Medicare and Budget Surpluses: GAO's Perspective on the President's
Proposal and the Need for Reform (Testimony, 03/10/99,
GAO/T-AIMD/HEHS-99-113).

The President proposes to use about two-thirds of the projected budget
surpluses over the next 15 years to reduce publicly held debt. At the
same time, he also proposes to transfer a like amount to the Social
Security and Medicare trust funds in the form of nonmarketable Treasury
securities, which is projected to extend the life of Medicare's Hospital
Insurance (HI) trust fund from 2008 to 2020. His proposal would trade
debt held by the public for debt held by the Social Security and
Medicare trust funds. These new Treasury securities would constitute a
new unearned claim on general funds for the HI program--a marked break
with the payroll tax-based financing structure of the program. This
change could undermine the remaining fiscal discipline associated with
the self-financing trust fund concept and could induce a false
complacency about the financial health of the HI program. Without
change, however, Medicare is projected to more than double its share of
the economy by 2050, and Social Security, health, and interest will take
nearly all the revenues the federal government takes in. Real and
substantive Medicare reform, not simple financing shifts among funds
within the budget, is essential. Acting now would allow changes to
benefits and health care delivery systems to be phased in gradually so
that stakeholders and participants would have time to adjust their
saving or retirement goals.

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

 REPORTNUM:  T-AIMD/HEHS-99-113
     TITLE:  Medicare and Budget Surpluses: GAO's Perspective on the 
             President's Proposal and the Need for Reform
      DATE:  03/10/99
   SUBJECT:  Economic analysis
             Future budget projections
             Fiscal policies
             Health care programs
             Presidential proposals
             Deficit reduction
             US Treasury securities
             Budget surplus
             Balanced budgets
             Debt held by public
IDENTIFIER:  Medicare Hospital Insurance Program
             Medicare Program
             Social Security Program
             Medicare Choice Program
             
Medicare and Budget Surpluses: GAO's Perspective on the President's
Proposal and the Need for Reform (Testimony, 03/10/99,
GAO/T-AIMD/HEHS-99-113).

The President proposes to use about two-thirds of the projected budget
surpluses over the next 15 years to reduce publicly held debt. At the
same time, he also proposes to transfer a like amount to the Social
Security and Medicare trust funds in the form of nonmarketable Treasury
securities, which is projected to extend the life of Medicare's Hospital
Insurance (HI) trust fund from 2008 to 2020. His proposal would trade
debt held by the public for debt held by the Social Security and
Medicare trust funds. These new Treasury securities would constitute a
new unearned claim on general funds for the HI program--a marked break
with the payroll tax-based financing structure of the program. This
change could undermine the remaining fiscal discipline associated with
the self-financing trust fund concept and could induce a false
complacency about the financial health of the HI program. Without
change, however, Medicare is projected to more than double its share of
the economy by 2050, and Social Security, health, and interest will take
nearly all the revenues the federal government takes in. Real and
substantive Medicare reform, not simple financing shifts among funds
within the budget, is essential. Acting now would allow changes to
benefits and health care delivery systems to be phased in gradually so
that stakeholders and participants would have time to adjust their
saving or retirement goals.

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

 REPORTNUM:  T-AIMD/HEHS-99-113
     TITLE:  Medicare and Budget Surpluses: GAO's Perspective on the 
             President's Proposal and the Need for Reform
      DATE:  03/10/99
   SUBJECT:  Economic analysis
             Future budget projections
             Fiscal policies
             Health care programs
             Presidential proposals
             Deficit reduction
             US Treasury securities
             Budget surplus
             Balanced budgets
             Debt held by public
IDENTIFIER:  Medicare Hospital Insurance Program
             Medicare Program
             Social Security Program
             Medicare Choice Program
             
Medicare and Budget Surpluses: GAO's Perspective on the President's
Proposal and the Need for Reform (Testimony, 03/10/99,
GAO/T-AIMD/HEHS-99-113).

The President proposes to use about two-thirds of the projected budget
surpluses over the next 15 years to reduce publicly held debt. At the
same time, he also proposes to transfer a like amount to the Social
Security and Medicare trust funds in the form of nonmarketable Treasury
securities, which is projected to extend the life of Medicare's Hospital
Insurance (HI) trust fund from 2008 to 2020. His proposal would trade
debt held by the public for debt held by the Social Security and
Medicare trust funds. These new Treasury securities would constitute a
new unearned claim on general funds for the HI program--a marked break
with the payroll tax-based financing structure of the program. This
change could undermine the remaining fiscal discipline associated with
the self-financing trust fund concept and could induce a false
complacency about the financial health of the HI program. Without
change, however, Medicare is projected to more than double its share of
the economy by 2050, and Social Security, health, and interest will take
nearly all the revenues the federal government takes in. Real and
substantive Medicare reform, not simple financing shifts among funds
within the budget, is essential. Acting now would allow changes to
benefits and health care delivery systems to be phased in gradually so
that stakeholders and participants would have time to adjust their
saving or retirement goals.

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

 REPORTNUM:  T-AIMD/HEHS-99-113
     TITLE:  Medicare and Budget Surpluses: GAO's Perspective on the 
             President's Proposal and the Need for Reform
      DATE:  03/10/99
   SUBJECT:  Economic analysis
             Future budget projections
             Fiscal policies
             Health care programs
             Presidential proposals
             Deficit reduction
             US Treasury securities
             Budget surplus
             Balanced budgets
             Debt held by public
IDENTIFIER:  Medicare Hospital Insurance Program
             Medicare Program
             Social Security Program
             Medicare Choice Program
             
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A399113t.book GAO

United States General Accounting Office

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

For Release on Delivery Expected at 10 a.m. Wednesday, March 10,
1999

MEDICARE AND BUDGET SURPLUSES

GAO's Perspective on the President's Proposal and the Need for
Reform

Statement of David M. Walker Comptroller General of the United
States

GAO/T-AIMD/HEHS-99-113

Page 1 GAO/T-AIMD/HEHS-99-113

Mr. Chairman and Members of the Committee: It is a pleasure to be
here today to discuss the President's recent proposal for
addressing Medicare and use of the projected budget surpluses over
the next 15 years. As you know, I testified last month on the
implications of the President's surplus proposals for Social
Security. Today, I will briefly reprise our views on the overall
fiscal consequences of the proposal, discuss what it does and does
not do for the Medicare program, and examine the importance of and
difficulty in making fundamental changes to this complex program.

Regarding the President's proposal:  It would significantly reduce
debt held by the public from current levels,

thereby also reducing net interest costs, raising national
savings, and contributing to future economic growth. This element
of the President's proposal would have positive short- and long-
term effects on the economy.  It provides a grant (or in the
President's word, a gift) of a new set of

Treasury securities for the Medicare Hospital Insurance (HI)
program which would extend the life of the HI trust fund from 2008
to 2020. It is important to note, however, that these new Treasury
securities would constitute a new unearned claim on general funds
for the HI program--a marked break with the payroll tax-based
financing structure of the program. This would be a significant
change that could serve to undermine the remaining fiscal
discipline associated with the self- financing trust fund concept.
It has no effect on the current and projected cash-flow deficits
that have

faced the HI program since 1992deficits that taxpayers will
continue to finance through higher taxes, lower spending elsewhere
or lower paydowns of publicly held debt than the baseline.
Importantly, the President's proposal would not provide any new
cash to pay for medical services.  It does not include any
meaningful program reform that would slow

spending growth in the HI program. In fact, the transfer of these
new Treasury securities to the HI program could very well serve to
reduce a sense of urgency for reform. At the same time, it could
strengthen pressure to expand Medicare benefits in a program that
is fundamentally unsustainable in its present form.

The current Medicare program is both economically and fiscally
unsustainable. This is not a new message--the Medicare Trustees
noted in

Page 2 GAO/T-AIMD/HEHS-99-113

the early 1990s that the program is unsustainable in its present
form. They also noted the need for dramatic and fundamental reform
of the program to assure its solvency. With regard to Medicare:

 The program's continued growth threatens to crowd out other
spending and economic activity of value to our society. Even if we
save the entire surplus, Medicare is projected to more than double
its share of the economy by 2050.  Meaningful reform of this
program is urgently needed and such reform

will require hard choices. The program changes enacted in 1997
illustrate how difficult even incremental reform is to adopt.
Major change requires reshaping the nation's perspective on health
care consumption and drawing distinctions between what the nation
needs, wants, and can afford both at the national and individual
level.  To be effective and sustainable, reforms must begin soon
and be

comprehensive in nature. However, the history of entitlement
reforms tell us that, to be enduring, such reforms must be
introduced gradually after widespread public education in order to
garner sufficient support from the system's multiple stakeholders.

Context: Long-term Outlook Is Important

It is important to look at the President's proposal in the context
of the fiscal situation in which we find ourselves. After nearly
30 years of unified budget deficits, we look ahead to projections
for surpluses as far as the eye can see. At the same time, we know
that we face a demographic tsunami in the future that poses
significant challenges for Social Security, Medicare, and our
economy as a whole. In this context, it is noteworthy that the
President has proposed a longer term framework for resource
allocation than has been customary in federal budgeting.

Although all projections are uncertainand they get more uncertain
the farther out they gowe have long held that a long-term
perspective is important in formulating fiscal policy for the
nation. Each generation is in part the custodian for the economy
it hands the next and the nation's long- term economic future
depends in large part on today's budget decisions. This
perspective is particularly important because our model and that
of the Congressional Budget Office (CBO) continue to show that
absent a change in policy, the changing demographics to which I
referred above will lead to renewed deficits. This longer term
problem provides the critical backdrop for making decisions about
today's temporary budget surpluses.

Page 3 GAO/T-AIMD/HEHS-99-113

Surpluses are the result of a good economy and difficult policy
decisions. They also provide a unique opportunity to put our
country on a more sustainable path for the long term, both for the
nation's fiscal policy and selected entitlement programs. Current
decisions can help in several important respects: (1) current
fiscal policy decisions can help expand the future capacity of our
economy by increasing national savings and investment, (2)
engaging in substantive reforms of retirement and health programs
can reduce future claims, (3) by acting now, we have the
opportunity of phasing in changes to Social Security and Medicare
programs over a sufficient period of time to enable our citizens
to adjust, and (4) failure to achieve needed reforms in the Social
Security and Medicare programs will drive future spending to
levels that will eventually squeeze out most or all discretionary
spending, including national defense spending. If we let the
achievement of a temporary budget surplus lull us into complacency
about the budget, then in the middle of the 21st century we could
face daunting demographic challenges without having built the
economic capacity or program and policy reforms to handle them.

The Proposal Before turning to Medicare specifically, it is
important to describe the President's overall proposal for using
the surpluses over the next 15 years.

The proposal's effects on Medicare are part of a broader
initiative to save a major share of the surplus to reduce the debt
held by the public and thereby enhance future economic capacity
for the nation.

The President proposes to use a significant portion of the total
projected unified budget surpluses over the next 15 years to
reduce debt held by the public. He also proposes to take some
related steps to address the financing problems facing both the
Medicare and Social Security programs. His approach to this,
however, is extremely complex and confusing.

Specifically, the President proposes to allocate about two-thirds
of the projected surplus over the next 15 years to reduce publicly
held debt. This portion of his proposal would increase our future
economic capacity. At the same time, the President proposes to
transfer a like amount to the Social Security and Medicare trust
funds in the form of nonmarketable Treasury securities. In effect,
the President's proposal would trade debt held by the public for
debt held by the Social Security and Medicare trust funds. The
administration has defended this approach as a way of assuring
both a reduction in debt held by the public and as securing a
first claim for both Social Security and Medicare on what they
call the debt-reduction dividend to pay future benefits for those
two programs. The HI program

Page 4 GAO/T-AIMD/HEHS-99-113

would receive nearly $700 billion in additional Treasury
securities -

representing nearly 15 percent of total surpluses over the 15
years. 1 This transfer is projected to extend the life of the HI
trust fund from 2008 to 2020.

The President's proposal has raised important questions about how
the federal government can promote long-term economic security by
using today's surplus resources to save for the future. In the
federal unified budget, the only way to save for the future is to
run a unified budget surplus or purchase a financial asset. When
there is a cash surplus it is used to reduce debt held by the
public. Therefore, to the extent that there is an actual cash
surplus, debt held by the public falls. This is exactly what
happened in fiscal year 1998 when the debt held by the public was
reduced by $51 billion.

In the federal budget, trust funds are not vehicles to park real
savings for the future. They are simply budget accounts used to
record receipts and expenditures earmarked for specific purposes.
A private trust fund can set aside money for the future by
increasing its assets. State governments similarly can park
surplus resources in real pension funds and other trust funds that
are routinely invested in assets (e.g., readily marketable
securities) outside the government. However, under current law,
when a trust fund like HI ran a surplus of payroll tax revenues
over benefit payments, the excess was invested in Treasury
securities and used to meet current cash needs of the government.
These securities are an asset to the trust fund, but they are a
claim on the Treasury. When a trust fund runs a cash deficit, like
HI has been doing since 1992, it redeems these securities to pay
benefit costs exceeding current payroll tax receipts. 2 Medicare
will be able to do this until 2008 under current law when its
trust fund securities will be exhausted. However, in order to
redeem these securities, the government as a whole must come up
with the cash by either increasing taxes, reducing spending, or
raising borrowing from the public above the baseline.

Increasing the balances of Treasury securities owned by HI trust
funds alone would increase the formal claim that the trust funds
have on future general revenues since the trust fund's securities
constitute a legal claim

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

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

Page 5 GAO/T-AIMD/HEHS-99-113

against the Treasury. However, increasing the HI trust fund
balances alone, without underlying reform, does nothing to make
the program more sustainable. From a macro perspective, the
critical question is not how much a trust fund has in assets, but
whether the government as a whole has the economic capacity to
finance the trust funds claims to pay benefits now and in the
future. From a micro perspective, trust funds can provide a vital
signaling function for policymakers about underlying fiscal
imbalances in covered programs. However, extending a trust fund's
paper solvency without reforms to make the underlying program more
sustainable can, in effect, obscure the warning signals that trust
fund balances provide.

Government Financing The President's proposals would enhance the
nation's future economic capacity by significantly reducing debt
held by the public from the current

level of 44 percent of gross domestic product (GDP) to 7 percent
over the 15-year period. The President notes that this would be
the lowest level since 1917. Nearly two-thirds of the projected
unified budget surplus would be used to reduce debt held by the
public. Because the surplus is also to be used for other
governmental activities, the amount of debt reduction achieved
would be less than the baseline (i.e., a situation in which none
of the surplus was used), but nonetheless the outcome would confer
significant short- and long-term benefits on the budget and the
economy.

Our previous work on the long-term effects of federal fiscal
policy has shown the substantial benefits of debt reduction. 3 One
of these is lowering the burden of interest payments in the
budget. Today, net interest represents the third-largest program
in the budget, after Social Security and Defense. Interest
payments, of course, are a function of both the amount of debt on
which interest is charged and the interest rate . At any given
interest rate, reducing publicly held debt reduces net interest
payments within the budget. For example, CBO estimates that the
difference between spending the surplus and saving the surplus is
$123 billion in annual interest payments for debt held by the
public by 2009--or almost $500 billion cumulatively between now
and then. Compared to spending the entire surplus, the President's
proposal would also substantially reduce projected interest
payments . Lower interest payments lead to larger surpluses; these
in turn lead to lower debt which

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

Page 6 GAO/T-AIMD/HEHS-99-113

leads to lower interest payments and so on: The miracle of
compound interest produces a virtuous circle. The result would be
to provide increased budgetary flexibility for future
decisionmakers who will be faced with enormous and growing
spending pressures from the aging population.

For the economy, lowering debt levels increases national saving
and frees up resources for private investment. This in turn leads
to increased productivity and stronger economic growth over the
long term. Over the last several years, we and CBO have both
simulated the long-term economic results from various fiscal
policy paths. These projections consistently show that reducing
debt held by the public increases national income over the next 50
years, thereby making it easier for the nation to meet future
needs and commitments. Our latest simulations done for the Senate
Budget Committee, as shown in figure 1, illustrate that any path
saving all or a significant share of the surplus in the near term
would produce demonstrable gains in per capita GDP over the long
run. 4 This higher GDP in turn would increase the nation's
economic capacity to handle all its commitments in the future.

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

Page 7 GAO/T-AIMD/HEHS-99-113

Figure 1: GDP Per Capita Under Alternate Fiscal Policy Simulations

Source: GAO Analysis. While reducing debt held by the public
appears to be a centerpiece of the President's proposaland has
significant benefitsas I noted above, the transfer of a portion of
the unified surpluses to the HI trust fund is a separate issue.
The transfer is not technically necessary: Whenever revenue
exceeds outlays and the cash needs of the Treasury, debt held by
the public falls.

25,000 30,000

35,000 40,000

45,000 50,000

55,000 60,000

65,000 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042
2046 2050

On- budget balance Save the surplus No surplus 1998 level Per
capita 1998 dollars

Page 8 GAO/T-AIMD/HEHS-99-113

The President's proposal appears to be premised on the belief that
the only the way to sustain surpluses is to tie them to Social
Security and Medicare. He has merged two separate questions: (1)
How much of the surplus should be devoted to reducing debt held by
the public? and (2) How should the nation finance these two
programs in the future? The President has proposed to save the
surplus by, in effect, hiding it in the Social Security and HI
trust funds. The additional nonmarketable Treasury securities
transferred to the Social Security and Medicare trust funds are
recorded as a subtraction from the unified budget surplusa new
budgetary concept. Accordingly, the surplus disappears under this
novel scoring approach since these transfers approximate the
surplus the President is proposing to save by reducing publicly
held debt. 5

Let me turn now to the question of how the President's proposal
would affect Medicare financing.

Impact on Medicare Financing

The mechanics of the proposed transfer of surpluses to the
Medicare program are, like the transfers to Social Security,
complex and difficult to follow. In form they are similar, but the
effects on Medicare would be somewhat different. Unlike Social
Security, Medicare's HI program has been experiencing a cash flow
deficit since 1992current payroll taxes and other revenues have
been insufficient to cover benefit payments and program expenses.
Accordingly, Medicare has been drawing on its special Treasury
securities, along with interest on those accumulated balances,
acquired during the years when the program generated a cash
surplus. In effect, these general fund payments can be viewed as
repaying the loan of cash that the trust fund provided the rest of
government when the Medicare program was in surplus. In fiscal
year 1999, the HI program will run a cash deficit of $8 billion.
As noted earlier, in order to redeem these securities, the
government must either raise taxes, cut spending, or increase
borrowing from the public. In essence, Medicare has already
crossed the point where it is a net claimant on the Treasurya
threshold that Social Security is not currently expected to reach
until 2013. Stated differently, the bleeding of the HI trust fund
has already started based on the program's annual cash flow
deficits.

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

Page 9 GAO/T-AIMD/HEHS-99-113

The current financing flows for the HI program are depicted in
figure 2 below. As the figure shows, to help pay benefits in
fiscal year 1999, the HI trust fund receives an $8 billion general
fund payment for interest it earned on its treasury securities
from its past cash surpluses. The HI fund also receives $5 billion
for a portion of the income taxes paid on Social Security
benefits.

Figure 2: Medicare Flows Under Current Law

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

Under the President's proposal, the above scenario would continue.
However, as shown in figure 3, at the point where total tax
receipts are allocated to pay for government activities, a new
financing step would be added to transfer a portion of the
projected unified budget surpluses to the Medicare HI trust fund.
The Treasury would do this by issuing a new set of securities for
the HI trust fund. Unlike the current securities owed the trust
fund, these new securities are not supported by payroll tax
surpluses in the program; rather, they represent what amounts to a
grant or gift. However, it is important to remember that these new
securities equal a

Benefits Claims for interest

earned on past surpluses Cash for benefit payments and additional

special treasuries Payroll Taxes*

Unified surplus would pay down the debt held by the public

Hospital Insurance Trust Fund General Fund

Discretionary Spending

Other Mandatory

Spending Other Taxes

Unified Budget

Page 10 GAO/T-AIMD/HEHS-99-113

portion of the excess cash that would be used to reduce the debt
held by the public. The administration argues that the new
securities are, in effect, supported by the enhanced economic
resources gained by reducing publicly held debt. Nonetheless, we
should remember that under the current law baselinei.e., with no
changes in tax or spending policythis would happen without
crediting additional securities to either the Social Security or
Medicare trust funds.

Figure 3: Medicare Flows Under President's Proposal

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

The financial consequences of this transfer are depicted in figure
4 below. This graph first shows that by providing the additional
Treasury securities, the solvency of the Hospital Insurance trust
fund would be extended from 2008 to 2020. However, the figure also
shows that the President's proposal does nothing to alter the
imbalance between the program's tax receipts and benefit payments.
It has been in cash deficit since 1992 and remains in a cash
deficit even with the new Treasury securities. Thus, the President

Payroll Taxes* Unified surplus would pay down

the debt held by the public

Hospital Insurance Trust Fund General Fund

Discretionary Spending

Other Mandatory

Spending Other Taxes

Benefits

Unified Budget Transfer for

Trust Fund New Special

Treasuries

Claims for interest earned on past surpluses

Cash for benefit payments and additional

special treasuries

Page 11 GAO/T-AIMD/HEHS-99-113

proposes to provide additional claims on the Treasury, not
additional cash to pay benefits.

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

Source: GAO Analysis.

Notwithstanding the fact that no real cash is exchanged, the
transfer of additional securities to Medicare is a discretionary
act with major economic consequences for the future financing of
the HI program. As with Social Security, this proposal represents
a fundamental shift in the way the HI program is financed. It
moves it away from payroll financing toward a formal commitment of
future general fund resources for the program for the future. The
general fund obligation would begin far earlier than for Social
Security. Specifically, the HI trust fund would begin drawing on
the general fund to redeem these new securities in 2008well before
the full reduction in publicly held debt and associated benefits
to the general fund will have been realized under the President's
plan. In addition,

-400 -300

-200 -100

0 100

200 300

400 500

600 Cash Surplus/Deficit Trust Fund Balance Trust Fund Balance
with Transfer

Cash Deficit 1992








Page 12 GAO/T-AIMD/HEHS-99-113

this is 24 years before the Social Security Trust Fund would begin
drawing on the additional Treasury securities that the President
is proposing to grant to that program.

The transfer would constitute an explicit general fund subsidy for
the HI programa subsidy whose magnitude is unprecedented for this
program. This is true because the newly transferred securities
would be in addition to any buildup of historical payroll tax
surpluses. Securities held by the trust fund have always
represented the value of the loan of its surpluses to the
Treasury--annual cash flows in excess of benefits and expenses,
plus interest. Under the President's proposal, the value of
securities held by the HI trust fund would exceed that supported
by earlier payroll tax surpluses and constitute a new and unearned
claim on the general fund for the future. In effect, the proposal
would shift the financing of the HI Trust Fund to look more like
that for the Part B Supplemental Medical Insurance (SMI) Trust
Fund. The SMI portion of Medicare obtains 75 percent of its
revenues from a general fund subsidy, with the remainder supported
by beneficiaries' premiums.

This is a major change in the underlying theoretical design of the
HI program. Whether you believe it is a major change actually
depends on what you assume about the likely future use of general
revenues under the current circumstances. For example, current
projections are that the HI Fund will exhaust its securities to
pay the full promised benefits in 2008. If you believe that this
shortfall wouldwhen the time camebe made up with general fund
moneys, then the shift embedded in the President's proposal merely
makes that explicit. If, however, you believe that there would be
changes in the benefit or tax structure of the fund instead, then
the President's proposal represents a very big change. In this
case, less of the long-term shortfall would be addressed through
future changes in the HI program itself and more would financed
through higher taxes or spending cuts elsewhere in the federal
budget as a whole. Thus, the question of bringing significant
general revenues into the financing of the HI program is a
question that deserves full and open debate. The debate should not
be overshadowed by the accounting complexity and budgetary
confusion of the President's proposal.

In our view, the proposal carries some significant risks that
should be carefully considered by the Congress. One risk is that
the transfers to both the Medicare and Social Security trust funds
would be made regardless of whether the expected budget surpluses
are actually realized. The amounts to be transferred apparently
would be written into law as either a fixed

Page 13 GAO/T-AIMD/HEHS-99-113

dollar amount or as a percent of taxable payroll rather than as a
percent of the actual unified surplus in any given year. These
transfers would have a claim on the general fund even if the
actual surplus fell below the amount specified for the transfers.
However, it is important to emphasize that any proposal to
allocate surpluses is vulnerable to the risk that those projected
surpluses may not materialize. Proposals making permanent changes
to use the surplus over a long period are especially vulnerable to
this risk.

The history of budget forecasts should remind us not to be
complacent about the certainty of these large projected surpluses.
In its most recent outlook book, CBO compared the actual deficits
or surpluses for 1988-1998 with the first projection it produced 5
years before the start of each fiscal year. Excluding the
estimated impact of legislation, CBO says its errors averaged
about 13 percent of actual outlays. Such a shift in 2004 would
mean a surplus $250 billion higher or lower; in 2009, the swing
would be about $300 billion. Accordingly, we should consider
carefully any permanent commitments that depend on the realization
of a long-term forecast.

The Compelling Need for Fundamental Program Reform

A more significant risk of the President's proposal is that by
appearing to extend financial stability for Medicare, it could
very well undercut the incentives to engage in meaningful and
fundamental reform of the HI programreform that is vital to making
the HI program sustainable over the long term. Unlike Social
Security, the HI program is already in a negative cash flow
positionpayroll taxes support 89 percent of spending now and will
cover less than one half 75 years from now. Even in the short
term, the HI program's annual outlays grow by several times the
rate of general inflation. Although its growth has slowed in
recent years, it remains one of the most volatile and
uncontrollable programs in the federal budget. According to CBO,
the growth of Medicareboth HI and SMI-- will increase its share of
the economy by nearly a full percentage point over the next 10
years, from 2.5 percent to 3.3 percent of GDP in 2009. By
contrast, the share devoted to Social Security is projected to
remain relatively flat during this period rising from 4.4 percent
of GDP in 1999 to 4.7 percent in 2009.

Over the long term, the program's growth rates are more daunting.
Absent any changes, the combined Medicare program (i.e., HI and
SMI) is projected to more than double its share of the economy by
2050from 2.7 percent now to 6.8 percent based on the Medicare
Trustees' most recent best estimated assumptions. When coupled
with Medicaid, federal health

Page 14 GAO/T-AIMD/HEHS-99-113

care costs will grow to nearly 10 percent of GDP by 2050, as
depicted in figure 5. The progressive absorption of a greater
share of the nation's resources for health is, like Social
Security, a reflection of the rising share of elderly in the
population. However, health care growth rates also reflect the
escalating cost growth of health care at rates well exceeding
general rates of inflation. Increases in the number and quality of
health services fueled by the explosive growth of medical
technology has spurred much of this extraordinary cost growth in
health care. Consequently, Medicare represents a much greater and
more complex fiscal challenge than even Social Security over the
longer term.

Figure 5: Medicare and Medicaid as a Share of GDP

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

The President's proposal to strengthen the HI program is more
perceived than real. Specifically, while the HI trust fund will
appear to have more

0.0 1.0

2.0 3.0

4.0 5.0

6.0 7.0

8.0 9.0

10. 0 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042
2046 2050

Medicare Part A Medicare Part B Medicaid Percentage of GDP

Page 15 GAO/T-AIMD/HEHS-99-113

resources as a result of the President's proposal, in reality
nothing about the program has really changed. The proposal does
not represent program reform but rather a supplemental means to
finance the current program. Stated differently, the reform
proposed has more form than substance.

What is most alarming is that the President's proposal could
induce a sense of false complacency about the financial health of
the HI program. The impending insolvency of the HI program sends
important signals to policymakers that the program needs to be
made more affordable through benefit changes, revenue increases,
or both. The 2008 date has become an important cue to policymakers
that could provide the impetus needed to make the hard choices
necessary to promote the solvency and sustainability of the HI
program for the long term. Extending the life of the HI trust fund
without substantive program reform could be a recipe for delay and
denial that could increase the ultimate fiscal and social cost of
HI program reform. At a minimum, the President's proposal is
likely to create a public misperception that something meaningful
is being done to reform the Medicare program.

Changes to the HI program should be made sooner rather than later.
The longer meaningful action is delayed, the more severe such
actions will have to be in the future. Since Medicare is the
fastest growing sector of the federal budget, early action to
reduce its costs will have compounding fiscal benefits. Even if
the rate of growth is not changed, reducing the base level of
spending can produce outyear dividends for the program's finances.
Moreover, acting now would allow changes to benefits and health
care delivery systems to be phased in gradually so that
stakeholders and participants can adjust their saving or
retirement goals accordingly.

When viewed together with Social Security, the programs' financial
burden on the future economy takes on daunting proportions. As
figure 6 shows, the cost of these two programs would nearly double
as a share of the payroll tax base over the long term. Assuming no
other changes, these programs would constitute an unimaginable
drain on the earnings of our future workers, even without
including the financing challenges of the SMI program.

Page 16 GAO/T-AIMD/HEHS-99-113

Figure 6: Social Security and Medicare's HI Program as a
Percentage of Taxable Payroll

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

Source: 1998 Social Security Trustees' Report.

There is another reason to take early action to reform both Social
Security and Medicare costs. Reducing the future costs of these
programs is vital to reclaiming our nation's future capacity to
address other important needs in the public sector. To move into
the future without changes in the Social Security, Medicare, and
Medicaid programs is to envision a very different role for the
federal government. Assuming no financing or benefit changes, our
long-term model (and that of CBO) shows a world in 2050 in which
Social Security, Medicare, and Medicaid absorb a much greater
share of the federal budget. (See figure 7.) Budgetary flexibility
declines drastically and there is increasingly less room for
programs for national defense, the

30 Percent

10 12

14 16

18 20

22 24

26 28


















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