Medicare Reform: Observations on the President's July 1999 Proposal
(Testimony, 07/22/1999, GAO/T-AIMD/HEHS-99-236).

Pursuant to a congressional request, GAO discussed the President's
recent proposal to reform Medicare.

GAO noted that: (1) the President's proposal contains programmatic
reforms that reflect a good faith effort to advance the reform debate;
(2) it provides a baseline for further debate and consideration of
reforming Medicare; (3) as such, it is an important step in the goal of
reaching a national consensus about how the nation is going to deal with
the explosive cost of medical care for the elderly population in the
decades to come; (4) Congress and the President may ultimately decide to
include some form of prescription drug coverage as part of Medicare; (5)
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; (6) the most critical issue facing Medicare is the need
to ensure the program's long-range financial integrity and
sustainability; (7) the 1999 annual reports of the Medicare Trustees
project that program costs will continue to grow faster than the rest of
the economy; (8) 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; (9) ideally, the unfunded promises
associated with today's program should be addressed before or concurrent
with proposals to make new ones; (10) to do otherwise might be
politically attractive but not fiscally prudent; (11) any potential
program expansion should be accompanied by meaningful reform of the
current Medicare program to help ensure sustainability; (12) to qualify
as meaningful reform, a proposal should make a significant down payment
toward ensuring Medicare's long-range financial integrity and
sustainability; (13) the President's latest proposal is projected to
virtually eliminate the publicly held debt by 2015; (14) such an
initiative would provide a substantial fiscal dividend by reducing
interest costs, raising national savings, and contributing to future
economic growth; (15) this initiative would help better afford future
commitments, but it would not alone be sufficient; and (16) 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.

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

 REPORTNUM:  T-AIMD/HEHS-99-236
     TITLE:  Medicare Reform: Observations on the President's July 1999
	     Proposal
      DATE:  07/22/1999
   SUBJECT:  Economic analysis
	     Health care programs
	     Presidential proposals
	     Future budget projections
	     Health insurance
IDENTIFIER:  Medicare Program
	     Social Security Program
	     Medicare Hospital Insurance Trust Fund
	     Supplemental Medical Insurance Program
	     Medicaid Program
	     Medicare Choice Program

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Cover
================================================================ COVER

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 PROPOSAL

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

GAO/T-AIMD/HEHS-99-236

GAO/AIMD/HEHS-99-236T

GAO/T-AIMD/HEHS-99-236

(935325/101871)

Abbreviations
=============================================================== ABBREV

  BBA - abbreviation
  CBO - abbreviation
  GDP - abbreviation
  HI - abbreviation
  PBM - abbreviation
  SMI - abbreviation

MEDICARE REFORM:  OBSERVATIONS ON
THE PRESIDENT'S JULY 1999 PROPOSAL
============================================================ Chapter 0

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. 

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 proposal. 

  -- 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 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 ï¿½holidayï¿½
     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.
----------------------------------------------------------------------
  -- 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 2015ï¿½this 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. 

--------------------
\1 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). 

   COMPETING CONCERNS POSE
   CHALLENGES FOR MEDICARE REFORM
---------------------------------------------------------- Chapter 0:1

The current Medicare program, without improvements, is ill-suited to
serve future generations of seniors and eligible disabled Americans. 
On the one 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.  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 programï¿½even modest program changes send ripples across the
program's 39-million-strong beneficiary population and the
approximately 1 million 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
      RED
-------------------------------------------------------- Chapter 0:1.1

Unlike private trust funds that can set aside money for the future
through investments in financial assets, the Medicare Hospital
Insurance (HI) Trust Fundï¿½which pays for inpatient hospital stays,
skilled nursing care, hospice, and certain home health servicesï¿½is
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 Treasuryï¿½a
threshold that Social Security is not currently expected to reach
until 2014.  In essence, for Medicare to ï¿½redeemï¿½ 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. 

   Figure 1:  Financial Outlook of
   the Hospital Insurance Trust
   Fund

   (See figure in printed
   edition.)

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. 

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

   (See figure in printed
   edition.)

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 enforcementï¿½i.e., essentially no
discretionary programs at all. 

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

   (See figure in printed
   edition.)

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

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

   (See figure in printed
   edition.)

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 programs. 

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

   (See figure in printed
   edition.)

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 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

   (See figure in printed
   edition.)

      MEDICARE OUT OF DATE
      RELATIVE TO OTHER HEALTH
      CARE PAYERS
-------------------------------------------------------- Chapter 0:1.2

In addition to its significant financial imbalance, Medicare is
unsatisfactory from a programmatic perspective.  BBA reforms were
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 availableï¿½in the case of a Medicare+Choice
planï¿½or are not affordable.  In short, many reform advocates believe
that Medicare's basic benefit package should be brought into line
with current commercial norms. 

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 spendingï¿½rising 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, 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 beneficiariesï¿½some of whom lack any
supplemental coverageï¿½will have total drug costs of $1,500 or more. 

      NUMBER AND SIZE OF AFFECTED
      PARTIES MAKE MEDICARE REFORM
      EXCEPTIONALLY DIFFICULT
-------------------------------------------------------- Chapter 0:1.3

The fact that changes to Medicare can create seismic reverberations
is not surprising.  Health care spending accounts for one-seventh of
the nation's economy, and Medicare is the nation's single largest
health care payer.  The program's beneficiary populations consist of
roughly 35 million seniors and 4 million disabled individuals under
age 65.  HCFA estimates that the program's billersï¿½physicians,
hospitals, equipment suppliers, and other providers of medical
servicesï¿½number 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
ratesï¿½including competition and other market conditionsï¿½played 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. 

--------------------
\2 See Medicare+Choice:  Reforms Have Reduced, but Likely Not
Eliminated, Excess Plan Payments (GAO/HEHS-99-144, Jun.  18, 1999). 

\3 See Medicare Managed Care Plans:  Many Factors Contribute to
Recent Withdrawals; Plan Interest Continues (GAO/HEHS-99-91, Apr. 
27, 1999). 

   PRESIDENT'S MEDICARE REFORM
   PROPOSAL
---------------------------------------------------------- Chapter 0:2

The President's proposal to reform Medicare is intended to function
on two levels:  first, as a Medicare financing strategy and, second,
as a 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
      PRESIDENT'S PROPOSAL
-------------------------------------------------------- Chapter 0:2.1

The President proposes to use 13 percent of the projected budget
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 particular. 

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
mechanismsï¿½ï¿½lockboxesï¿½ï¿½that 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
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
ï¿½although less than the baseline, which assumes that all surpluses
would be savedï¿½would 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'
retirement. 

With regard to the Medicare program itself, the proposed ï¿½transferï¿½
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 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 sustainableï¿½that 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
benefitsï¿½both 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
2027ï¿½well 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. 

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 reforms. 

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. 

--------------------
\4 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. 

\5 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). 

      PROGRAMMATIC ASPECTS OF
      PRESIDENT'S PROPOSAL
-------------------------------------------------------- Chapter 0:2.2

The President's reform plan also consists of several programmatic
changesï¿½most 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 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 proposalï¿½projecting a
higher cost for the drug benefit and smaller savingsï¿½underscores 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 PLAN COMPETITION
------------------------------------------------------ Chapter 0:2.2.1

Under the President's proposal, private health plans serving Medicare
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 premium. 

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. 

However, the extent to which price competition among health plans
would produce savings depends on the design and implementation
particularsï¿½which 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
beneficiariesï¿½that is, be risk adjustedï¿½if 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 servicesï¿½either 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. 

--------------------
\6 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). 

         PROVISIONS FOR PROPOSED
         PRESCRIPTION DRUG BENEFIT
------------------------------------------------------ Chapter 0:2.2.2

The second major programmatic element of the President's proposal is
the 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 ï¿½pharmacy benefit managersï¿½ (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 the drug benefit and
would competitively bid to manage the benefit for a particular
geographic area.  They would negotiate prices with drug
manufacturers. 

Several of the prescription drug benefit provisions contain elements
of fiscal discipline, transparency, and economy.  For example, the
separate premiumï¿½for which the government's share must be calculated
each yearï¿½serves 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 costs. 

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 employersï¿½equaling
     two-thirds of what the program would pay for Medicare drug
     coverageï¿½aims 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 Medicare and receive alternative benefits from
     their former employers, including ï¿½wrap-aroundï¿½ 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 ï¿½buy-inï¿½ programs, in which the federal government and
     the state together subsidizeï¿½through Medicaidï¿½some 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 Medicareï¿½as a public programï¿½is 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 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 terms. 

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. 

--------------------
\7 Beneficiaries with income between 135 and 150 percent of the
federal poverty level would pay a partial, sliding-scale premium
based on their income. 

   CONCLUDING OBSERVATIONS
---------------------------------------------------------- Chapter 0:3

I would like to conclude by pointing to the historic opportunity
presented by the recently projected surpluses.  Some advocate
spending the 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 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 grandchildren. 

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 creditï¿½a 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
stakeï¿½not 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 reformsï¿½vulnerable to erosionï¿½could be discarded altogether. 
Recent experience implementing BBA reforms provides us some sobering
lessons about the difficulty of undertaking reform and the need for
effectiveness, flexibility, and steadfastness.  Effectiveness
involves collecting the data necessary to assess impactï¿½separating
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. 

-------------------------------------------------------- Chapter 0:3.1

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

   GAO CONTACTS AND
   ACKNOWLEDGMENTS
---------------------------------------------------------- Chapter 0:4

For future contacts regarding this testimony, please call Paul L. 
Posner, Director of Budget Issues, at (202) 512-9573 or William J. 
Scanlon, Director 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. 

*** End of document. ***