       Net Interest
       All Other Spending

                                         When viewed together with Social Security, the financial burden of
                                         Medicare on the future taxpayers becomes unsustainable. As figure 5
                                         shows, the cost of these two programs combined 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. This analysis, moreover, does not
                                         incorporate the financing challenges associated with the SMI and Medicaid

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Figure 5: Social Security and Medicare Part A as a Percent of Taxable Payroll

 30       Percent of Taxable Payroll




                                                        Current Level




















                                           Early action to address the structural imbalances in this program is
                                           critical. First, ample time is needed to phase in the kinds of changes
                                           needed to put this program on a more sustainable footing before the baby
                                           boomers retire. Second, timely action to bring costs down pays large fiscal
                                           dividends for the program and the budget. Our long-term budget
                                           simulations, as shown in figure 6, illustrates how critical early action on
                                           Medicare reform is to our long-term fiscal future. Any reforms slowing
                                           Medicare’s per person growth rate from a projected average annual rate of
                                           4.5 percent to 4 percent over a 70-year period would yield the kind of
                                           savings needed to truly establish a sustainable budget policy for the long
                                           term. Because of the high projected growth of Medicare in the coming

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                                          years, the earlier the reform begins, the greater the savings due to the
                                          effects of compounding. Reforms fully phased in by 2002 would enable us
                                          to maintain surpluses over the entire 70-year simulation period.

Figure 6: Federal Deficits as a Share of GDP Under Alternative Medicare Simulations

20          Percent of GDP





     1998                2010                          2030                             2050                          2070

                  No Action
                   Action Taken in 2002
                  Action Taken in 2012

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                           Medicare Reform: Observations on the
                           President’s July 1999 Proposal

Medicare Out of Date       In addition to its significant financial imbalance, Medicare is
Relative to Other Health   unsatisfactory from a programmatic perspective. BBA reforms were
Care Payers                designed in part to modernize the program’s pricing and payment
                           strategies, but Medicare has not yet become a prudent purchaser. In its
                           current form, the program lacks the flexibility to readily adjust its
                           administered prices and fees in line with market rates and lacks the tools
                           to exercise meaningful control over the volume of services used.

                           In addition, concerns continue to be voiced about the current coverage
                           gaps in protections for Medicare beneficiaries, which contrast with what is
                           available for younger Americans with private employer-based coverage.
                           Medicare’s basic benefit package largely reflects the offerings of the
                           commercial insurance market in 1965 when the program began. Although
                           commercial policies have evolved since then, Medicare’s package for the
                           most part has not. For example, unlike many current commercial policies,
                           Medicare does not cover routine physical examinations or outpatient
                           prescription drugs or cap beneficiaries’ out-of-pocket spending.
                           Two-thirds of Medicare beneficiaries obtain prescription drug coverage by
                           participating in the Medicaid program (if they are eligible), obtaining a
                           supplemental insurance policy privately or through an employer, or
                           enrolling in a Medicare+Choice plan. However, in some cases, these
                           options do not provide adequate coverage, leaving high users with
                           significant out-of-pocket costs; for many of the remaining third of
                           beneficiaries, these options are inaccessible altogether, either because
                           they are not available—in the case of a Medicare+Choice plan—or are not
                           affordable. In short, many reform advocates believe that Medicare’s basic
                           benefit package should be brought into line with current commercial

                           The challenge facing the Congress today is to identify reform options that
                           satisfy the need to make Medicare’s costs more sustainable while
                           addressing certain gaps in coverage. With respect to prescription drug
                           coverage, striking this balance is particularly difficult. On the one hand,
                           financing a prescription drug benefit would be a costly proposition. From
                           1992 to 1997, prescription drug spending grew on average by 11 percent a
                           year, compared with a 5-percent average growth rate for health
                           expenditures overall. As a result, drug spending during that same period
                           consumed a larger share of total health care spending—rising from
                           5.6 percent to 7.2 percent. In addition, the elderly population, which
                           constitutes the majority of Medicare beneficiaries, consists of relatively
                           high users of prescription drugs. In 1995 (the most recent year for which
                           data are available), annual drug costs were $600 per elderly person,

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                          compared to just over $140 for a nonelderly individual. On the other hand,
                          the lack of a prescription drug benefit creates a significant burden for
                          those who have little or no supplemental coverage. In 1999, an estimated
                          20 percent of Medicare beneficiaries—some of whom lack any
                          supplemental coverage—will have total drug costs of $1,500 or more.

Number and Size of        The fact that changes to Medicare can create seismic reverberations is not
Affected Parties Make     surprising. Health care spending accounts for one-seventh of the nation’s
Medicare Reform           economy, and Medicare is the nation’s single largest health care payer. The
                          program’s beneficiary populations consist of roughly 35 million seniors
Exceptionally Difficult   and 4 million disabled individuals under age 65. HCFA estimates that the
                          program’s billers—physicians, hospitals, equipment suppliers, and other
                          providers of medical services—number about 1 million.

                          BBA payment reforms are the latest case example illustrating the intensity
                          of reactions from providers affected by legislative changes. BBA sought to
                          lower future payments to Medicare’s managed care plans and to providers
                          historically paid through cost reimbursement. Affected providers are
                          currently seeking to repeal various BBA provisions, with some relying on
                          anecdotal evidence rather than systematic analysis to make their case. A
                          recent illustration is the reporting of health plan withdrawals from the
                          Medicare+Choice program. Plans cite, and the press reports, inadequate
                          payment rates as the reason for dropping out of Medicare or reducing
                          enrollees’ benefits. GAO has another point of view based on our
                          fact-gathering and analyses.

                          BBA sought to moderate Medicare’s payments to managed care plans
                          because, ironically, Medicare managed care cost, not saved, the
                          government money. That is, the government was paying more to cover
                          beneficiaries in managed care than it would have if these individuals had
                          remained in the traditional fee-for-service program. In our recent
                          published work, we noted that BBA has reduced, but not eliminated, excess
                          payments.2 In fact, Medicare’s payments to some plans are generous
                          enough to finance prescription drugs and other extras not available to the
                          majority of senior and disabled beneficiaries that remain in traditional
                          Medicare. We have also reported that factors additional to or even
                          exclusive of payment rates—including competition and other market

                           See Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated, Excess Plan Payments
                          (GAO/HEHS-99-144, Jun. 18, 1999).

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                       Medicare Reform: Observations on the
                       President’s July 1999 Proposal

                       conditions—played a significant role in plan dropouts.3 The question this
                       raises for policymakers is to what extent should they be concerned about
                       health plan dropouts from Medicare when plan participation means that
                       the government finances non-Medicare benefits for a minority of
                       beneficiaries while paying more for these beneficiaries than for those in
                       traditional Medicare. Among other lessons, however, the intensity of
                       pressure to roll back BBA’s curbs on managed care rate increases teaches
                       us the difficulty that this Committee and the Congress as a whole face in
                       making appropriate Medicare payment reforms.

                       The President’s proposal to reform Medicare is intended to function on
President’s Medicare   two levels: first, as a Medicare financing strategy and, second, as a
Reform Proposal        package of programmatic reforms. On the basis of GAO’s work on these
                       topics, I would like to discuss several key issues.

Financing Aspect of    The President proposes to use 13 percent of the projected budget
President’s Proposal   surpluses over the next 15 years to provide additional Treasury securities
                       to the HI Trust Fund and partially offset the cost of the proposed
                       prescription drug benefit.4 This aspect of the proposal has important
                       implications for the budget as a whole as well as for Medicare financing in

                       With regard to its more general budgetary significance, the President’s
                       proposal is part of a broader initiative that would save a major share of the
                       surplus to reduce debt held by the public. Most of the surplus transferred
                       to Medicare would be invested in federal Treasuries and the President is
                       proposing budget enforcement mechanisms—“lockboxes”—that would
                       ensure that these transfers be used solely to reduce publicly held debt. As
                       the President himself has suggested, debt reduction plays a critical role in
                       enhancing our economic capacity to finance our burgeoning commitments
                       over the long run. The President’s June Midsession Review projects that
                       his proposals would reduce debt held by the public by $3.6 trillion over the
                       next 15 years, virtually eliminating publicly held debt by 2015.
                       Approximately two-thirds of total projected unified budget surpluses

                       See Medicare Managed Care Plans: Many Factors Contribute to Recent Withdrawals; Plan Interest
                       Continues (GAO/HEHS-99-91, Apr. 27, 1999).
                        In the Midsession Review, the President proposes to transfer $794 billion of the projected 15-year
                       surpluses to Medicare—$723 would be used to acquire additional Treasury securities for the HI Trust
                       Fund and the remainder would help pay for the proposed drug benefit. Excluding financing costs
                       associated with the President’s proposed new spending, this amount represents 15 percent of
                       projected surpluses. However, when computed to include these costs, the transfer represents
                       13 percent of total projected surpluses.

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would be used to reduce the debt through lockbox provisions dedicating
all of Social Security’s surpluses, and about a quarter of the on-budget
surplus would be transferred to Medicare for debt reduction. However,
because of the transfers to Medicare, debt held by government accounts
would increase by about $1 trillion over the 15-year period.

The reduction in publicly held debt proposed by the President —although
less than the baseline, which assumes that all surpluses would be
saved—would confer significant short- and long-term benefits to the
budget and the economy. Our own work on long-term budget outlooks
illustrates the benefits of maintaining surpluses for debt reduction.
Interest on the debt represents today the third largest expenditure in the
federal budget. Reducing the publicly held debt reduces these costs,
freeing up budgetary resources for other programmatic priorities. Under
the President’s plan, interest expense would fall from $229 billion in 1999
to about $10 billion in 2014. For the economy, lowering debt increases
national saving and frees up resources for private investment. This in turn
leads to stronger economic growth and higher incomes over the long term.

Over the last several years, our simulations illustrate the long-term
economic consequences flowing from different fiscal policy paths.5 Our
models consistently show that saving all or a major share of projected
budget surpluses ultimately leads to demonstrable gains in GDP per capita
over a 50-year period. GDP per capita would more than double from present
levels by saving most or all of projected surpluses, while incomes would
eventually fall if we failed to sustain any of the surplus. Although rising
productivity and living standards are always important, they are especially
critical for the 21st Century, for they will increase the economic capacity
of the projected smaller workforce to finance future government programs
along with the obligations and commitments for the baby boomers’

With regard to the Medicare program itself, the proposed “transfer” of
surpluses would extend the solvency of the HI Trust Fund on paper from
2015 to 2027. This initiative, however, represents a major departure in
financing for the HI program. Established as a payroll tax funded program,
HI would now receive an explicit grant of funds from general revenues not
supported by underlying payroll tax receipts. Treasury securities held by
the Trust Fund have always represented the value of the loan provided by
the HI program’s prior payroll tax surpluses to the Treasury. Under the

 See Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, Feb. 25, 1998) and Budget
Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, Oct. 22, 1997).

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Medicare Reform: Observations on the
President’s July 1999 Proposal

President’s proposal, the value of securities held by the HI Trust Fund
would exceed that supported by earlier payroll tax surpluses and this
grant would constitute a new claim on the general fund for the future. In
effect, the proposed transfer would make the HI Trust Fund financing look
more like that of the part B SMI Trust Fund, which obtains 75 percent of its
funding from the general fund.

As the foregoing suggests, this is a major change in the theoretical design
of the HI program that deserves full and open debate. The size of the
imbalances between Medicare’s outlays and payroll tax revenues for the HI
program may well justify the need for additional financing from general
revenues. The President argues that Medicare should be guaranteed a
share of the benefits resulting from the fiscal improvement that debt
reduction and lower interest costs would bring about. However, using
surpluses to finance Medicare entails significant risks.

The President’s proposal to grant Medicare additional Treasury securities
creates the risk of reducing transparency about the underlying financial
condition of the HI Trust Fund. Although arguably justified as a way to lock
in debt reduction, the transfers are not necessary to do this. What
concerns me is the transfers extend the solvency of the HI Trust Fund on
paper without making the hard choices needed to make the whole
Medicare program more sustainable in economic or budgetary terms.
Increasing the HI Trust Fund balance alone, without underlying program
reform, does nothing to make the Medicare program more
sustainable—that is, it does not reduce the program’s projected share of
GDP or the federal budget. 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 all of Medicare’s promised
benefits—both now and in the future.

In fact, the transfer would interfere with the vital signaling function that
trust fund mechanisms can serve for policymakers about underlying fiscal
imbalances in covered programs. The greatest risk is that the proposed
transfer will reduce the sense of urgency that impending trust fund
bankruptcy provides to policymakers by artificially extending the solvency
of the HI program through 2027—well into the peak of the baby boomers’
retirement. Furthermore, increasing the Trust Fund’s paper solvency does
not address cost growth in the SMI portion of Medicare, which is projected
to grow even faster than HI in coming decades.

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                          Medicare Reform: Observations on the
                          President’s July 1999 Proposal

                          The President’s proposal to transfer funds to the HI Trust Fund would, in
                          effect, increase the general fund contribution to total Medicare funding.
                          Increasing the balances of Treasury securities owned by the HI Trust Fund
                          alone would increase the formal claim that the Trust Fund has on future
                          general revenues since the Trust Fund’s securities constitute a legal claim
                          against the Treasury. These are resources that will not be available for
                          competing priorities in either domestic or defense areas. When
                          considering both HI and SMI programs together, the share of general fund
                          financing would grow under the President’s proposal from its current level
                          of 34 percent to about 57 percent by 2027. Although the programs’ costs
                          are projected to grow to these levels in the absence of any changes, the
                          proposals would lock in general fund financing of these costs through the
                          transfer of additional Treasury securities. In effect, the proposal would
                          likely ensure that projected Trust Fund shortfalls through 2027 will be
                          financed through the general fund rather than through Medicare program

                          Finally, any proposal to allocate surpluses is vulnerable to the risk that
                          those projected surpluses may not materialize. Commitments often prove
                          to be permanent while surpluses can be fleeting. Although recent budget
                          forecasts have proven to be too pessimistic, the history of budget forecasts
                          should remind us not to be complacent about the certainty of these large
                          projected surpluses. In its January 1999 report, the Congressional Budget
                          Office (CBO) compared the actual deficits or surpluses for 1988 through
                          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 swing of $250 billion and about $300 billion in 2009.
                          Accordingly, any permanent commitments that are dependent on the
                          realization of a long-term forecast should be considered carefully.

Programmatic Aspects of   The President’s reform plan also consists of several programmatic
President’s Proposal      changes—most notably, a proposal for health plans to compete on the
                          basis of price and the addition of a prescription drug benefit. The plan also
                          calls for measures intended to help Medicare operate more efficiently or
                          strengthen future financing, including the following: create a preferred
                          provider option in which beneficiaries would be rewarded with lower
                          cost-sharing requirements when choosing providers preferred by
                          Medicare; expand the use of centers of excellence, in which providers that
                          specialize in performing such procedures as coronary artery bypass
                          surgery receive a global fee for all services provided rather than a separate

                          Page 18                            GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
                                 Medicare Reform: Observations on the
                                 President’s July 1999 Proposal

                                 fee for each service; extend certain BBA provisions that reduce provider
                                 payment rate increases, thus helping to slow future program spending;
                                 impose a 20-percent copayment for clinical laboratory services; and index
                                 the part B deductible for inflation.

                                 Overall, the Office of Management and Budget estimates that the changes
                                 in price competition and cost incentives would achieve savings of
                                 $72 billion over 10 years. However, these savings would offset only 60
                                 percent of the total projected $118 billion for the new prescription drug
                                 benefit, with the remainder being financed through a portion of the
                                 general fund transfers, as discussed earlier. CBO’s re-estimate of the
                                 President’s proposal—projecting a higher cost for the drug benefit and
                                 smaller savings—underscores the uncertainty and volatility inherent in
                                 health care cost estimates. This argues for proceeding cautiously in
                                 expanding the Medicare program to include new benefits.

                                 Now I would like to elaborate on the competitive pricing of health plan
                                 premiums and the addition of a prescription drug benefit.

Provisions for Proposed Health   Under the President’s proposal, private health plans serving Medicare
Plan Competition                 beneficiaries would compete on the basis of cost and quality to provide
                                 Medicare-covered benefits. Instead of administratively established
                                 payment rates, plans would set their own premiums for a standard
                                 package of benefits. The government’s contribution would be limited to
                                 96 percent of the estimated fee-for-service costs of enrolled beneficiaries.
                                 Beneficiaries choosing plans priced under the 96-percent level would pay
                                 reduced part B premiums and could retain these savings or use them to
                                 buy optional benefits. Beneficiaries choosing plans exceeding the
                                 96-percent level would pay an amount additional to the standard part B

                                 In principle, the competitive pricing of managed care plan premiums has
                                 considerable merit and could help produce savings for both the program
                                 and beneficiaries. Using market forces to set prices would constitute a
                                 major advance. Price competition among plans is more likely to lead to
                                 payments that appropriately compensate efficient plans rather than the
                                 excessive payment levels that have resulted from administratively set
                                 prices. Taxpayers would benefit in two ways: first, because the
                                 government’s contribution would be lower than if beneficiaries remained
                                 in traditional Medicare and, second, because the government would net
                                 25 percent of the savings achieved through the enrollment of beneficiaries
                                 in plans priced below the government contribution cap.

                                 Page 19                            GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
                            Medicare Reform: Observations on the
                            President’s July 1999 Proposal

                            However, the extent to which price competition among health plans would
                            produce savings depends on the design and implementation
                            particulars—which the Administration has not yet made available. Our
                            previous work demonstrates conclusively that health plan payments must
                            take into account the health status of enrolled beneficiaries—that is, be
                            risk adjusted—if savings are to be realized.6 Also critical is how Medicare
                            will estimate average fee-for-service spending and calculate its
                            contribution to health plan premiums. Currently, average fee-for-service
                            spending varies dramatically across geographic areas, due primarily to
                            differences in beneficiaries’ use of medical services and, to a lesser extent,
                            differences in local prices. Some of the variation can reflect an area’s
                            inappropriate use of services—either too low or too high. Because such
                            inappropriate utilization is embedded in the fee-for-service expenditure
                            data, benchmarking plan payments against current fee-for-service
                            spending levels requires careful scrutiny. The Administration indicates it
                            will incorporate a geographic adjustment that will take into consideration
                            these local differences, but it has released few details on how this process
                            would work.

Provisions for Proposed     The second major programmatic element of the President’s proposal is the
Prescription Drug Benefit   addition of a prescription drug benefit. Essentially, the prescription drug
                            benefit would be voluntary, requiring a premium separate from the current
                            part B premium and 50-percent copayment from beneficiaries for each
                            prescription. Beneficiaries would be permitted to enroll for the benefit,
                            generally, only when they are first eligible. The benefit is designed to be
                            phased in. In 2002, the beneficiary’s premium would be about $24 per
                            month, with Medicare paying up to $1,000 per-beneficiary annually. By
                            2008, the premium would rise to about $44 per month, with Medicare
                            paying up to $2,500 per-beneficiary annually. The poorest beneficiaries
                            would not pay premiums or copayments, and other low-income
                            beneficiaries would receive premium assistance.

                            Enrollees in Medicare managed care plans would receive their
                            prescription drug benefit as they do currently. Beneficiaries in traditional
                            Medicare would get their benefit through private companies called
                            “pharmacy benefit managers” (PBM) or through entities that essentially
                            operate like a PBM. In the private sector today, PBMs under contract with
                            third-party payers administer and manage enrollees’ prescription drug
                            benefit. As proposed for Medicare, PBMs would be paid a fee for managing

                            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, Feb. 25, 1999) and Medicare
                            HMOs: HCFA Can Promptly Eliminate Hundreds of Millions in Excess Payments (GAO/HEHS-97-16,
                            Apr. 25, 1997).

                            Page 20                               GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
    Medicare Reform: Observations on the
    President’s July 1999 Proposal

    the drug benefit and would competitively bid to manage the benefit for a
    particular geographic area. They would negotiate prices with drug

    Several of the prescription drug benefit provisions contain elements of
    fiscal discipline, transparency, and economy. For example, the separate
    premium—for which the government’s share must be calculated each
    year—serves as a mechanism to track the benefit’s aggregate costs. The
    50-percent copayment and the annual cap are likely to help control
    excessive utilization. The one-time enrollment opportunity encouraging
    beneficiary participation would help spread risk across a larger pool of
    individuals, not just among the high users. This provision would help
    prevent a situation in which a greater contribution from the government
    would be needed to finance the benefit if only frequent users chose to
    enroll. Finally, premium and copayment subsidies would help relieve
    low-income beneficiaries from some of the burden of high out-of-pocket

    We note, however, the following design and implementation concerns
    regarding the drug benefit as proposed.

•   Cost of the benefit. This new benefit is not fully paid for by other offsetting
    program changes. General funds from the projected surpluses make up the
    difference; but as I said earlier, this would finance a permanent benefit
    expansion with an uncertain revenue stream.
•   Targeting of the benefit. A primary means of allocating limited resources is
    to target them on the greatest needs. With the exception of greater federal
    subsidies for certain near-poor Medicare beneficiaries, the proposed
    coverage is not targeted to need. The proposal provides first-dollar
    coverage rather than using a deductible that would make beneficiaries
    more cost-sensitive and would reduce total program expenditures. In
    addition, it would cap the benefit at $2,500, leaving some beneficiaries
    incurring catastrophic drug expenses without coverage.
•   Substitution for employer-provided. The proposed benefit could mean that
    some costs borne by employers and retirees through retiree health benefit
    plans would become the responsibility of the federal taxpayer. A partial
    subsidy to employers—equaling two-thirds of what the program would pay
    for Medicare drug coverage—aims at minimizing the number of employers
    and retirees dropping employer-sponsored coverage. How effective the
    subsidy works in preventing substitution remains to be seen. Some
    employers may still find it advantageous to drop coverage. Retirees may
    actually approve if they prefer to obtain the full drug benefit from

    Page 21                            GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
    Medicare Reform: Observations on the
    President’s July 1999 Proposal

    Medicare and receive alternative benefits from their former employers,
    including “wrap-around” drug coverage that fills some of the gaps in the
    Medicare benefit.
•   Uneven impact across states. In assisting low-income Medicare
    beneficiaries with premiums and cost-sharing of the new drug benefit, the
    President’s proposal would build on existing Medicare “buy-in” programs,
    in which the federal government and the state together subsidize—through
    Medicaid—some combination of Medicare premiums, deductibles, and
    copayments. For individuals between 100 and 150 percent of the federal
    poverty level, the President’s proposal provides for full federal funding of
    the prescription drug benefit; for those below 100 percent, the proposal
    calls for shared funding between the federal government and the state.7
    States would experience varying levels of fiscal relief or additional burden,
    depending on the extent to which they ensured that these individuals
    receive their benefit.

    More than 40 percent of low-income individuals eligible for the current
    Medicare buy-in benefits are not enrolled, and enrollment is particularly
    low among eligible individuals above the federal poverty level. The
    inclusion of the drug benefit would create a greater incentive for these
    beneficiaries to enroll in the Medicare buy-in program. Further, the full
    federal funding of the drug benefit for those above the federal poverty
    level could help reduce the disincentives that states face when considering
    whether to actively encourage beneficiaries to enroll in a federally
    mandated program that is not fully funded by the federal government. At
    the same time, significantly greater enrollment in the Medicare buy-in
    programs resulting from the new drug benefit and outreach efforts would
    increase a state’s financial exposure for matching funds that subsidize
    beneficiaries’ Medicare part B premiums. States with eligibility standards
    for full Medicaid benefits that are well below the federal poverty level
    would be more likely to incur additional obligations.

•   Obstacles to realizing the savings potential of PBMs. In the private sector,
    the negotiations between PBMs and drug manufacturers and PBMs and
    pharmacies are determined privately, whereas Medicare—as a public
    program—is required to have transparent policies that are determined
    openly. If a PBM, as a Medicare contractor, has to conduct such
    negotiations in public, achieving meaningful discounts for Medicare may
    be difficult. Moreover, a PBM’s span of control, not specified in the
    President’s proposal, could have mixed effects on the PBM’s ability to

     Beneficiaries with income between 135 and 150 percent of the federal poverty level would pay a
    partial, sliding-scale premium based on their income.

    Page 22                                  GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
               Medicare Reform: Observations on the
               President’s July 1999 Proposal

               control drug costs. On the one hand, the greater the number of
               beneficiaries within that span, the greater the potential for moving market
               share to take advantage of manufacturers’ discounts; on the other hand,
               the greater the number of affected providers, the greater the pressure for
               the PBM to include all willing providers, which would undermine its ability
               to negotiate with selected manufacturers or providers offering the best

               Finally, I would caution that the creation of a new and compelling benefit
               for this program not exacerbate Medicare’s financial problems and should
               include a way to monitor future costs to the government. Although the
               President’s proposed 50-percent copayment could serve to control
               excessive utilization, that copayment rate and other financial control
               mechanisms are subject to erosion. As you know, the part B premium
               originally was set at a level to finance 50 percent of the part B program
               costs. However, less than 10 years later, the method for setting the part B
               premium was tied to changes in cost of living, resulting in premiums
               dropping below 25 percent of the program costs. Under current law, the
               premium is set at 25 percent of premium costs, far from the original
               cost-sharing arrangement, and the projected costs of the part B program
               are expected to continue to escalate, with general Treasury revenues
               paying 75 percent of those costs.

               Given this history, it would be prudent to target the benefit to those most
               in need and include additional safety valves to check excessive program
               cost growth. If expenditure or funding thresholds were established, they
               could be used to trigger periodic congressional reviews and could prompt
               legislative action if spending projections showed that the thresholds were
               likely to be exceeded.

               I would like to conclude by pointing to the historic opportunity presented
Concluding     by the recently projected surpluses. Some advocate spending the
Observations   surpluses to address a host of pent-up demands on the spending and/or
               revenue sides of the budget, built up from years of struggling with and
               finally succeeding in eliminating deficits. Updating Medicare’s benefit
               package is but one of a number of legitimate claims being made for the use
               of these surpluses.

               It is my hope that in considering all of these competing claims in the
               present we also think about the unprecedented challenge facing future
               generations in our aging society. Relieving them of some of the burden of

               Page 23                            GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
Medicare Reform: Observations on the
President’s July 1999 Proposal

today’s financing commitments would help fulfill this generation’s
fiduciary responsibility: it would also serve to preserve some capacity to
make their own choices by both strengthening the budget and the
economy they inherit. While not ignoring today’s needs and demands, we
should remember that surpluses can be used as an occasion to promote
the transition to a more sustainable future for our children and

In this regard, I think the President’s proposal has the advantage of putting
forth a long-term plan that would help promote future growth by paying
down the publicly held debt. Many in the Congress putting forth
constructive reform proposals for Social Security and Medicare also
deserve credit—a sustainable future involves both fiscal policies that
would improve national savings as well as real programmatic reforms to
reduce the burdens of obligations and commitments on future generations.

In determining how to finance the Medicare program, much is at
stake—not only the future of Medicare itself but also preserving the
nation’s future fiscal flexibility to pursue other important national goals
and programs. Mr. Chairman, I feel that the greatest risk lies in extending
the HI Trust Fund’s solvency while doing nothing to improve the program’s
long-term sustainability, or worse, in adopting changes that may aggravate
the long-term financial outlook for the program and the budget.

General fund infusions and expanded benefits may well be a necessary
part of any major reform initiative. Updating the benefit package is
probably a key part of any realistic reform program to address the
legitimate expectations of an aging society for health care both now and in
the future. The President’s proposal also includes a broader package of
reforms that provide a good point of departure for addressing Medicare’s
current fiscal imbalance. However, more needs to be done to ensure the
program’s longer term sustainability. In addition, the Congress should
consider adequate fiscal incentives to control costs and an enhanced
targeting strategy in connection with any proposal to provide a
prescription drug benefit.

I am under no illusions about how difficult Medicare reform will be.
Experience shows that forecasts can be far off the mark. Benefit
expansions are often permanent, while the more belt-tightening payment
reforms—vulnerable to erosion—could be discarded altogether. Recent
experience implementing BBA reforms provides us some sobering lessons
about the difficulty of undertaking reform and the need for effectiveness,

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                   Medicare Reform: Observations on the
                   President’s July 1999 Proposal

                   flexibility, and steadfastness. Effectiveness involves collecting the data
                   necessary to assess impact—separating the transitory from the permanent
                   and the trivial from the important. Flexibility is critical to make changes
                   and refinements when conditions warrant and when actual outcomes
                   differ substantially from the expected ones. Steadfastness is needed when
                   particular interests pit the primacy of their needs against the more global
                   interest of making Medicare affordable, sustainable, and effective for
                   current and future generations of Americans. This makes it all the more
                   important that any new benefit expansion be carefully designed to balance
                   needs and affordability both now and over the longer term.

                   The bottom line is that surpluses represent both an opportunity and an
                   obligation. We have an opportunity to use our unprecedented economic
                   wealth and fiscal good fortune to address today’s needs, but an obligation
                   to do so in a way that improves the prospects for future generations. This
                   generation has a stewardship responsibility to future generations to
                   reduce the debt burden they inherit, to provide a strong foundation for
                   future economic growth, and to ensure that future commitments are both
                   adequate and affordable. Prudence requires making the tough choices
                   today while the economy is healthy and the cohort of workers is relatively
                   large. National saving pays future dividends over the long term, but only if
                   meaningful reform begins soon. Entitlement reform is best done with
                   considerable lead time to phase in changes and before the changes needed
                   become dramatic and disruptive. The prudent use of the nation’s current
                   and projected budget surpluses combined with meaningful Medicare and
                   Social Security program reforms can help achieve both of these goals.

                   Mr. Chairman, this concludes my prepared statement. I will be happy to
                   answer any questions you or other Members of the Committee may have.

                   For future contacts regarding this testimony, please call Paul L. Posner,
GAO Contacts and   Director of Budget Issues, at (202) 512-9573 or William J. Scanlon, Director
Acknowledgments    of Health Financing and Public Health at (202) 512-7114. Other individuals
                   who made key contributions include Linda F. Baker, Hannah F. Fein,
                   James R. McTigue, and Deborah Spielberg.

(935325/101871)    Page 25                            GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
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