Medicare Reform: Issues Associated With General Revenue Financing
(Testimony, 03/27/2000, GAO/T-AIMD-00-126).

Pursuant to a congressional request, GAO discussed the use of general
fund revenues as part of Social Security and Medicare reform, focusing
on general revenue financing of the Medicare program.

GAO noted that: (1) a consensus appears to be emerging that substantive
financing and programmatic reforms are necessary to put Medicare on a
sustainable footing for the future; (2) the current Medicare program,
without improvements, is ill-suited to serve future generations of
seniors and eligible disabled Americans; (3) on the other hand, the
program is fiscally unsustainable in its present form, as the disparity
between program expenditures and program revenues is expected to widen
dramatically in the coming years; (4) on the other hand, 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; (5) thus, while financial questions loom, pressure is mounting
to update Medicare's outdated benefit design; (6) however, doing so
carries with it the potential to exacerbate Medicare's spending
trajectory; (7) given the aging of the nation's society and the
increasing cost of modern medical technology, it is inevitable that the
demands on the Medicare program will grow; (8) the National Bipartisan
Commission on the Future of Medicare noted that the program will require
additional resources as the percent of the population eligible for
benefits increases; (9) one major uncertainty in Medicare's future
financing needs, the Commission noted, is the inability to predict the
evolution of the health care delivery system or technology's impact on
health care costs; (10) at the same time the Commission emphasized the
urgent need for reforms that will slow the growth in Medicare spending;
(11) given the size of Medicare's projected funding needs, it is
realistic to expect that reforms to bring down future costs will have to
proceed in an incremental and iterative fashion; (12) comprehensive
Medicare reform cannot, once implemented, be put on automatic pilot;
(13) recent experience implementing changes shows that reform is a
dynamic process requiring vigilance and flexibility; (14) the
Comptroller General testified before Congress on the financing of the
Hospital Insurance trust fund that additional general revenues may very
well be necessary, but such a change would represent a marked departure
from payroll tax financing with implications that warrant explicit and
serious debate; and (15) leading reform proposals that address
comprehensive reform such as those of the President and Breaux-First
include the use of general funds as part of their financing mechanism.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD-00-126
     TITLE:  Medicare Reform: Issues Associated With General Revenue
	     Financing
      DATE:  03/27/2000
   SUBJECT:  Health care programs
	     Trust funds
	     Health services administration
	     Health insurance cost control
	     Financial management
	     Future budget projections
	     Budget surplus
	     Proposed legislation
IDENTIFIER:  Hospital Insurance Trust Fund
	     Social Security Program
	     Medicare Program
	     Medicare Trust Fund
	     Medicare Supplemental Medical Insurance Program

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   * For Release on Delivery
     Expected at
     2 p.m.

Monday,

March 27, 2000

GAO/T-AIMD-00-126

medicare reform

Issues Associated With General Revenue Financing

        Statement of Paul L. Posner

Director, Budget Issues

Accounting and Information Management Division

Testimony

Before the Special Committee on Aging, U.S. Senate

United States General Accounting Office

GAO

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss the use of general fund
revenues as part of Social Security and Medicare reform. As you requested, I
will focus my remarks specifically on general revenue financing of the
Medicare program. Despite some very positive, short-term developments
regarding our economy, the federal surplus, and Medicare spending, the
bigger picture remains virtually unchanged. Long-term cost pressures facing
the program are considerable. Even before adding a prescription drug
benefit, for example, projected program spending threatens to absorb
unsustainable shares of the nation's budgetary and economic resources. The
Office of the Actuary at the Health Care Financing Administration has
estimated the actuarial imbalance for the Hospital Insurance (HI) portion of
Medicare at $2.9 trillion through 2074-this is the present value of the
amount by which future payments exceed projected revenues for the program.
In testimony before this and other congressional committees, the Comptroller
General has expressed concern about the expanded use of general revenues in
program financing and the need for comprehensive reform that will address
the program's long-term sustainability. My statement today will underscore
these concerns.

It is tempting to push aside this gloomy forecast in light of recent surplus
projections. However, the recent good news on the budget does not mean that
difficult budget choices are a thing of the past. First, it is important to
recognize that, by their very nature, projections are uncertain. This is
especially true today because, as the Congressional Budget Office (CBO)
notes, it is too soon to tell whether recent boosts in revenue reflect a
major structural change in the economy or a more temporary divergence from
historical trends. Indeed, CBO points out that assuming a return to
historical trends and slightly faster growth in Medicare would change the
on-budget surplus to a growing deficit. This means we should treat surplus
predictions with caution.

Moreover, while the size of future surpluses could exceed or fall short of
projections, 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 begin addressing the structural
imbalances in Medicare, Social Security, and other entitlement programs
before the approaching demographic tidal wave makes the imbalances more
dramatic and possible solutions much more difficult and painful.

As the foregoing suggests, the stakes associated with Medicare reform are
high not only for the program but also for the rest of the federal budget,
both now and for future generations. Without meaningful reform, the
long-term financial outlook for the Medicare program is bleak. Current
policy decisions can help us prepare for the challenges of an aging society
in several important ways: (1) by reducing public debt to increase national
saving and investment, (2) by reforming entitlement programs to reduce
future claims and free up resources for other competing priorities, and
(3) by establishing a more sustainable Medicare program that delivers
effective and affordable health care to our nation's seniors.

Leading reform proposals that address comprehensive reform such as those of
the President and Breaux-Frist include the use of general funds as part of
their financing mechanisms. While some precedent exists for the use of
general funds in federal trust funds, we need to ask how such general fund
infusions can be structured so as to facilitate, not impede, needed reform
and fiscal discipline.

In this context, I would like to make a few summary points before delving
into the specifics of Medicare's financial health and issues raised by
increased reliance on general revenue financing.

   * To qualify as meaningful reform, any proposal should make a significant
     down payment toward ensuring Medicare's long-range financial integrity
     and sustainability-the most critical issue facing Medicare. Reform
     efforts ought not to be piecemeal. Financial reforms such as general
     revenue financing should not be considered alone but as part of a
     broader reform package. Recent history with Medicare reform shows that
     benefit expansions are compelling while fiscal controls and constraints
     are difficult to enact and sustain.
   * General fund infusions may well be a necessary part of program reform,
     but caution is warranted in considering the commitment of additional
     general revenues. General revenue financing can extend the solvency of
     the program but does not alone do anything to make the program more
     sustainable in the long term. In fact, without underlying reforms,
     general revenue financing could very well serve to reduce the sense of
     urgency to make needed program changes that impending trust fund
     bankruptcy provides to policymakers.
   * In addition, some consideration should be given to a process to guard
     against the risk that growing program financial needs will routinely be
     met with additional general fund infusions, thereby further mortgaging
     the future and crowding out other national needs. Accordingly, any
     additional general revenue infusions should be coupled with mechanisms
     to monitor costs over time and to alert policymakers of the need to
     take timely action when total projected costs exceed thresholds or
     triggers related to some indicator of sustainability.

Health care costs compete with other legitimate priorities in the federal
budget, and their projected growth threatens to crowd out future
generations' flexibility to decide which competing priorities will be met
.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 issues
affecting domestic programs. 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. Given the size of
Medicare's projected funding needs, it is realistic to expect that reforms
intended to bring down future costs will have to proceed incrementally. 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" with
retirees a far smaller proportion of the population than they will be in the
future.

Federal Trust Funds

The federal budget consists of several fund types: the general fund, special
funds, public enterprise funds, intragovernmental funds, and trust funds.
All of these except trust funds are considered to be "federal funds." All
unified budget transactions fall within either of two fund groups: (1)
federal funds and (2) trust funds.

Although some budget summary tables show only about a dozen major trust
funds, in fiscal year 1998 there were 112 trust funds. These covered a wide
range of purposes: from social insurance (Social Security and Medicare),
employee compensation (pensions and health benefits), insurance, natural
resources and environmental cleanup to transportation. Social Security is by
far the largest trust fund, followed by federal employee retirement funds
(civilian and military) and the Medicare trust funds.

In the federal budget, the term "trust fund" neither means what it does for
a private trust fund nor indicates unique characteristics within the federal
budget. The manager of a private trust has a fiduciary obligation to the
beneficiary and must manage the trust's assets on behalf of that beneficiary
according to the stipulations of the trust. The manager cannot unilaterally
alter the terms of that trust. In contrast, the federal government both owns
the assets of most trust funds and can, through legislation, raise or lower
the fund's collections or payments, or alter the purposes of the trust fund.

Unlike a private trust fund, which can set aside money for the future by
increasing its assets, federal trust funds are not vehicles to park "real"
savings for the future. They are simply budget accounting mechanisms used to
record receipts and expenditures earmarked for specific purposes. This is
unlike state governments, which 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. Under current
law, when a federal trust fund like the HI trust fund runs a surplus of
payroll tax revenues over benefit payments, that surplus must be 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, as the HI trust fund did
between 1992 and 1998, it redeems these securities to pay benefit costs
exceeding current payroll tax receipts. Medicare will be able to do this
until 2015 under current law when the HI trust fund securities are projected
to be exhausted. However, in order to redeem these securities, the
government as a whole must come up with cash by increasing taxes, reducing
spending, reducing projected surpluses, or borrowing more from the public if
projected surpluses are not realized.

Since the trust fund's securities constitute a legal claim against the
Treasury, increasing the balances of Treasury securities held by the HI
trust fund would extend its solvency and increase the formal claim that HI
has on future general revenues. 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 fund's claims to pay benefits now
and in the future and at what cost for other competing claims for scarce
resources. 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 solvency without reforms
to make the underlying program more sustainable can obscure the warning
signals that trust fund balances provide, thereby creating a false sense of
security and delaying needed reform.

Medicare's Financial Condition

Medicare Is Fiscally Unsustainable in the Long Term

Figure 1: Medicare Spending as a Percentage of Gross Domestic Product (GDP)
1999 to 2073

Absent reform, the financial burden of Medicare and Social Security on
future taxpayers becomes unsustainable. As figure 2 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.

Figure 2: Social Security and Medicare HI Costs as a Percentage of Taxable
Payroll, 1999 to 2074

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital
Insurance Trust Fund, and 1999 Annual Report, Board of Trustees of the
Federal Old Age and Survivors Disability Insurance Trust Funds.

While the problems facing the Social Security program are significant,
Medicare's challenges are even more daunting. To bring Social Security into
actuarial balance today would require raising the payroll tax by 2.07
percentage points-a 17-percent increase-whereas the HI payroll tax would
have to be raised by 1.46 percentage points-a 50-percent increase-to restore
actuarial balance to the HI trust fund. This analysis, moreover, does not
incorporate the financing challenges associated with the SMI and Medicaid
programs.

When viewed from the perspective of the entire budget and the economy, the
growth in Medicare and Social Security spending will become progressively
unsustainable over the longer term. Our updated budget simulations show that
to move into the future without making changes in the Social Security,
Medicare, and Medicaid programs is to envision a very different role for the
federal government. Assuming, for example, that the Congress and the
President adhere to the often-stated goal of saving the Social Security
surpluses, our long-term model shows a world by 2030 in which Social
Security, Medicare, and Medicaid increasingly absorb available revenues
within the federal budget. Under this scenario, these programs would require
more than three-quarters of total federal revenue. (See fig. 3.) Budgetary
flexibility would be drastically constrained and little room would be left
for other federal spending priorities such as national defense, the young,
infrastructure, and law enforcement.

Figure 3: Composition of Spending as a Share of GDP Under the "Eliminate
Non-Social Security Surpluses" Simulation

Notes:

  1. Revenue during the simulation period is lower as a share of GDP than
     the 1999 level due to unspecified permanent policy actions that reduce
     revenue and increase spending to eliminate the non-Social Security
     surpluses.
  2. Medicare expenditure projections follow the Trustees' 1999 intermediate
     assumptions. The projections reflect the current benefit and financing
     structure.

Source: GAO's January 2000 analysis.

The levels of public saving assumed in the simulation exceed both U.S.
historical levels and those sustained by most other countries we have
studied. Essentially, saving just the Social Security surplus would
eliminate debt held by the public-an outcome with benefits for both the
budget and the economy. But it would require sustained fiscal sacrifice
unlike any seen in our modern experience. Under this simulation, debt held
by the public would not only be eliminated; the U.S. would be investing
federal surpluses in nongovernmental assets for several years. Moreover, the
levels of public saving assumed in the simulation will not by themselves be
enough in the long term to promote the kind of economic growth to which we
have become accustomed. Even assuming these significant and unprecedented
levels of fiscal restraint over many years, entitlement spending will still
encumber an unsustainable share of federal resources in the future.

As with Social Security, the progressive absorption of a greater share of
the nation's resources for health care is in part a reflection of the
increasing growth in the elderly population, but Medicare cost growth rates
also reflect the escalation of health care costs at rates well exceeding
general rates of inflation. Increases in the number and quality of health
care 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 health 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.

Medicare's Current Program and Financing Structure

The 1999 Trustees' annual report showed that Medicare's HI component was, on
a cash basis, in the red from 1992 to 1998; in fiscal year 1998, earmarked
payroll taxes covered only 89 percent of HI spending. Although the Office of
Management and Budget has recently reported a $12 billion cash surplus for
the HI program in fiscal year 1999 due to lower than expected program
outlays, the Trustees' report issued in March 1999 projected continued cash
deficits for the HI trust fund. (See fig. 4.)

Figure 4: Financial Outlook of the Hospital Insurance Trust Fund, 1990 to
2025

Much of the public debate focuses on trust fund balances-and the 1999
Trustees' report estimates that the HI trust fund will remain solvent
through 2015. However, the more important measure is the net cash impact of
the trust fund on the government as a whole. From this perspective, when the
HI trust fund has an annual cash deficit, as it did from 1992 through 1998,
Medicare is a net claimant on the Treasury-a threshold that Social Security
is not currently expected to reach until 2014. To finance these cash
deficits, Medicare drew on its special issue Treasury securities acquired
during the years when the program generated a cash surplus. In essence, for
Medicare to "redeem" its securities, the government must raise taxes, cut
spending for other programs, or reduce projected surpluses. Figure 5 depicts
the relationship of the HI trust fund to the unified budget and the general
fund under current law when the trust fund has a cash surplus.

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

Note: If the trust fund has a cash surplus, debt held by the fund increases
because special Treasuries are issued to the fund. If the fund is in
deficit, the flow is reversed with the fund redeeming special Treasuries and
receiving cash from the general fund to make benefit payments.

Source: GAO analysis.

In contrast to HI, SMI, also known as part B, is financed through general
revenues and beneficiary premiums. The history of SMI financing illustrates
the difficulties of maintaining fiscal discipline. Originally the part B
premium was set at a level to finance 50 percent of SMI program costs.
However, less than 10 years later, the method for setting the SMI premium
was tied to changes in the cost of living, resulting in premiums dropping
below 25 percent of program costs. Under current law, the premium is now set
at 25 percent of program costs, with general revenues paying the remaining
75 percent.

Currently, the financial health of the entire Medicare program is generally
gauged by the solvency of the HI trust fund-not the imbalance between total
program revenue and total program spending (both HI and SMI). Clearly HI
trust fund solvency is an incomplete measure, and since SMI is projected to
grow faster than HI in the coming decades, the HI trust fund risks becoming
an increasingly inadequate signal of future fiscal imbalances. This measure
could in fact become misleading if additional general revenue were used in
program financing.

When outlays outstrip revenues in the HI fund, it is tempting to shift some
expenditures to SMI. Such cost shifting extends the solvency of the HI Trust
Fund but does nothing to address the fundamental financial health of the
program. Worse, it masks the problem and may cause fiscal imbalances to go
unnoticed. For example, in 1997 the Balanced Budget Act modified the home
health benefit, which resulted in shifting a portion of home health spending
from the HI trust fund to SMI. Although this shift extended HI trust fund
solvency, it increased the draw on general revenues in SMI while generating
little net savings. Ultimately, the critical question is not how much a
trust fund has in assets, but whether the government as a whole can afford
the promised benefits now and in the future and at what cost to other claims
on scarce resources.

Use of General Funds in Medicare Reform Raises Design Issues

Given the aging of our society and the increasing cost of modern medical
technology, it is inevitable that the demands on the Medicare program will
grow. The National Bipartisan Commission on the Future of Medicare noted
that the program will require additional resources as the percent of the
population eligible for benefits increases. One major uncertainty in
Medicare's future financing needs, the Commission noted, is the inability to
predict the evolution of the health care delivery system or the impact that
technology will have on health care costs. At the same time the Commission
emphasized the urgent need for reforms that will slow the growth in Medicare
spending.

Consider the case of prescription drug coverage. In 1965, when the Medicare
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 in some cases. Most private insurance options
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 prescription drug
spending is increasing rapidly. From 1993 to 1998, prescription drug
spending grew at an average annual rate of 12.4 percent compared with 5
percent average annual growth in health care expenditures overall. A recent
study has suggested that expanding Medicare's benefit package to include
prescription drugs could add between 7.2 and 10 percent annually to total
program costs, and CBO estimates the cost of the President's proposed
prescription drug benefit at $149 billion in additional federal spending
between 2003 and 2010. Although the case for adding a prescription drug
benefit to Medicare is appealing, any benefit expansion needs to be
targeted, include appropriate cost controls, and other program reforms that
will begin to close the gap between existing promised and funded benefits.

Given the size of Medicare's projected funding needs, it is realistic to
expect that reforms to bring down future costs will have to proceed in an
incremental and iterative fashion. Comprehensive Medicare reform cannot,
once implemented, be put on automatic pilot. Recent experience implementing
changes shows that reform is a dynamic process requiring vigilance and
flexibility.

Last year, when the Comptroller General testified before the Congress on the
financing of the HI trust fund, he said that additional general revenues may
very well be necessary, but such a change would represent a marked departure
from payroll tax financing with implications that warrant explicit and
serious debate. Leading reform proposals that address comprehensive reform
such as those of the President and Breaux-Frist include the use of general
funds as part of their financing mechanisms. While some precedent exists for
the use of general funds in federal trust funds, we need to ask how such
general fund infusions can be structured so as to facilitate, not impede,
needed reform and fiscal discipline.

The proposed changes to Medicare financing raise some important issues that
are not unique to the Medicare program but arise whenever general revenues
are commingled with other types of revenues such as payroll taxes and
beneficiary premiums in a federal trust fund. Whatever the financing
structure of Medicare, a continuing need will exist for a signal of future
fiscal imbalances to alert policymakers of the need to take timely and
prudent action. In addition, some consideration should be given to a process
that could guard against the risk that growing program financial needs will
routinely be met with additional general fund infusions, thereby further
mortgaging the future and crowding out other national needs. Such a process
could also be used to periodically re-assess the mix of differing sources of
program financing.

In the remainder of this testimony I would like to examine design issues
raised by leading reform proposals' expanded use of general revenue,
focusing on the implications for program fiscal discipline and consequences
for the unified budget.

The President's Proposal

In addition the proposal would earmark a portion of the projected non-Social
Security surpluses for Medicare. According to the Office of Management and
Budget, the proposal would use $432 billion, or 58 percent of the projected
on-budget surpluses, over the next 10 years for Medicare. Of the $432
billion, $299 billion (40 percent of the on-budget surplus) would be
transferred to the HI trust fund and used to reduce debt held by the public.
The proposal would use $98 billion of projected on-budget surpluses to pay
for the proposed prescription drug benefit. The remaining $35 billion would
be used to establish a reserve fund. This fund is to be used for debt
reduction or, in the event that the President and the Congress agree, for a
policy that provides protections against catastrophic drug costs for
Medicare beneficiaries or policies that otherwise strengthen the Medicare
program.

The proposed transfer of surpluses would extend the solvency of the HI trust
fund from 2015 to 2025 and preserve the divided financing structure (HI and
SMI). It would not, however, address the sustainability of the Medicare
program and may, in fact, serve to decrease the likelihood of needed reform.
The transfer would also represent a significant departure in how HI is
financed. 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. That is, the value of securities held by the HI trust
fund would exceed that supported by earlier payroll tax surpluses, and these
additional securities would constitute a new claim on the general fund for
the future. Figure 6 depicts the flow of funds for the HI program under the
President's proposal.

Figure 6: Hospital Insurance Trust Fund Flows Under the President's Proposal

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

Note: If the trust fund has a cash surplus, debt held by the fund increases
because special Treasuries are issued to the fund. If the fund is in
deficit, the flow is reversed with the fund redeeming special Treasuries and
receiving cash from the general fund to make benefit payments.

Source: GAO analysis.

According to the Administration, the underlying rationale for the transfers
is 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.

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, including all of the Social Security surplus, to reduce debt
held by the public. According to the Administration's projections, this
initiative will reduce interest payments from $230 billion in 1999 to nearly
zero in 2013 when publicly held debt would be virtually eliminated. The
reduction in publicly held debt proposed by the President would confer
significant short- and long-term benefits to the budget and the economy. Our
work on long-term budget outlooks illustrates the benefits of maintaining
surpluses for debt reduction. Today, interest on the debt represents the
third largest expenditure in the federal budget. Reducing the publicly held
debt reduces these costs, freeing up budgetary resources for other
programmatic priorities. 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.

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. However, the mechanism the President has
proposed entails significant risks if considered on its own without being
coupled to reforms. Indeed, I would note that the President has also
included certain reforms as part of his proposal. Without underlying reform,
increasing the HI trust fund balances would do nothing to make the
program-HI or SMI-more sustainable. In fact, the transfer would interfere
with the 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 2025-well into
the peak of the baby boomers' retirement. Furthermore, the SMI portion of
Medicare, projected to grow even faster than HI, is unaffected by this
transfer.

This is a major change in the underlying theoretical design of the HI
program. Whether you believe it is a major change in reality 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 trust fund
will exhaust its securities to pay the full promised benefits in 2015. If
you believe that this shortfall would be made up with general funds when the
time came, 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 be financed through higher taxes or spending cuts elsewhere in the
federal budget as a whole. Again, we have recognized that the President has
now coupled his financing proposal with substantive Medicare reforms. It is
critical that these two elements not be severed.

Another issue the proposal raises is whether the transfers 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 a
fixed dollar amount rather than as a percent of the actual on-budget surplus
in any given year. These transfers would have a claim on future general
revenues even if the actual on-budget surplus fell below the amount
specified for the transfers. 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 Breaux-Frist Proposal

In these and certain other respects, the Breaux-Frist proposal incorporated
recommendations made by the National Bipartisan Commission on the Future of
Medicare. The Commission called attention to the inadequacy of the HI trust
fund as a measure of total program solvency, noting that the portion of
Medicare expenditures paid by general funds has increased over time relative
to the share paid by payroll taxes and beneficiary premiums. According to
the Commission, a new measure of solvency was needed that would couple the
uncertainty inherent in the task of gauging program financing in light of
the difficulty in predicting future health care technology with the real
need for the public to evaluate the cost of Medicare and how we should
choose to fund this program over time.

The 40-percent threshold for general fund contributions proposed by
Breaux-Frist would provide a mechanism that would require policymakers to
revisit Medicare reform if program financing demands continue to grow in the
coming decades as the proportion of the population eligible for benefits
grows. This mechanism could prompt future Congresses to periodically revisit
Medicare financing issues and enact needed reforms. In concept the use of a
threshold holds the potential to enhance future federal budgetary
flexibility by calling attention when Medicare's share of general revenues
is about to exceed specified levels. If coupled with an effective oversight
process, a threshold mechanism could also prompt Congress to debate the
appropriate proportions of general fund contributions, payroll taxes, and
premiums for Medicare financing in the context of contemporary economic and
budgetary environments.

Current spending projections show that absent reform that addresses total
program cost, this limit would be reached in less than 10 years. (See fig.
7.) These data underscore the need for reform to include appropriate
measures of fiscal sustainability as well as a credible process to give
policymakers timely warning when fiscal targets are in danger of being
overshot.

Figure 7: Projected Funding Gap Under a 40-Percent Threshold for General
Revenue Source: 1999 Annual Report, Board of Trustees of the Federal Hospital
Insurance Trust Fund and 1999 Annual Report, Federal Supplementary Insurance
Trust Fund.

Designing a Threshold for General Fund Contributions

The Breaux-Frist approach would deem the trust fund "programmatically
insolvent" if the general revenue transfer needed to make payments exceeded
40 percent of total Medicare expense for the fiscal year. While this
establishes a "trigger" for insolvency, it does not specify what would
happen if insolvency occurs. Both a trigger and some resulting specified
course of action would be necessary to ensure that imbalances between trust
fund receipts and payments are addressed before they become an unending
drain on general revenues.

Given that Medicare cost growth has generally been faster than growth in the
rest of the budget, a trigger that permits the dollar amount of general
revenue financing to float upward as Medicare expenses increase would allow
increasingly larger shares of general revenues from other government
programs. To avoid this potentially unencumbered draw on general revenue a
number of different indicators might be explored as possible triggers to
action. For example, a trigger could be defined as when the general revenue
transfer reaches some specified percent of total federal revenues. Such a
trigger could limit general revenue support to a certain share of federal
revenue rather than letting it grow at the same rate as Medicare expenses as
in Breaux-Frist. Other possible triggers could be a specified floor in the
trust fund, such as the balance falling below 1 year's worth of payments;
the percentage of gross domestic product devoted to Medicare; or program
spending per enrollee.

Whatever the trigger, the key question would be what happens when the
trigger limits are reached. One approach in designing such a trigger would
be to couple it with specified actions to occur if the trigger is reached. A
"hard" trigger would include specific provisions that would automatically go
into effect if the trigger is reached. Perhaps more realistically, a
"softer" trigger could require the Congress or the President to take some
action or to re-affirm acceptance of the Medicare cost growth and provide
additional general revenues to cover it. This would at least ensure that the
Congress and the President periodically review and decide how to address
cost growth if it occurs.

Several alternatives might be considered for implementing such a trigger.
For example, reaching a trigger could require the President to propose how
to deal with the growth and the Congress to vote on the proposal, either
accepting it or developing an alternative. Or the congressional budget
process could be used to require the Congress to deal with Medicare cost
growth by establishing a point of order against a budget resolution that
includes a Medicare spending path that exceeds a specified trigger measure.
Raising the point of order could require the Congress to propose changes to
Medicare to bring it within the specified measure or vote to accept the cost
growth. If program changes are desired, reconciliation instructions could be
included in the budget resolution. The President would be brought into the
process as it progressed because changes to Medicare would require enactment
of a law. In fact, the current budget process contains a similar point of
order against worsening the financial condition of the Social Security trust
funds.

Discipline cannot be instilled by a process change alone; leaders must be
committed to enforcing discipline for it to be effective. The trust fund
mechanism has shown that when such processes or mechanisms are viewed as
credible, they can help focus the debate and promote timely actions. If the
signaling feature of trust funds is to be weakened by general revenue
injections, it is imperative that some other process discipline be
developed, either as I have suggested or in some other way. We will be happy
to work with your staff to further develop any of the ideas I have mentioned
or others that may be proposed to inject the necessary discipline.

Concluding Observations

It is my hope that we will think about the unprecedented challenge facing
future generations in our aging society. Relieving them of some of the
burden of today's financing commitments would help fulfill this generation's
fiduciary responsibility. It would also preserve some capacity to make their
own choices by strengthening both 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 grandchildren. While reducing debt
is important, debt reduction alone will be insufficient to secure our
economic future. 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.

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 will 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 workforce 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 that are 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.

(935360)

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