Testimony 

Before the Joint Economic Committee 

United States General Accounting Office 

GAO

For Release on Delivery 

Expected at 10:00 a.m. 

Thursday, April 10, 2003 MEDICARE

Financial Challenges and 

Considerations for Reform 

Statement of David M. Walker 

Comptroller General of the United States 

GAO-03-577T 
Page 1 GAO-03-577T 

Mr. Chairman and Members of the Committee: 

I am pleased to be here today as you examine Medicare’s financial health 

and consider the budgetary and economic challenges presented by an 

aging society. I have been particularly attentive to the sustainability 

challenges faced by the nation’s two largest entitlement programs—

Medicare and Social Security—for more than a decade since I served as a 

public trustee for these programs in the early 1990s. The recent 

publication of the 2003 Trustees’ annual report reminds us, once again, 

that the status quo is not an option for Medicare. If the program stays on 

its present course, in 10 years Hospital Insurance (HI) Trust Fund outlays 

will begin to exceed tax receipts, and by 2026 the HI trust fund will be 

exhausted. It is important to note that trust fund insolvency does not mean 

the program will cease to exist; program tax revenues will continue to 

cover a portion of projected expenditures.1

 However, Medicare is only part 

of the broader health care financing problem that confronts both public 

programs and private payers. The unrelenting growth in health care 

spending is producing a health care sector that continues to claim an 

increasing share of our gross domestic product (GDP). 

Despite the grim outlook for Medicare’s financial future, fiscal discipline 

imposed on Medicare through the Balanced Budget Act of 1997 (BBA) 

continues to be challenged, and interest in modernizing the program’s 

benefit package to include prescription drug coverage and catastrophic 

protection continues to grow. Such unabated pressures highlight the 

urgency for meaningful reform. As we deliberate on the situation, we must 

be mindful of several key points: 

• The traditional measure of HI Trust Fund solvency is a misleading gauge of 

Medicare’s financial health. Long before the HI Trust Fund is projected to 

be insolvent, pressures on the rest of the federal budget will grow as HI’s 

projected cash inflows turn negative and grow as the years pass. 

Moreover, a focus on the financial status of HI ignores the increasing 

burden Supplemental Medical Insurance (SMI)—Medicare part B—will 

place on taxpayers and beneficiaries. 

 1

Under the Trustees 2003 intermediate assumptions, revenues from the HI payroll tax and 

taxation of certain Social Security benefits are initially projected to cover about threefourths of projected expenditures once the trust fund is exhausted. This ratio, however, is 

projected to decline rapidly. 
Page 2 GAO-03-577T 

• GAO’s most recent long-term budget simulations continue to show that 

demographic trends and rising health care spending will drive escalating 

federal deficits and debt, absent meaningful entitlement reforms or other 

significant tax or spending actions. To obtain budget balance, massive 

spending cuts, tax increases, or some combination of the two would be 

necessary. Neither slowing the growth of discretionary spending nor 

allowing the tax reductions to sunset will eliminate the imbalance. In 

addition, while additional economic growth will help ease our burden, the 

potential fiscal gap is too great to grow our way out of the problem. 

• Since the cost of a drug benefit would boost spending projections even 

further, adding drug coverage when Medicare’s financial future is already 

bleak will require difficult policy choices that will mean trade-offs for both 

beneficiaries and providers. Just as physicians take the Hippocratic oath 

to “do no harm,” policymakers should avoid adopting reforms that will 

worsen Medicare’s long-term financial health. 

• Our experience with Medicare—both the traditional program and its 

private health plan alternative—provides valuable lessons that can guide 

consideration of reforms. For example, we know that proposals to enroll 

beneficiaries in private health plans must be designed to encourage 

beneficiaries to join efficient plans and ensure that Medicare shares in any 

efficiency gains. We also recognize that improvements to traditional 

Medicare are essential, as this program will likely remain significant for 

some time to come. 

Ultimately, we will need to look at broader health care reforms, as 

spending growth problems are not exclusive to Medicare. For both public 

and private payers, containing growth in health expenditures will be an 

abiding 21st century challenge. In today’s health care sector, there are few 

incentives for providers and consumers to be prudent in their ordering and 

use of health care services, too little transparency with regard to the value 

and costs of care, and inadequate accountability to ensure that health care 

plans and providers meet standards for appropriate use and quality. 

These problems cannot be solved overnight. It will require committed, 

long-term resolve and sustained attention to help policymakers and the 

public understand the need to move beyond the status quo. The magnitude 

of the challenge suggests that reforms will need to be phased in over time 

to minimize any temporary disruptions that may result. However, 

incremental reforms should build upon each other and continue to bring 

us closer to our desired goals. This argues for having a systematic process 

for setting common goals and assessing the potential for any proposed 

reforms to meet these goals. At GAO, we are developing a framework—
Page 3 GAO-03-577T 

that is, a comprehensive set of criteria—for consideration by the Congress, 

to help policymakers evaluate proposed health care reforms. 

Now I would like to discuss overall trends in health care spending, the 

financial challenges Medicare faces, and considerations for health care 

reform efforts. 

To best understand Medicare’s fiscal plight, we should also understand the 

broader health care context in which it operates. Total health care 

spending from all sources—public and private—continues to increase at a 

breathtaking pace. From 1990 through 2000, spending nearly doubled from 

about $696 billion to about $1.3 trillion (see fig. 1). From 2000 through 

2010, the rate of spending growth is expected to accelerate somewhat, 

resulting in an estimated $2.7 trillion in total annual health care spending 

by the end of the period. Increases in medical prices account for a little 

more than half of the 20-year spending increase, while increases in the use 

of services—owing to population growth and rise in the number of 

services used per person—and more expensive services account for the 

rest. 

Figure 1: Total National Health Care Spending, 1990–2010 

Note: The figure for 2010 is projected. All dollars are nominal. 

Trends in Health Care 

Spending Systemwide 

Pose Significant 

Challenges for 21st 

Century 

0

500

1000

1500

2000

2500

3000

1990 2000 2010

Dollars in billions 

Source: Centers for Medicare & Medicaid Services (CMS), Office of the Actuary, 

National Health Statistics Group.
Page 4 GAO-03-577T 

The rapid growth in health care spending means that an increasing share 

of the nation’s output, as measured by GDP, will be devoted to the 

production of health care services and goods. In 1970, spending on health 

care represented about 7 percent of GDP (see fig. 2). By 2010, health care 

spending’s share of GDP is expected to rise to about 17 percent. 

Figure 2: Total National Health Care Spending as a Percentage of GDP, 1970–2010 

Note: The figure for 2010 is projected. 

At the same time that health care spending has increased, consumers have 

become more insulated from these costs. In 1962, nearly half—46 

percent—of health care spending was financed by individuals out of their 

own pockets (see fig. 3). The remaining 54 percent was financed by a 

combination of private health insurance and public programs. By 2002, the 

amount of health care spending financed by individuals out of their own 

pockets was estimated to have dropped to 14 percent. 

0

2

4

6

8

10

12

14

16

18

1970 1980 1990 2000 2010

National health expenditures as a percentage of GDP

Sources: CMS, Office of the Actuary, National Health Statistics Group and 

U.S. Department of Commerce, Bureau of Economic Analysis.
Page 5 GAO-03-577T 

Figure 3: Sources of Health Care Financing, 1962–2002 

Note: The figure for 2002 is estimated. 

Tax considerations encourage employers to offer health insurance to their 

employees, as the value of the premium is excluded from the calculation 

of employees’ taxable earnings. Moreover, the value of the insurance 

coverage does not figure into the calculation of payroll taxes. These tax 

exclusions represent a significant source of foregone federal revenue, 

currently amounting to about 1 percent of GDP. 

Today the Medicare program faces a long-range and fundamental financing 

problem driven by known demographic trends and projected escalation of 

health care spending beyond general inflation. The lack of an immediate 

crisis in Medicare financing affects the nature of the challenge, but it does 

not eliminate the need for change. Within the next 10 years, the first baby 

boomers will begin to retire, putting increasing pressure on the federal 

budget. From the perspectives of the program, the federal budget, and the 

economy, Medicare in its present form is not sustainable. Acting sooner 

Outlook Worsening 

for Medicare’s LongTerm Sustainability 

1962 1982 2002

Private health insurance

Medicaid

Medicare

Other public

Other private

Out-of-pocket

46%

22%

14%

37%

16%

16%

12%

30%

16%

10%

16%

23%

25%

Source: CMS, Office of the Actuary, National Health Statistics Group.

6% 6% 5%
Page 6 GAO-03-577T 

rather than later would allow changes to be phased in so that the 

individuals who are most likely to be affected, namely younger and future 

workers, will have time to adjust their retirement planning while helping 

to avoid related “expectation gaps.” Since there is considerable confusion 

about Medicare’s current financing arrangements, I would like to begin by 

describing the nature, timing, and extent of the financing problem. 

As you know, Medicare consists of two parts—HI and SMI. HI, which pays 

for inpatient hospital stays, skilled nursing care, hospice, and certain home 

health services, is financed by a payroll tax. Like Social Security, HI has 

always been largely a pay-as-you-go system. SMI, which pays for physician 

and outpatient hospital services, diagnostic tests, and certain other 

medical services, is financed by a combination of general revenues and 

beneficiary premiums. Beneficiary premiums pay for about one-fourth of 

SMI benefits, with the remainder financed by general revenues. These 

complex financing arrangements mean that current workers’ taxes 

primarily pay for current retirees’ benefits except for those financed by 

SMI premiums.2

As a result, the relative numbers of workers and beneficiaries have a major 

impact on Medicare’s financing. The ratio, however, is changing. In the 

future, relatively fewer workers will be available to shoulder Medicare’s 

financial burden. In 2002 there were 4.9 working-age persons (18 to 64 

years) per elderly person, but by 2030, this ratio is projected to decline to 

2.8. For the HI portion of Medicare, in 2002 there were nearly 4 covered 

workers per HI beneficiary. Under the Trustees’ intermediate 2003 

estimates, the Medicare Trustees project that by 2030 there will be only 2.4 

covered workers per HI beneficiary. (See fig. 4.) 

 2

Another small source of funding derives from the tax treatment of Social Security benefits. 

Under certain circumstances, up to 85 percent of an individual’s or couple’s Social Security 

benefits are subject to income taxes. Under present law, the Old-Age and Survivors 

Insurance (OASI) and Disability Insurance (DI) Trust Funds are credited with the income 

taxes attributable to the taxation of the first 50 percent of OASDI benefit payments. The 

remainder of the income taxes attributable to the taxation of up to 85 percent of OASDI 

benefit payments is credited to the HI Trust Fund. Any other income taxes paid by retirees 

would also help finance the general revenue contribution to SMI. 

Demographic Trends And 

Expected Rise in Health 

Care Costs Drive 

Medicare’s Long-Term 

Financing Problem 
Page 7 GAO-03-577T 

Figure 4: Ratio of HI-Covered Workers to Beneficiaries 

Note: Projections based on the intermediate assumptions of The 2003 Annual Report of the Boards of 

Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust 

Funds. 

The demographic challenge facing the system has several causes. People 

are retiring early and living longer. As the baby boom generation ages, the 

share of the population age 65 and over will escalate rapidly. A falling 

fertility rate is the other principal factor underlying the growth in the 

elderly’s share of the population. In the 1960s, the fertility rate was an 

average of 3 children per woman. Today it is a little over 2, and by 2030 it 

is expected to fall to 1.95—a rate that is below replacement. The 

combination of the aging of the baby boom generation, increased 

longevity, and a lower fertility rate will drive the elderly as a share of total 

population from today’s 12 percent to almost 20 percent in 2030. 

Taken together, these trends threaten both the financial solvency and 

sustainability of this important program. Labor force growth will continue 

to decline and by 2025 is expected to be less than a third of what it is 

today. (See fig. 5.) Relatively fewer workers will be available to produce 

the goods and services that all will consume. Without a major increase in 

productivity, low labor force growth will lead to slower growth in the 

economy and slower growth of federal revenues. This in turn will only 

accentuate the overall pressure on the federal budget. This slowing labor 

force growth is not always recognized as part of the Medicare debate, but 

4.6

4.1 4.1 4.0

3.7

2.9

2.4 2.3 2.2 2.1 2.0

0

1

2

3

4

5

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070

Workers per HI beneficiary

Source: CMS, Office of the Actuary.
Page 8 GAO-03-577T 

it is expected to affect the ability of the federal budget and the economy to 

sustain Medicare’s projected spending in the coming years. 

Figure 5: Labor Force Growth 

Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the Board 

of Trustees of the Federal Old-Age and Survivors Insurance and the Federal Disability Insurance 

Trust Funds. Percentage change is calculated as a centered 5-year moving average. 

The demographic trends I have described will affect both Medicare and 

Social Security, but Medicare presents a much greater, more complex, and 

more urgent challenge. Unlike Social Security, Medicare spending growth 

rates reflect not only a burgeoning beneficiary population, but also the 

escalation of health care costs at rates well exceeding general rates of 

inflation. The growth of medical technology has contributed to increases 

in the number and quality of health care services. Moreover, the actual 

costs of health care consumption are not transparent. Third-party payers 

largely insulate covered consumers from the cost of health care decisions. 

These factors and others contribute to making Medicare a greater and 

more complex fiscal challenge than even Social Security. 

Current projections of future HI income and outlays illustrate the timing 

and severity of Medicare’s fiscal challenge. Today, the HI Trust Fund takes 

in more in taxes than it spends. Largely because of the known 

demographic trends I have described, this situation will change. Under the 

Trustees’ 2003 intermediate assumptions, program outlays are expected to 

HI’s Trust Fund Faces 

Cash Flow Problems Long 

before the HI Trust Fund Is 

Projected to Be Insolvent 

0

1

2

3

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Percentage change (5-yr moving average)

Source: Social Security Administration, Office of the Chief Actuary, and GAO.
Page 9 GAO-03-577T 

begin to exceed program tax revenues in 2013 (see fig. 6). To finance these 

cash deficits, HI will need to draw on the special-issue Treasury securities 

acquired during the years of cash surpluses. For HI to “redeem” its 

securities, the government will need to obtain cash through some 

combination of increased taxes, spending cuts, and/or increased 

borrowing from the public (or, if the unified budget is in surplus, less debt 

reduction than would otherwise have been the case). Neither the decline 

in the cash surpluses nor the cash deficits will affect the payment of 

benefits, but the negative cash flow will place increased pressure on the 

federal budget to raise the resources necessary to meet the program’s 

ongoing costs. This pressure will only increase when Social Security also 

experiences negative cash flow and joins HI as a net claimant on the rest 

of the budget.3

Figure 6: Medicare’s HI Trust Fund Faces Cash Deficits as Baby Boomers Retire 

Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the 

Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance 

Trust Funds. 

 3

Under the Trustees’ intermediate 2003 projections, this will occur for Social Security 

(OASDI) in 2018. 

-400

-300

-200

-100

0

100

200

2000 2005 2010 2015 2020 2025 2030 2035 2040

Cash surplus

Cash deficit

Billions of 2003 dollars

Source: CMS, Office of the Actuary, and GAO.

Medicare HI

cash deficit

2013
Page 10 GAO-03-577T 

The gap between HI income and costs shows the severity of HI’s financing 

problem over the longer term. This gap can also be expressed relative to 

taxable payroll (the HI Trust Fund’s funding base) over a 75-year period. 

This year, under the Trustees 2003 intermediate estimates, the 75-year 

actuarial deficit is projected to be 2.40 percent of taxable payroll—a 

significant increase from last year’s projected deficit of 2.02 percent. This 

means that to bring the HI Trust Fund into balance over the 75-year 

period, either program outlays would have to be immediately reduced by 

42 percent or program income immediately increased by 71 percent, or 

some combination of the two. These estimates of what it would take to 

achieve 75-year trust fund solvency understate the extent of the problem 

because the program’s financial imbalance gets worse in the 76th and 

subsequent years. Every year that passes we drop a positive year and add a 

much bigger deficit year. 

The projected exhaustion date of the HI Trust Fund is a commonly used 

indicator of HI’s financial condition. Under the Trustees 2003 intermediate 

estimates, the HI Trust Fund is projected to exhaust its assets in 2026. This 

solvency indicator provides information about HI’s financial condition, but 

it is not an adequate measure of Medicare’s sustainability for several 

reasons. HI Trust Fund balances do not provide meaningful information on 

the government’s fiscal capacity to pay benefits when program cash 

inflows fall below program outlays. As I have described, the government 

would need to come up with cash from other sources to pay for benefits 

once outlays exceeded program tax income. 

In addition, the HI Trust Fund measure provides no information on SMI. 

SMI’s expenditures, which account for about 43 percent of total Medicare 

spending, are projected to grow even faster than those of HI in the near 

future. Moreover, Medicare’s complex structure and financing 

arrangements mean that a shift of expenditures from HI to SMI can extend 

the solvency of the HI Trust Fund, creating the appearance of an 

improvement in program’s financial condition. For example, the Balanced 

Budget Act of 1997 modified the home health benefit, which resulted in 

shifting a portion of home health spending from the HI Trust Fund to SMI. 

Although this shift extended HI Trust Fund solvency, it increased the draw 

on general revenues and beneficiary SMI premiums while generating little 

net savings. 

Ultimately, the critical question is not how much a trust fund has in assets, 

but whether the government as a whole and the economy can afford the 

promised benefits now and in the future and at what cost to other claims 

on scarce resources. To better monitor and communicate changes in 
Page 11 GAO-03-577T 

future total program spending, new measures of Medicare’s sustainability 

are needed. As program changes are made, a continued need will exist for 

measures of program sustainability that can signal potential future fiscal 

imbalance. Such measures might include the percentage of program 

funding provided by general revenues, the percentage of total federal 

revenues or gross domestic product devoted to Medicare, or program 

spending per enrollee. As such measures are developed, questions would 

need to be asked about actions to be taken if projections showed that 

program expenditures would exceed the chosen level. 

Taken together, Medicare’s HI and SMI expenditures are expected to 

increase dramatically, rising from about 12 percent of federal revenues in 

2002 to more than one-quarter by midcentury. The budgetary challenge 

posed by the growth in Medicare becomes even more significant in 

combination with the expected growth in Medicaid and Social Security 

spending. This growth in spending on federal entitlements for retirees will 

become increasingly unsustainable over the longer term, compounding an 

ongoing decline in budgetary flexibility. Over the past few decades, 

spending on mandatory programs has consumed an ever-increasing share 

of the federal budget. 4

 In 1962, prior to the creation of the Medicare and 

Medicaid programs, spending for mandatory programs plus net interest 

accounted for about 32 percent of total federal spending. By 2002, this 

share had almost doubled to approximately 63 percent of the budget. (See 

fig. 7.) 

 4

“Mandatory spending” refers to outlays for entitlement programs such as Food Stamps, 

Medicare, veterans’ pensions, payment of interest on the public debt, and nonentitlements 

such as payments to states from Forest Service receipts. In 2002 Social Security, Medicare, 

and Medicaid accounted for over 71 percent of mandatory spending. 

Absent Reform of 

Medicare and Other 

Entitlements for the 

Elderly, Budgetary 

Flexibility Will Disappear 
Page 12 GAO-03-577T 

Figure 7: Federal Spending for Mandatory and Discretionary Programs, Fiscal Years 1962, 1982, and 2002 

In much of the past decade, reductions in defense spending helped 

accommodate the growth in these entitlement programs. Even before the 

events of September 11, 2001, however, this ceased to be a viable option. 

Indeed, spending on defense and homeland security will grow as we seek 

to combat new threats to our nation’s security. 

GAO prepares long-term budget simulations that seek to illustrate the 

likely fiscal consequences of the coming demographic tidal wave and 

rising health care costs. These simulations continue to show that to move 

into the future with no changes in federal retirement and health programs 

is to envision a very different role for the federal government. Assuming, 

for example, that the tax reductions enacted in 2001 do not sunset and 

discretionary spending keeps pace with the economy, by midcentury 

federal revenues may be inadequate to pay Social Security and interest on

the federal debt. Spending for the current Medicare program—without any

additional new benefits—is projected to account for more than onequarter of all federal revenues. To obtain budget balance, massive 

spending cuts, tax increases, or some combination of the two would be 

necessary. (See fig.8). Neither slowing the growth of discretionary 

spending nor allowing the tax reductions to sunset eliminates the 

1962

6%

68%

26%

Discretionary

Mandatory

Net interest

1982

45%

44%

11%

2002

9%

37%

54%

Source: Budget of the United States Government: Fiscal Year 2004, Office of Management and Budget.
Page 13 GAO-03-577T 

imbalance. In addition, while additional economic growth would help ease 

our burden, the projected fiscal gap is too great for us to grow our way out 

of the problem. 

Figure 8: Composition of Spending as a Share of GDP Assuming Discretionary 

Spending Grows with GDP after 2003 and the 2001 Tax Cuts Do Not Sunset 

Note: Assumes currently scheduled Social Security benefits are paid in full throughout the simulation 

period. Social Security and Medicare projections are based on the Trustees’ 2003 intermediate 

assumptions. 

Indeed, long-term budgetary flexibility is about more than Social Security 

and Medicare. While these programs dominate the long-term outlook, they 

are not the only federal programs or activities that bind the future. The 

federal government undertakes a wide range of programs, responsibilities, 

and activities that obligate it to future spending or create an expectation 

for spending. Our recent report describes the range and measurement of 

such fiscal exposures—from explicit liabilities such as environmental 

cleanup requirements to the more implicit obligations presented by life0

10

20

30

40

50

2000 2015 2030 2050

Fiscal year

Percentage of GDP

Net interest

Social Security

Medicare and Medicaid

All other spending

Revenue

Source: GAO’s March 2003 analysis.
Page 14 GAO-03-577T 

cycle costs of capital acquisition or disaster assistance.5 Making 

government fit the challenges of the future will require not only dealing 

with the drivers—entitlements for the elderly—but also looking at the 

range of other federal activities. A fundamental review of what the federal 

government does and how it does it will be needed. 

At the same time, it is important to look beyond the federal budget to the 

economy as a whole. Figure 9 shows the total future draw on the economy 

represented by Medicare, Medicaid, and Social Security. Under the 2003 

Trustees’ intermediate estimates and the Congressional Budget Office’s 

(CBO) most recent long-term Medicaid estimates, spending for these 

entitlement programs combined will grow to 14 percent of GDP in 2030 

from today’s 8.4 percent. Taken together, Social Security, Medicare, and 

Medicaid represent an unsustainable burden on future generations. 

Figure 9: Social Security, Medicare, and Medicaid Spending as a Percentage of GDP 

Note: Projections based on the intermediate assumptions of the 2003 Trustees’ Reports, CBO’s 

March 2003 short-term Medicaid estimates, and CBO’s June 2002 Medicaid long-term projections 

under midrange assumptions. 

 5

U.S. General Accounting Office, Fiscal Exposures: Improving the Budgetary Focus on 

Long-Term Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003). 

Medicare Is Projected 

to Absorb EverIncreasing Shares of 

the Economy 

0

5

10

15

20

25

2000 2010 2020 2030 2040 2050 2060 2070

Percentage of GDP

Social Security

Medicaid

Medicare

Source: CMS, Office of the Actuary, SSA, Office of the Actuary, CBO and GAO.
Page 15 GAO-03-577T 

Although real incomes are projected to continue to rise, they are expected 

to grow more slowly than has historically been the case. At the same time, 

the demographic trends and projected rates of growth in health care 

spending I have described will mean rapid growth in entitlement spending. 

Taken together, these projections raise serious questions about the 

capacity of the relatively smaller number of future workers to absorb the 

rapidly escalating costs of these programs. 

As HI trust fund assets are redeemed to pay Medicare benefits and SMI 

expenditures continue to grow, the program will constitute a claim on real 

resources in the future. As a result, taking action now to increase the 

future pool of resources is important. To echo Federal Reserve Chairman 

Alan Greenspan, the crucial issue of saving in our economy relates to our 

ability to build an adequate capital stock to produce enough goods and 

services in the future to accommodate both retirees and workers in the 

future.6

 The most direct way the federal government can raise national 

saving is by increasing government saving, that is, as the economy returns 

to a higher growth path, a balanced fiscal policy that recognizes our longterm challenges can help provide a strong foundation for economic growth 

and can enhance our future budgetary flexibility. It is my hope that we will 

think about the unprecedented challenge facing future generations in our 

aging society. Putting Medicare on a sustainable path for the future would 

help fulfill this generation’s stewardship responsibility to succeeding 

generations. It would also help to preserve some capacity for future 

generations to make their own choices for what role they want the federal 

government to play. 

As with Social Security, both sustainability and solvency considerations 

drive us to address Medicare’s fiscal challenges sooner rather than later. 

HI Trust Fund exhaustion may be more than 20 years away, but the 

squeeze on the federal budget will begin as the baby boom generation 

begins to retire. This will begin as early as 2008, when the leading edge of 

the baby boom generation becomes eligible for early retirement.7

 CBO’s 

current 10-year budget and economic outlook reflects this. CBO projects 

that economic growth will slow from an average of 3.2 percent a year from 

2005 through 2008 to 2.7 percent from 2009 through 2013 reflecting slower 

 6

Testimony before the Senate Committee on Banking, Housing, and Urban Affairs, July 24, 

2001. 

7

In 2008 the first baby boomers will reach age 62 and become eligible for Social Security 

benefits; in 2011, they will reach age 65 and become eligible for Medicare benefits. 
Page 16 GAO-03-577T 

labor force growth. At the same time, annual rates of growth in entitlement 

spending will begin to rise. Annual growth in Social Security outlays is 

projected to accelerate from 5.2 percent in 2007 to 6.6 percent in 2013. 

Annual growth in Medicare enrollees is expected to accelerate from 1.1 

percent today to 2.9 percent in 2013. Acting sooner rather than later is 

essential to ease future fiscal pressures and also provide a more 

reasonable planning horizon for future retirees. We are now at a critical 

juncture. In less than a decade, the profound demographic shift that is a 

certainty will have begun. 

Despite a common awareness of Medicare’s current and future fiscal 

plight, pressure has been building to address recognized gaps in Medicare 

coverage, especially the lack of a prescription drug benefit and protection 

against financially devastating medical costs. Filling these gaps could add 

massive expenses to an already fiscally overburdened program. Under the 

Trustees 2003 intermediate assumptions, the present value of HI’s 

actuarial deficit is $6.2 trillion.8

 This difficult situation argues for tackling 

the greatest needs first and for making any benefit additions part of a 

larger structural reform effort. 

The Medicare benefit package, largely designed in 1965, provides virtually 

no outpatient drug coverage. Beneficiaries may fill this coverage gap in 

various ways. All beneficiaries have the option to purchase supplemental 

policies—Medigap—when they first become eligible for Medicare at age 

65. Those policies that include drug coverage tend to be expensive and 

provide only limited benefits. Some beneficiaries have access to coverage 

through employer-sponsored policies or private health plans that contract 

to serve Medicare beneficiaries. In recent years, coverage through these 

sources has become more expensive and less widely available. 

Beneficiaries whose income falls below certain thresholds may qualify for 

Medicaid or other public programs. According to one survey, in the fall of 

 8

This estimate represents the present value of HI’s future expenditures less future tax 

income, taking into account the amount of HI trust fund assets at hand at the beginning of 

the projection period and adjusting for the ending target trust fund balance. Excluding the 

ending target trust fund balance, HI’s unfunded obligation is estimated to be $5.9 trillion 

over the 75-year period under the Trustees 2003 intermediate assumptions. 

Pressure to Address 

Medicare Coverage 

Gaps Must Be 

Balanced against 

Program 

Sustainability 

Concerns 
Page 17 GAO-03-577T 

1999, more than one-third of beneficiaries reported that they lacked drug 

coverage altogether.9

Medicare also does not limit beneficiaries’ cost-sharing liability. The 

average beneficiary who obtained services had a total liability for 

Medicare-covered services of $1,700, consisting of $1,154 in Medicare 

copayments and deductibles in addition to the $546 in annual part B 

premiums in 1999, the most recent year for which data are available on the 

distribution of these costs. The burden can, however, be much higher for 

beneficiaries with extensive health care needs. In 1999, about 1 million 

beneficiaries were liable for more than $5,000, and about 260,000 were 

liable for more than $10,000 for covered services. In contrast, employersponsored health plans for active workers typically limited maximum 

annual out-of-pocket costs for covered services to less than $2,000 per 

year for single coverage.10

Modernizing Medicare’s benefit package will require balancing competing 

concerns about program sustainability, federal obligations, and the 

hardship faced by some beneficiaries. In particular, the addition of a 

benefit that has the potential to be extremely expensive—such as 

prescription drug coverage—should be focused on meeting the needs 

deemed to be of the highest priority. This would entail targeting financial 

help to beneficiaries most in need—those with catastrophic drug costs or 

low incomes—and, to the extent possible, avoiding the substitution of 

public for private insurance coverage. As I continue to maintain, acting 

prudently means making any benefit expansions in the context of overall 

program reforms that are designed to make the program more sustainable 

over the long term instead of worsening the program’s financial future. 

One reform to help improve Medicare’s financial future would be to 

modify Medicare’s cost-sharing rules and provide beneficiaries with better 

incentives to use care appropriately. Health insurers today commonly 

design cost-sharing requirements—in the form of deductibles, 

coinsurance, and copayments—to ensure that enrollees are aware that 

 9

Mary A. Laschober and others, “Trends in Medicare Supplemental Insurance and 

Prescription Drug Coverage, 1996 to 1999,” Health Affairs Web Exclusive (Bethesda, Md: 

Project Hope, Feb. 27, 2002). 

http://www.healthaffairs.org/1130_abstract_c.php?ID=http://www.healthaffairs.org/Library/

v21n2/s4.pdf (downloaded Mar. 19, 2003). 

10The Kaiser Family Foundation and Health Research and Education Trust, Employer 

Health Benefits: 2000 Annual Survey (Menlo Park, Calif. and Chicago: 2000). 
Page 18 GAO-03-577T 

there is a cost associated with the provision of services and to use them 

prudently. Ideally, cost-sharing should encourage beneficiaries to evaluate 

the need for discretionary care but not discourage necessary care. 

Coinsurance or copayments would be required generally for services 

considered to be discretionary and potentially overused and would aim to 

steer patients to lower cost or better treatment options. Care must be 

taken, however, to avoid setting cost-sharing requirements so high as to 

create financial barriers to care. 

Medicare fee-for-service cost-sharing rules diverge from these common 

insurance industry practices in important ways. For example, Medicare 

imposes a relatively high deductible of $840 for hospital admissions, which 

are rarely optional. In contrast, Medicare has not increased the part B 

deductible since 1991. For the last 12 years, the deductible has remained 

constant at $100 and has thus steadily declined as a proportion of 

beneficiaries’ real incomes. Adjusted for inflation, the deductible has fallen 

to $74.39 in 1991 dollars. 

In recent years, leading proposals have been made to restructure Medicare 

that have included greater reliance on private health plans and reforms to 

the traditional fee-for-service program. The weaknesses identified in these 

two components of the current program suggest several lessons regarding 

such restructuring. Experience with Medicare’s private health plan 

alternative, called Medicare+Choice, suggests that details matter if 

competition is to produce enhanced benefits for enrollees and savings for 

the program. In addition, the traditional program must not be left 

unattended because it will be an important part of Medicare for years to 

come. The strategies needed to address either structural component must 

incorporate sufficient incentives to achieve efficiency, adequate 

transparency to reveal the cost of health care, and appropriate 

accountability mechanisms to ensure that the promised care and level of 

quality are actually delivered. 

If the inclusion of private health plans is to produce savings for Medicare, 

private incentives and public goals must be properly aligned. This means 

designing a program that will encourage beneficiaries to select health plan 

options most likely to generate program savings. This is not the case in the 

current Medicare+Choice program. For example, incentives for health 

plan efficiency exist, but any efficiency gains achieved do not produce 

Medicare savings. Payments to private health plans that participate in 

Medicare+Choice are not set through a competitive process. Instead, plans 

Medicare Reforms 

Should Realign 

Incentives, Improve 

Transparency, and 

Strengthen 

Accountability 

Reforms That Include 

Private Plans Should 

Incorporate Incentives 

Sufficient to Result in 

Program Savings 
Page 19 GAO-03-577T 

receive a fixed payment from Medicare as prescribed by statute and in 

return must provide all Medicare-covered services with the exception of 

hospice. Efficient health plans are better able to afford to provide extra 

benefits, such as outpatient prescription drug benefits; charge a lower 

monthly premium; or both and may do so to attract beneficiaries and 

increase market share. Until recently, however, these efficiency and 

market share gains were advantageous to beneficiaries and health plans 

but generated no savings for Medicare. Even today, the opportunity for the 

program to realize savings from competition among Medicare+Choice 

health plans remains extremely limited.11 This experience has shown that 

savings are not automatic from simply enrolling beneficiaries in private 

health plans. 

The Medicare+Choice experience offers another lesson about private 

plans and program savings. That is, as we recommended in 1998, payments 

to health plans must be adequately risk-adjusted for the expected health 

care costs of the beneficiaries they enroll. Otherwise, the government can 

inadequately compensate health plans that enroll less healthy beneficiaries 

with higher expected health care costs or will overpay health plans that 

enroll relatively healthy beneficiaries with low expected health care costs. 

Moreover, health plans will have an incentive to avoid enrolling less 

healthy beneficiaries with higher expected health care costs. In 2000, we 

reported that the failure to adequately adjust Medicare’s payments to 

private health plans for beneficiaries’ expected health care costs 

unnecessarily increased Medicare spending by $3.2 billion in 1998.12

A third lesson is that the use of private plans to serve Medicare 

beneficiaries may not be feasible in all locations nationwide. In 

Medicare+Choice, it has been difficult and expensive to encourage private 

 11Beginning in 2003, Medicare health plans may, in effect, rebate to beneficiaries some, or 

all, of Medicare’s $58.70 monthly part B premium. Both beneficiaries and the government 

benefit if health plans use this option to compete because, for every $1 reduction in health 

care premiums, the health plans must return $0.25 to the government. If a health plan 

rebates the entire part B premium, the government saves $14.68 per beneficiary per month. 

Currently, five Medicare+Choice health plans in eight counties rebate at least a portion of 

the part B premium. In 2003, Medicare began pilot testing an arrangement for sharing 

financial risk with preferred provider organizations that enroll program beneficiaries. As of 

March 2003, there were 56,677 enrollees in these preferred provider organizations. 

12See U.S. General Accounting Office, Medicare+Choice: Payments Exceed Cost of Fee-forService Benefits, Adding Billions to Spending, GAO/HEHS-00-161 (Washington, D.C: Aug. 

23, 2000). CMS has since begun to phase in a payment adjustment system that is designed 

to help prevent some of these excess payments. 
Page 20 GAO-03-577T 

health plans to serve rural areas. Payment rates have been substantially 

raised in rural areas since 1997, yet by 2003 nearly 40 percent of 

beneficiaries living in rural areas lack access to a private health plan; in 

contrast, 15 percent of beneficiaries in urban areas lack access to a plan. 

Finally, the Medicare+Choice experience underscores the importance of 

beneficiaries having user-friendly, accurate information to compare their 

health plan options and of holding private health plans appropriately 

accountable for the services they have promised to deliver. 

Leading Medicare reform proposals have included traditional Medicare as 

a component in their design. Traditional Medicare is likely to have a 

significant role for years to come, as any fundamental structural reforms 

would take considerable time before plan and beneficiary participation 

becomes extensive. Therefore, addressing flaws in the traditional program 

should be part of any plan to steer Medicare away from insolvency and 

improve its sustainability for future generations. The experience of other 

health insurers’ use of cost-containment strategies, including some 

incentives for beneficiaries to make value-based choices, suggests a 

strategy for modernizing the program’s design. In the current program, the 

lack of insurance-type protections and difficulty in setting payment rates 

keep Medicare from achieving greater efficiencies and thus from 

improving its balance sheet. 

Coverage through Medigap—policies that meet federally established 

standards and are sold by private insurers—helps to fill in some of 

Medicare’s gaps, but Medigap plans also have shortcomings. As required 

by law, Medigap plans must conform to 1 of 10 standard benefit packages, 

which vary in levels of coverage. Medigap offers beneficiaries stop-loss 

protections that are lacking in traditional Medicare, but these policies 

diminish important program protections by covering required deductibles 

and coinsurance. The most popular Medigap plans are fundamentally 

different from employer-sponsored health insurance policies for retirees in 

that they do not require individuals to pay deductibles, coinsurance, and 

copayments. Such cost-sharing requirements are intended to make 

beneficiaries aware of the costs associated with the use of services and 

encourage them to use these services prudently. In contrast, Medigap’s 

first-dollar coverage—the elimination of deductibles or coinsurance 

associated with the use of covered services—undermines this objective. 

Although such coverage reduces financial barriers to health care, it 

diminishes beneficiaries’ sensitivity to costs and likely increases 

beneficiaries’ use of services, adding to total Medicare spending. 

Fixing Flaws In Traditional 

Medicare Essential to Alter 

Program’s Fiscal Course 

Supplemental Coverage 

Reduces Beneficiary Cost 

Sensitivity 
Page 21 GAO-03-577T 

Traditional Medicare needs the tools that other insurers use to achieve 

better value for the protection provided. Instead of working at crosspurposes to the traditional program, Medigap should be better coordinated 

with it. Insurance-type reforms to Medicare and Medigap—namely, the 

preservation of cost-sharing requirements in conjunction with stop-loss 

provisions—could help improve beneficiaries’ sensitivity to the cost of 

care while better protecting them against financially devastating medical 

costs. 

Medicare too often pays overly generous rates for certain services and 

products, preventing the program from achieving a desirable degree of 

efficiency. For example, for certain services, our work has shown 

substantially higher Medicare payments relative to providers’ costs—35 

percent higher for home health care in the first six months of 2001 and 19 

percent higher for skilled nursing facility care in 2000.13 Similarly, 

Medicare has overpaid for various medical products. Last year, we 

reported that, in 2000, Medicare paid over $1 billion more than other 

purchasers for certain outpatient drugs that the program covers. Earlier 

findings that have since been addressed by the Congress following our 

recommendations showed Medicare paying over $500 million more than 

another public payer for home oxygen equipment. Excessive payments 

hurt not only the taxpayers but also the program’s beneficiaries or their 

supplemental insurers, as beneficiaries are liable for copayments equal to 

20 percent of Medicare’s approved fee. For certain outpatient drugs, 

Medicare’s payments to providers were so high that the beneficiaries’ 

copayments exceeded the price at which providers could buy the drugs. In 

2001, we recommended that, for covered outpatient prescription drugs, 

Medicare establish payment levels more closely related to actual market 

transaction costs, using information available to other public programs 

that pay at lower rates. 

Over the past two decades, at the Congress’ direction, Medicare has 

implemented a series of payment reforms designed to promote the 

efficient delivery of services and control program spending. Some reforms 

required establishing set fees for individual services; others required 

paying a fixed amount for a bundle of services. The payment methods 

 13See U.S. General Accounting Office, Medicare Home Health Care: Payments to Home 

Health Agencies Are Considerably Higher than Costs, GAO-02-663 (Washington, D.C: May 

6, 2002) and U.S. General Accounting Office, Skilled Nursing Facilities: Medicare 

Payments Exceed Costs for Most but Not All Facilities, GAO-03-183 (Washington, D.C: 

Dec. 31, 2002). 

Difficulties in Setting Payment 

Rates 
Page 22 GAO-03-577T 

introduced during this time were designed to include—in addition to 

incentives for efficiencies—a means to calibrate payments to ensure 

beneficiary access and fairness to providers. 

A major challenge in administering these methods—whether based on fee 

schedules or prospective payment systems using bundled payments—

involves adjusting the payments to better account for differences in 

patients’ needs and providers’ local markets to ensure that the program is 

paying appropriately and adequately. Payment rates that are too low can 

impair beneficiary access to services and products, while rates that are too 

high add unnecessary financial burdens to the program. As a practical 

matter, Medicare is often precluded from using market forces—that is, 

competition—to determine appropriate rates. In many cases, Medicare’s 

size and potential to distort market prices makes it necessary to use means 

other than competition to set a price on services and products. 

Most of Medicare’s rate-setting methods are based on formulas that use 

historical data on providers’ costs and charges. Too often, these data are 

not recent or comprehensive enough to measure the costs incurred by 

efficient providers. At the same time, data reflecting beneficiaries’ access 

to services are also lacking. When providers contend that payments are 

not adequate, typically information is not readily available to provide the 

analytical support needed to determine whether these claims are valid. I 

have noted in the past the essential need to monitor the impact of program 

policy changes so that distinguishing between desirable and undesirable 

consequences can be done systematically and in a timely manner. To that 

end, I have also noted the importance of investing adequate resources in 

the agency that runs Medicare to ensure that the capacity exists to carry 

out these policy-monitoring activities. 

Under some circumstances, competition may be feasible and practical for 

setting more appropriate rates. Medicare has pilot tested “competitive 

bidding” in a few small markets. According to program officials, these test 

projects have shown that, for selected medical products, Medicare has 

saved money on items priced competitively. As part of these competitive 

bidding tests, steps were taken to monitor beneficiary access and product 

quality. To use competitive bidding on a broader scale, Medicare would 

require not only new authority but would need to make substantial 

administrative preparations, as competing with a larger number of 

products nationally would entail bidding in multiple markets and 

monitoring access and quality once prices had been set. 
Page 23 GAO-03-577T 

Medicare’s financial challenge is very real. The 21st century has arrived 

and the demographic tidal wave is on the horizon. Within 5 years, 

individuals in the vanguard of the baby boom generation will be eligible 

for Social Security and 3 years after that they will be eligible for Medicare. 

The future costs of serving the baby boomers are already becoming a 

factor in CBO’s short-term cost projections. 

Clearly the issue before us is not whether to reform Medicare but how. I 

feel the greatest risk lies in doing nothing to improve Medicare’s long-term 

sustainability. It is my hope that we will think about the unprecedented 

challenge of facing future generations in our aging society. Engaging in a 

comprehensive effort to reform the program and put it on a sustainable 

path for the future would help fulfill this generation’s stewardship 

responsibility to succeeding generations. 

Medicare reform would be done best with considerable lead time to phase 

in changes and before the changes that are needed become dramatic and 

disruptive. Given the size of Medicare’s financial challenge, it is only 

realistic to expect that reforms intended to bring down future costs will 

have to proceed incrementally. We should begin this now, when retirees 

are still a far smaller proportion of the population than they will be in the 

future. The sooner we get started, the less difficult the task will be. 

As we contemplate the forecast for Medicare’s fiscal condition and its 

implications, we must also remember that the sources of some of its 

problems—and its solutions—are outside the program and are universal to 

all health care payers. Some tax preferences mask the full cost of 

providing health benefits and can work at cross-purposes to the goal of 

moderating health care spending. Therefore, it may be important to 

reexamine the incentives contained in current tax policy and consider 

potential reforms. Advances in medical technology are also likely to keep 

raising the price tag of providing care, regardless of the payer. Although 

technological advances unquestionably provide medical benefits, judging 

the value of those benefits—and weighing them against the additional 

costs—is more difficult. Consumers are not as informed about the cost of 

health care and its quality as they may be about other goods and services. 

Thus, while the greater use of market forces may help to control cost 

growth, it will undoubtedly be necessary to employ other cost control 

methods as well. 

We must also be mindful that health care costs compete with other 

legitimate priorities in the federal budget, and their projected growth 

threatens to crowd out future generations’ flexibility to decide which 

Concluding 

Observations 
Page 24 GAO-03-577T 

competing priorities will be met. In making important fiscal decisions for 

our nation, policymakers need to consider the fundamental differences 

between wants, needs, and what both individuals and our nation can 

afford. This concept applies to all major aspects of government, from 

major weapons system acquisitions to issues affecting domestic programs. 

It also points to the fiduciary and stewardship responsibility that we all 

share to ensure the sustainability of Medicare for current and future 

generations within a broader context of providing for other important 

national needs and economic growth. 

A major challenge policymakers face in considering health care reforms is 

the dearth of timely, accurate information with which to make decisions. 

Medicare’s size and impact on the nation’s health care economy means 

that its payment methods and rate adjustments, no matter how reasonable, 

often produce opposition. Recent experience with the payment reforms 

established in the BBA illustrates this point. In essence, these reforms 

changed Medicare’s payment methods to establish incentives for providers 

to deliver care efficiently. BBA’s changes were enacted in response to 

continuing rapid growth in Medicare spending that was neither sustainable 

nor readily linked to demonstrated changes in beneficiary needs. 

Nonetheless, affected provider groups conducted a swift, intense 

campaign to roll back the BBA changes. In the absence of solid, datadriven analyses, affected providers’ anecdotes were used to support 

contentions that Medicare payment changes were extreme and threatened 

their financial viability. This and similar reactions to mandated Medicare 

payment reforms underscore how difficult it is, without prompt and 

credible data, to defend against claims that payments changes have 

resulted in insufficient compensation that could lead to access problems. 

The public sector can play an important role in educating the nation about 

the limits of public support. Currently, there is a wide gap between what 

patients and providers expect and what public programs are able to 

deliver. Moreover, there is insufficient understanding about the terms and 

conditions under which health care coverage is actually provided by the 

nation’s public and private payers. In this regard, GAO is preparing a 

health care framework that includes a set of principles to help 

policymakers in their efforts to assess various health financing reform 

options. This framework will examine health care issues systemwide and 

identify the interconnections between public programs that finance health 

care and the private insurance market. The framework can serve as a tool 

for defining policy goals and ensuring the use of consistent criteria for 

evaluating changes. By facilitating debate, the framework can encourage 

acceptance of changes necessary to put us on a path to fiscal 
Page 25 GAO-03-577T 

sustainability. I fear that if we do not make such changes and adopt 

meaningful reforms, future generations will enjoy little flexibility to fund 

discretionary programs or make other valuable policy choices. 

Mr. Chairman, this concludes my prepared statement. I will be happy to 

answer any questions you or other committee members may have. 

For future contacts regarding this testimony, please call William J. 

Scanlon, Director, Health Care Issues, at (202) 512-7114. Other individuals 

who made key contributions include Linda Baker, James Cosgrove, Jessica 

Farb, Hannah Fein, James McTigue, Yorick F. Uzes, and Melissa Wolf. 

Contacts and 

Acknowledgments 
Page 26 GAO-03-577T 

Major Management Challenges and Program Risks: Department of 

Health and Human Services. GAO-03-101. Washington D.C.: January 2003. 

Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs 

and Uncertainties. GAO-03-213. Washington, D.C.: January 24, 2003. 

Skilled Nursing Facilities: Medicare Payments Exceed Costs for Most but 

Not All Facilities. GAO-03-183. Washington, D.C.: December 31, 2002. 

Medicare Home Health Care: Payments to Home Health Agencies Are 

Considerably Higher than Costs. GAO-02-663. Washington, D.C.: May 6, 

2002. 

Medicare: Financial Outlook Poses Challenges for Sustaining Program 

and Adding Drug Coverage. GAO-02-643T. Washington, D.C.: April 17, 

2002. 

Medigap: Current Policies Contain Coverage Gaps, Undermine Cost 

Control Incentives. GAO-02-533T. Washington, D.C.: March 14, 2002. 

Medicare: New Spending Estimates Underscore Need for Reform. GAO01-1010T. Washington, D.C.: July 25, 2001. 

Medicare: Cost-Sharing Policies Problematic for Beneficiaries and 

Program. GAO-01-713T. Washington, D.C.: May 9, 2001. 

Medicare: Higher Expected Spending and Call for New Benefit 

Underscore Need for Meaningful Reform. GAO-01-539T, Washington, D.C.: 

March 22, 2001. 

Medicare+Choice: Plan Withdrawals Indicate Difficulty of Providing 

Choice While Achieving Savings. GAO/HEHS-00-183. Washington, D.C.: 

September 7, 2000. 

Medicare+Choice: Payments Exceed Cost of Fee-for-Service Benefits, 

Adding Billions to Spending. GAO/HEHS-00-161. Washington, D.C.: 

August 23, 2000. 

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