a

GAO

United States Government Accountability Office

Report to Congressional Committees

October 2004 MEDICARE 

PHYSICIAN 

PAYMENTS

Concerns about 

Spending Target 

System Prompt 

Interest in Considering 

Reforms

GAO-05-85
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-85.

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and methodology, click on the link above. 

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Highlights of GAO-05-85, a report to 

congressional committees 

October 2004

MEDICARE PHYSICIAN PAYMENTS

Concerns about Spending Target System 

Prompt Interest in Considering Reforms 

To moderate Medicare spending for physician services, the SGR system sets 

spending targets and adjusts physician fees based on the extent to which 

actual spending aligns with specified targets. If growth in the number of 

services provided to each beneficiary—referred to as volume—and in the 

average complexity and costliness of services—referred to as intensity—is 

high enough to cause spending to exceed the SGR target, fee updates are set 

lower than inflation in the cost of operating a medical practice. A wide 

enough gap between spending and the target results in fee reductions. 

Physician groups are dissatisfied with SGR as a system to update physician 

fees. For example, they question the fairness of including rapidly growing 

spending for physician-administered drugs in the SGR system’s definition of 

physician services expenditures. The groups also contend that the 

allowance for growth in volume and intensity is too low and lacks the 

flexibility to allow for factors outside physicians’ control. 

 

Fee updates under the SGR system have varied widely within an allowed 

range largely because of annual fluctuations in the growth of the volume and 

intensity of services that physicians provide to beneficiaries. Certain system 

design features, such as the use of cumulative spending targets and the need 

to estimate data, also reduce the stability and predictability of updates. 

However, MMA’s revision of the allowance for growth in volume and 

intensity of services from an annual change to a 10-year moving average will 

help to make future updates more stable and predictable. 

Possible alternatives to the SGR system cluster around the two broad 

approaches under consideration: (1) end the use of spending targets and 

separate fee updates from explicit efforts to moderate spending growth or 

(2) retain spending targets but modify the current SGR system to address 

perceived shortcomings. CMS projects that either of the two approaches will 

result in higher aggregate spending, thereby increasing the difficulty of 

addressing Medicare’s long-run financial challenges. The first approach 

emphasizes stable fee updates, while the second approach automatically 

adjusts fee updates if spending growth deviates from a predetermined target. 

While seeking to pay physicians appropriately, it is important to consider 

how modifications or alterations to the SGR system would affect the longterm sustainability and affordability of the Medicare program. In this 

context, the choice between the two approaches may hinge on whether 

primary consideration should be given to stable fee increases or to the need 

for fiscal discipline within the Medicare program. 

CMS agreed with the concluding observations in the draft report. Groups 

representing physicians commented that overall, the draft report offered a 

good analysis of problems with the SGR system, but did not fully reflect their 

concerns. We modified the draft as appropriate. 

Concerns were raised about the 

current system Medicare uses to 

determine annual changes to 

physician fees—the sustainable 

growth rate (SGR) system—when 

fees were reduced by 5.4 percent in 

2002. Subsequent administrative 

and legislative actions modified or 

overrode the SGR system, resulting 

in fee increases for 2003, 2004, and 

2005. However, projected fee 

reductions for 2006-2012 have 

raised new concerns about the SGR 

system. Policymakers are 

considering whether to eliminate 

spending targets or modify them. 

 

The Medicare Prescription Drug, 

Improvement, and Modernization 

Act of 2003 (MMA) required that 

GAO study SGR and potential 

alternatives to the system. This 

report examines (1) how the SGR 

system is designed to control 

spending for physician services, 

(2) what concerns have been raised 

about the SGR system and its 

components, (3) what affects the 

stability and predictability of 

physician fee updates under the 

SGR system, and (4) what 

alternatives to the current SGR 

system exist. GAO reviewed 

relevant laws and regulations and 

interviewed officials and 

organizations representing 

physicians. On the basis of this 

information, GAO identified 

potential alternatives to the SGR 

system and requested illustrative 

simulations of fee updates and 

spending on physician services 

from the Centers for Medicare & 

Medicaid Services (CMS). 
Page i GAO-05-85 Medicare Physician Payments 

Letter 1

Results in Brief 4 

Background 6 

SGR System Designed to Adjust Fee Updates to Bring Actual 

Spending for Physician Services in Line with Spending Targets 12 

Various Concerns Raised about SGR System and Its Components 17 

Variable Growth in Provision of Physician Services and Certain 

SGR System Design Elements Reduce Stability and 

Predictability of Physician Fee Updates 21 

Alternatives for Updating Physician Fees Would Eliminate 

Spending Targets or Revise Current SGR System 27 

Concluding Observations 56 

Agency and Industry Comments and Our Evaluation 57 

Appendix I Calculation of the Performance Adjustment Factor 63 

Appendix II Corrections to Prior Estimates Caused the SGR 

System’s Cumulative Targets to Produce Negative 

Updates 64 

Appendix III Comments from the Centers for Medicare & Medicaid 

Services 68 

Tables 

Table 1: CMS’s Estimate of the 2005 Sustainable Growth Rate and 

Its Determinants, as of March 2004 13 

Table 2: Estimated 2005 Fee Update, as of March 2004 16 

Figures 

Figure 1: Average Annual Percentage Change in Medicare Spending 

for Physician Services per Beneficiary, 1980–2003 8 

Figure 2: Growth in Volume and Intensity of Medicare Physician 

Services per Beneficiary, 1980–2003 10 

Figure 3: Projected MEI and Fee Update under Current Law 24 

Contents 
Page ii GAO-05-85 Medicare Physician Payments 

Figure 4: Annual Percentage Change in Real GDP Per Capita and 

10-Year Moving Average Change in Real GDP Per Capita, 

1992–2003 26 

Figure 5: Projected MEI and Fee Updates under Current Law and 

under Option of Eliminating Spending Targets and Tying 

Fee Updates to MEI 30 

Figure 6: Projected Aggregate Spending under Current Law and 

under Option of Eliminating Spending Targets and Tying 

Fee Updates to MEI 31 

Figure 7: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Option of Eliminating Spending Targets and Tying 

Fee Updates to MEI 32 

Figure 8: Projected MEI and Fee Updates under Current Law and 

under Option of Not Including Any Part B Drugs in the 

SGR System Beginning in 2005 35 

Figure 9: Projected Aggregate Spending under Current Law and 

under Option of Not Including Any Part B Drugs in the 

SGR System Beginning in 2005 36 

Figure 10: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Option of Not Including Any Part B Drugs in the 

SGR System Beginning in 2005 37 

Figure 11: Projected MEI and Fee Updates under Current Law and 

under Option of Resetting the Cumulative Spending 

Target Equal to Cumulative Actual Spending as of 2006 39 

Figure 12: Projected Aggregate Spending under Current Law and 

under Option of Resetting the Cumulative Spending 

Target Equal to Cumulative Actual Spending as of 2006 40 

Figure 13: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Option of Resetting the Cumulative Spending 

Target Equal to Cumulative Actual Spending as of 2006 41 

Figure 14: Projected MEI and Fee Updates under Current Law and 

under Option of Eliminating the Cumulative Aspect of 

Spending Targets 43 

Figure 15: Projected Aggregate Spending under Current Law and 

under Option of Eliminating the Cumulative Aspect of 

Spending Targets 44 
Page iii GAO-05-85 Medicare Physician Payments 

Figure 16: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Option of Eliminating the Cumulative Aspect of 

Spending Targets 45 

Figure 17: Projected MEI and Fee Updates under Current Law and 

under Option of Increasing Volume and Intensity Growth 

Allowance to GDP Plus 1 Percentage Point 47 

Figure 18: Projected Aggregate Spending under Current Law and 

under Option of Increasing Volume and Intensity Growth 

Allowance to GDP Plus 1 Percentage Point 48 

Figure 19: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Option of Increasing Volume and Intensity Growth 

Allowance to GDP Plus 1 Percentage Point 49 

Figure 20: Projected MEI and Fee Updates under Current Law and 

under Combination of Options of Resetting the 

Cumulative Spending Target Equal to Cumulative Actual 

Spending as of 2006, Not Including Any Part B Drugs in 

the SGR System Beginning in 2005, and Using GDP Plus 1 

Percentage Point 51 

Figure 21: Projected Aggregate Spending under Current Law and 

under Combination of Options of Resetting the 

Cumulative Spending Target Equal to Cumulative Actual 

Spending as of 2006, Not Including Any Part B Drugs in 

the SGR System Beginning in 2005, and Using GDP Plus 1 

Percentage Point 52 

Figure 22: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Combination of Options of Resetting the 

Cumulative Spending Target Equal to Cumulative Actual 

Spending as of 2006, Not Including Any Part B Drugs in 

the SGR System Beginning in 2005, and Using GDP Plus 1 

Percentage Point 53 

Figure 23: Projected MEI and Fee Updates under Current Law and 

under Combination of Options of Not Including Any Part 

B Drugs in the SGR System Beginning in 2005 and 

Eliminating the Cumulative Aspect of Spending Targets 54 

Figure 24: Projected Aggregate Spending under Current Law and 

under Combination of Options of Not Including Any Part 

B Drugs in the SGR System Beginning in 2005 and 

Eliminating the Cumulative Aspect of Spending Targets 55 
Page iv GAO-05-85 Medicare Physician Payments 

Figure 25: Projected Real Spending for Physician Fee Schedule 

Services per FFS Beneficiary under Current Law and 

under Combination of Options of Not Including Any Part 

B Drugs in the SGR System Beginning in 2005 and 

Eliminating the Cumulative Aspect of Spending Targets 56 

Figure 26: Formula Used to Determine the Performance 

Adjustment Factor in 2005 63 

Figure 27: Percentage Change in MEI, SGR Fee Schedule Update, 

and Medicare Physician Services Spending per 

Beneficiary, 1998–2005 65 
Page v GAO-05-85 Medicare Physician Payments 

Abbreviations 

BBA Balanced Budget Act of 1997 

BBRA Medicare, Medicaid, and SCHIP Balanced Budget 

 Refinement Act of 1999 

CBO Congressional Budget Office 

CMS Centers for Medicare & Medicaid Services 

CPI-U consumer price index for urban consumers 

ESRD end-stage renal disease 

FFS fee-for-service 

GDP gross domestic product 

HHS Department of Health and Human Services 

HI Hospital Insurance 

MedPAC Medicare Payment Advisory Commission 

MEI Medicare Economic Index 

MMA Medicare Prescription Drug, Improvement, and 

 Modernization Act of 2003 

MVPS Medicare volume performance standard 

OACT Office of the Actuary 

PAF performance adjustment factor 

PPRC Physician Payment Review Commission 

SGR sustainable growth rate 

SMI Supplementary Medical Insurance 

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Page 1 GAO-05-85 Medicare Physician Payments 

October 8, 2004 

Congressional Committees 

Physicians and others raised concerns about the current system Medicare 

uses to determine annual changes to physician fees when those fees were 

reduced by 5.4 percent in 2002. This reduction was triggered, in part, 

because spending on physician services had exceeded predetermined 

spending targets and Medicare’s system for updating fees—the sustainable 

growth rate (SGR) system—called for a reduction in fees to impose fiscal 

discipline.1

 Subsequent administrative and legislative actions modified or 

overrode the SGR system, resulting in fee increases for 2003, 2004, and 

2005. Absent additional action, however, fees are expected to fall by 

approximately 5 percent each year beginning in 2006 and continuing 

through 2012 as the SGR system attempts to offset previous excess 

spending and align actual spending with the system’s spending targets. 

According to physician groups, such a decline in fees would likely 

discourage many physicians from treating Medicare beneficiaries. As a 

result of these concerns, policymakers are interested in considering the 

appropriateness of current spending targets and the SGR system as a 

method for determining physician fee updates. Essentially, they are 

considering whether to eliminate spending targets or retain them, while 

making modifications to the system. 

Although the current focus of concern is largely on the potential for 

declining physician fees, the historic challenge for Medicare has been to 

find ways to moderate the rapid growth in spending for physician services 

under the Medicare Supplementary Medical Insurance (SMI)—or Part B—

program. In the 1980s, attempts to moderate spending by limiting 

physician fees without addressing aggregate expenditures for physician 

services were unsuccessful because increases in the number of services 

physicians provided per beneficiary—known as volume—and the average 

complexity and costliness of those services—known as intensity—

continued to drive up spending. As a result, in the Omnibus Budget 

Reconciliation Act of 1989,2

 the Congress required the establishment of a 

 1

The SGR system reduced fees by 4.8 percent. Additional adjustments resulted in a total fee 

reduction of 5.4 percent. 

2

See Pub. L. No. 101-239, §6102, 103 Stat. 2106, 2169-89. 

United States Government Accountability Office

Washington, DC 20548 
Page 2 GAO-05-85 Medicare Physician Payments 

national Medicare physician fee schedule and a system for annually 

updating fees that included spending targets. The fee schedule and 

spending targets first affected physician fees in 1992. The SGR system, 

Medicare’s current system for updating physician fees, was established in 

the Balanced Budget Act of 1997 (BBA) and was implemented in 1998.3

Both the SGR and its predecessor system provided for cumulative fee 

updates that generally exceeded cumulative increases in physicians’ cost 

of providing services.4

 Since the establishment of the national fee schedule 

and spending targets, the growth in spending for Medicare physician 

services has slowed substantially. Nonetheless, recent increases in 

physician expenditures due to volume and intensity growth are a reminder 

that the historic challenge of moderating spending growth has not 

disappeared. 

The Medicare Prescription Drug, Improvement, and Modernization Act of 

2003 (MMA) required us to study certain adjustments to physician fees, 

including the SGR system and alternatives to the system.5

 As discussed 

with the committees of jurisdiction, this report examines (1) how the SGR 

system is designed to control spending for physician services, (2) what 

concerns have been raised about the SGR system and its components, 

(3) what affects the stability and predictability of physician fee updates 

under the SGR system, and (4) what alternatives to the current SGR 

system exist. 

In addressing these objectives, we analyzed Medicare expenditure data 

from the Medicare Trustees’ 1998 and 2004 annual reports.6

 We also 

reviewed laws and regulations pertaining to the SGR system and its 

predecessor spending target system and interviewed officials at the 

 3

See Pub. L. No. 105-33, §4503, 111 Stat. 251, 433-34. BBA set a specific fee update for 1998. 

See BBA, §4505, 111 Stat. 435-39. Physician fees were first affected by the SGR system in 

1999. 

4

Specifically, from 1992 through 2001, fee updates resulting from the SGR and its 

predecessor system, increased by 39.7 percent, whereas input prices increased by 25.9 

percent. These updates do not reflect other required adjustments, such as those for 

legislated changes and for budget neutrality. 

5

See Pub. L. No. 108-173, §953, 117 Stat. 2066, 2427-28. 

6

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

Insurance Trust Funds, 1998 Annual Report of the Board of Trustees of the Federal 

Supplementary Medical Insurance Trust Fund (Washington, D.C.: Apr. 28, 1998), and 

2004 Annual Report of the Board of Trustees of the Federal Hospital Insurance and 

Federal Supplementary Medical Insurance Trust Funds (Washington, D.C.: Mar. 23, 2004). 
Page 3 GAO-05-85 Medicare Physician Payments 

Centers for Medicare & Medicaid Services (CMS), the agency responsible 

for administering Medicare; the Congressional Budget Office (CBO); the 

Medicare Payment Advisory Commission (MedPAC);7

 and organizations 

representing physicians, including the American Medical Association, the 

Medical Group Management Association, the Alliance for Specialty 

Medicine, and the American College of Physicians. On the basis of these 

document reviews and interviews, we identified potential alternatives to 

the SGR system. We requested illustrative simulations of fee updates and 

total spending under these alternatives from the CMS Office of the Actuary 

(OACT).8

 Total spending includes expenditures from all sources—that is, 

government outlays and beneficiary spending, including monthly Part B 

premiums, deductibles, and coinsurance payments.9

 Because the 

simulation estimates produced by CMS OACT include total spending from 

all sources, the estimated spending changes will differ from CBO’s cost 

estimates for the same alternatives. CBO, which is responsible for 

estimating how legislated changes would affect federal spending, does not 

include beneficiary spending when it estimates the cost of SGR 

alternatives. CMS OACT and CBO estimates may also differ as the result of 

differences in the underlying assumptions used by the two agencies. Our 

analyses apply only to spending affected by the SGR system—that is, 

physician spending in the traditional fee-for-service (FFS) program. We 

assessed the reliability of the Medicare expenditure data and data used for 

the simulations under alternatives to the SGR system by interviewing 

agency officials knowledgeable about the data and who are responsible for 

producing the projections for the SGR system. We determined that the 

data were sufficiently reliable for the purposes of our study. We performed 

this work from January 2004 through September 2004 in accordance with 

generally accepted government auditing standards. 

 7

MedPAC is an independent federal body that advises the Congress on issues affecting the 

Medicare program. 

8

CMS OACT has the program responsibility to calculate Medicare’s spending targets for 

physician services and annual physician fee updates. In producing these simulations, CMS 

OACT used the agency’s assumptions regarding the various factors that affect the SGR 

system, such as projected fee-for-service enrollment. 

9

The Part B premium amount is adjusted each year so that expected premium revenues 

equal 25 percent of expected Part B spending. Beneficiaries must pay coinsurance—usually 

20 percent—for most Part B services. 
Page 4 GAO-05-85 Medicare Physician Payments 

To help impose fiscal discipline and moderate Medicare spending for 

physician services, the SGR system sets spending targets and adjusts fees 

paid to physicians based on the extent to which actual spending aligns 

with specified targets. SGR system targets are designed to allow real 

spending per beneficiary—that is, spending per beneficiary adjusted for 

the estimated underlying cost of providing physician services—to grow at 

the same rate that the national economy (as measured by the rate that real 

gross domestic product (GDP)) grows over time on a per capita basis—

currently estimated to be about 2.3 percent annually.10 If Medicare 

spending for physician services remains on target, the annual increase in 

physician fees is set equal to the estimated change in physicians’ cost of 

providing services.11 However, if growth in the volume and intensity of 

services provided is high enough to cause spending to exceed the SGR 

system target, future fee updates are set below the estimated increase in 

physicians’ average cost for providing services—in other words, 

physicians receive fee increases that are lower than the Medicare 

Economic Index (MEI). If the gap between spending and the target is wide 

enough, the SGR system results in fee reductions. Conversely, if volume 

and intensity growth is low enough to cause spending to fall below the 

target, the SGR system benefits physicians by producing fee increases that 

exceed the change in their cost of providing services. Under the SGR 

system’s cumulative spending targets, excess spending that is not offset in 

one year accumulates in succeeding years until it is recouped. 

Physician groups are dissatisfied with SGR as a system to update 

physician fees and have raised various concerns about its components. In 

general, they note that expenditures for physician services constitute 

Medicare’s only spending that is subject to a target system. Physician 

groups report that under this system, fee updates—which are explicitly 

linked to spending controls—have caused payment rates in recent years to 

fall behind physicians’ cost of providing services. Among specific 

concerns, physician groups question the fairness of reducing fee updates 

for physician services to offset rapidly growing expenditures for certain 

outpatient drugs that are covered by Medicare Part B and that are largely 

physician administered. The groups also contend that the SGR system’s 

 10This rate incorporates the 10-year moving average of real GDP per capita. 

11The change in the cost of providing physician services is measured by the Medicare 

Economic Index (MEI). MEI measures input prices for resources needed to provide 

physician services. It is designed to estimate the increase in the total cost for the average 

physician to operate a medical practice. 

Results in Brief 
Page 5 GAO-05-85 Medicare Physician Payments 

allowance for spending growth due to volume and intensity increases—the 

growth rate of real GDP per capita—is too low and inflexible. Physician 

groups contend that as a result, factors outside physicians’ control—such 

as any future declines in the FFS population’s average health status and 

introduction of new, effective medical technology—may cause spending to 

exceed the SGR system targets and thus lead to reduced fee updates. 

Additional concerns include whether CMS’s method used to account for 

spending increases due to changes in laws and regulations—which can 

change payments or expand the extent and number of Medicare-covered 

services—is sufficiently complete, accurate, and transparent. 

For several reasons, fee updates under the SGR system have varied—

within a specified range—and have been difficult to predict accurately.12 A 

principal cause of variation within this range has been annual fluctuations 

in the growth of the volume and intensity of services that physicians 

provide to beneficiaries. Since the SGR system was implemented in 1998, 

volume and intensity growth has ranged from 1.2 percent in 1999 to 6.1 

percent in 2002. Two system design characteristics also reduce the 

stability and predictability of updates. First, the SGR system is designed to 

respond to fluctuating volume and intensity growth by adjusting fee 

updates to keep cumulative spending in line with the targets. Attempting 

to control cumulative spending tends to amplify the variation in annual 

updates. For example, if spending has exceeded the spending target, the 

SGR system must reduce future updates both to slow future spending 

growth and to recoup previous excess spending. Second, uncertainty in 

estimates of data used in the SGR system makes long-term estimates of fee 

updates less predictable and causes updates to vary from year to year as 

new data become available and estimates of data used in the SGR system 

are revised. 

Alternatives to the SGR system we identified cluster around the two 

approaches that policymakers are considering. One approach would end 

the use of spending targets—separating fee updates from efforts to 

moderate spending growth. MedPAC is a proponent of this approach and 

since 2001 has recommended tying fee updates to estimated changes in 

physicians’ cost of providing services. It has further recommended that 

Medicare seek to control spending growth by, among other things, 

 12The SGR system permits annual physician fee updates to vary by as much as 7 percent 

below to 3 percent above the estimated change in physicians’ cost of providing services as 

measured by MEI. 
Page 6 GAO-05-85 Medicare Physician Payments 

identifying and addressing the utilization of rapidly growing services, such 

as diagnostic imaging. The other approach includes alternatives that 

would retain spending targets but modify the current SGR system to 

address perceived shortcomings. These modifications could include 

removing the Part B prescription drug expenditures that are currently 

counted in the SGR system; resetting the targets by not requiring the 

system to recoup previous excess spending; using annual, rather than 

cumulative, targets to dampen the fluctuation in fee updates; and 

modifying the allowance for increased spending due to volume and 

intensity growth. The advantage of eliminating spending targets would be 

greater fee update stability and predictability, whereas the advantage of 

retaining spending targets as part of the system for updating fees is that 

the system would automatically work to moderate spending if volume and 

intensity growth began to increase above allowable rates. However, either 

approach compared to current law, under which fees are projected to be 

reduced by as much as 5 percent or more for several years, will be very 

expensive—ranging from 4 percent to 23 percent higher cumulative 

spending over the 10-year period from 2005 to 2014. Given the importance 

of the long-term sustainability and affordability of the Medicare program, 

examining the impact of spending over a longer period may be appropriate 

when contemplating modifications or alternatives to the SGR system. 

CMS agreed with our concluding observations and expressed its 

commitment to pay physicians appropriately to ensure that Medicare 

beneficiaries have access to high-quality health care. Groups representing 

physicians commented that overall, a draft of our report offered a good 

analysis of problems with the SGR system, but indicated it did not fully 

reflect the extent of their concerns. Some of the issues the groups raised 

were outside the scope of our report. We modified the report as 

appropriate. 

Medicare spending per beneficiary on physician services has varied 

substantially—both among geographic areas and in its growth over time. 

The geographic variation in spending—unrelated to beneficiary health 

status or outcomes—provides evidence that health needs alone do not 

determine spending. Consequently, policymakers have deemed it both 

reasonable and desirable to question the appropriateness of current and 

projected physician services spending and to explicitly consider the 

affordability of such spending when setting physician fees. The 

implementation of a national fee schedule and spending targets in 1992, 

for example, was designed, in part, to address issues of affordability and 

program sustainability by slowing spending growth. Moderating this 

Background 
Page 7 GAO-05-85 Medicare Physician Payments 

growth remains part of the larger effort to ensure future Medicare program 

sustainability. 

In 1989, the Physician Payment Review Commission (PPRC) reported that 

from 1979 through 1989 (the decade prior to the establishment of spending 

targets), Medicare spending on physician services per beneficiary more 

than tripled, rising much more rapidly than general inflation.13 At that time, 

PPRC recommended an expenditure target for controlling aggregate 

spending on physician services. The target was to apply initially to all 

physician services nationally and later to evolve to separate targets for 

regions, categories of physician services, or both. 

Then, as now, utilization of physician services varied widely by geographic 

area, while the Medicare patient populations in these areas differed little 

from one another in their illnesses. Some studies report that variation in 

service use indicates that in some parts of the country compared with 

others, there was either overuse or underuse of services. Recent studies of 

Medicare expenditures show that regional variation in the use of medical 

services remains and that the spending disparities among areas are 

explained by physicians’ discretionary practices rather than by differences 

in patient populations’ health status.14

Three periods from 1980 to the present describe Medicare’s recent 

experience in spending for physician services. Figure 1 shows growth in 

Medicare spending per beneficiary for physician services during the three 

periods. In the first period, 1980 through 1991, Medicare’s payment rates 

for physician services were based on historical charges for these services, 

and limits were placed on fees and fee updates but not on aggregate 

 13PPRC, established by the Congress in the Consolidated Omnibus Budget Reconciliation 

Act of 1985, Pub. L. No. 99-272, §9305, 100 Stat. 82, 190-91 (1986), was charged with 

advising the Congress on methods to reform payment to physicians under the Medicare 

program and with making recommendations annually. Subsequent legislation expanded 

PPRC’s responsibilities to include, among other things, setting standards for expenditure 

growth and updating fees and monitoring beneficiary access and financial liability. In 1997, 

BBA dissolved PPRC and the Prospective Payment Assessment Commission and formed 

MedPAC. BBA, §4022, 111 Stat. 350-355. 

14John E. Wennberg, Elliot S. Fisher, and Jonathan S. Skinner, “Geography And The Debate 

Over Medicare Reform,” Health Affairs Web Exclusive, February 13, 2002; E.S. Fisher et 

al., “The Implications of Regional Variations in Medicare Spending, Part 1: The Content, 

Quality, and Accessibility of Care,” Annals of Internal Medicine (2003): 273–287; and E.S. 

Fisher et al.,”The Implications of Regional Variations in Medicare Spending, Part 2: Health 

Outcomes and Satisfaction with Care,” Annals of Internal Medicine (2003): 288–298. 

Some Spending on 

Physician Services May Be 

Unnecessary, as Suggested 

by Unwarranted Regional 

Variation in Use of 

Physician Services 

Physician Service 

Expenditures Have Grown 

Less Rapidly after 

Spending Targets and Fee 

Schedule Were Established 
Page 8 GAO-05-85 Medicare Physician Payments 

spending. In the 1992 through 1997 period, physician services were paid 

under a national fee schedule, and the first spending target system—called 

the Medicare volume performance standard (MVPS)—set an allowable 

growth rate for aggregate spending that was used to adjust physician fees. 

From 1998 on, services continue to be paid under a fee schedule and the 

SGR system replaced the MVPS system and uses a different method to set 

an acceptable growth rate for aggregate spending. 

Figure 1: Average Annual Percentage Change in Medicare Spending for Physician 

Services per Beneficiary, 1980–2003 

Notes: Spending changes for 1980 through 1991 are for the years ending June 30 and represent 

average Medicare spending for beneficiaries in the traditional FFS program, net of beneficiary cost 

sharing. Spending for end-stage renal disease (ESRD) patients is not included. Spending changes for 

1992 through 1997 and 1998 through 2003 are for calendar years and represent changes in total 

allowed charges—Medicare spending, including beneficiary cost sharing—for beneficiaries in the 

traditional FFS program. 

In the 1980s, Medicare paid physicians on the basis of “reasonable charge,” 

defined as the lowest of the physician’s actual charge, the customary 

charge (the amount the physician usually charged for the service), or the 

prevailing charge (based on comparable physicians’ customary charges). 

Under this system, payment inconsistencies existed among physicians by 

services, specialties, and locations. The system also had an inflationary 

bias, as a rise in customary charges could increase prevailing charges over 

11.6

4.4

6.0

0

2

4

6

8

10

12

14

1980–1991 1992–1997 1998–2003

Percentage

Source: GAO analysis of data from CMS and the Boards of Trustees of the Federal Hospital Insurance (HI) and Supplementary 

Medical Insurance (SMI) Trust Funds.

Pretargets MVPS SGR

Fee schedule and 

spending targets in effect
Page 9 GAO-05-85 Medicare Physician Payments 

time.15 During this decade, expenditures for physician services grew 

rapidly: from 1980 through 1991, Medicare spending per beneficiary for 

physician services grew at an average annual rate of 11.6 percent. 

Although the Congress froze fees or limited fee increases in the 1980s, 

spending continued to rise because there were no limits on growth in the 

volume and intensity of services physicians provided to beneficiaries. 

Recognizing that the expenditure growth of the 1980s was not sustainable, 

the Congress reformed the way Medicare paid for physician services in the 

traditional FFS program by requiring the establishment of a national fee 

schedule for physician services and a system for controlling aggregate 

physician service spending, MVPS. The establishment of a fee schedule in 

1992 was an attempt to break the link between physicians’ charges and 

Medicare payments. The fee schedule was designed to pay for services 

based on the relative resources used by physicians to provide different 

types of care and to address the inflationary bias of the charge-based 

system. The adoption of a spending target system was an attempt to 

control spending growth attributable to increases in the volume and 

intensity of physician services. 

Under MVPS, a performance standard for a given year was set, indicating a 

growth rate for expenditures that should not be exceeded. The extent to 

which actual expenditure growth fell above or below the performance 

standard helped to determine the update to physician fees 2 years later. 

For example, in 1993, CMS compared actual spending in 1992 with the 

performance standard for 1992; the difference largely determined the 

update to physician fees in 1994.16 The performance standard was based on 

changes in four factors: the number of FFS Medicare beneficiaries, 

practice cost inflation, the historical growth in volume and intensity, and 

laws and regulations that could affect spending for physician services.17

From 1992 through 1997—the period that MVPS was used to set fee 

updates—annual spending growth for physician services was far lower 

than in the preceding decade. The decline in spending growth during this 

 15Beginning in 1975, increases in prevailing charges were limited to the change in MEI. 

16Under MVPS, the fee updates depended on both the change in MEI and the difference 

between actual spending and the performance standard. 

17Inflation was measured as a weighted average of input price increases, estimated by MEI 

for physician services and the consumer price index for urban consumers (CPI-U) for 

laboratory services. 
Page 10 GAO-05-85 Medicare Physician Payments 

period was the result, in large part, of slower volume and intensity growth. 

For example, from 1985 through 1991, spending per beneficiary grew at an 

average annual rate of 10.8 percent; during that period, volume and 

intensity of service use per beneficiary rose an average 7 percent annually. 

From 1992 through 1997, the growth in spending per beneficiary fell to 4.4 

percent; during that period, average annual growth in volume and intensity 

of service use per beneficiary fell to 1 percent. (See fig. 2.) 

Figure 2: Growth in Volume and Intensity of Medicare Physician Services per Beneficiary, 1980–2003 

Notes: Data are for beneficiaries in the traditional FFS program only. Data for ESRD patients are not 

included. From 1980 through 1992, volume and intensity of services changes are based on Medicare 

outlays for all physician services. From 1993 through 2003, volume and intensity of services changes 

are based on Medicare outlays for physician services covered by the fee schedule. 

Concerns about the MVPS spending targets arose in 1995 when physician 

fees were expected to fall over time unless there were continual declines 

in the volume and intensity of services provided.18, 19 In response to the 

 18Physician Payment Review Commission, 1995 Annual Report to Congress (Washington, 

D.C.: 1995). 

Percentage

8.3

3.7

7.6

9.7

3.9

6.5

9.0

9.4

1.7

3.4

1.5 1.2

3.5

4.3

6.1

4.5

-0.7 -0.2 0.2

1.5

-1

0

1

2

3

4

5

6

7

8

9

10

1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Fee schedule and 

spending targets

first affected updates

Source: GAO analysis of data from CMS and the Boards of Trustees of the Federal HI and SMI Trust Funds.

Charge-based system

Fee schedule and MVPS

Fee schedule and SGR
Page 11 GAO-05-85 Medicare Physician Payments 

system’s perceived shortcomings, the Congress took action in BBA in 1997 

to replace it with the SGR system.20 In 1998 and 1999, the first 2 years of 

the SGR system, volume and intensity growth remained similar to the rate 

under MVPS. However, from 2000 through 2003, volume and intensity 

growth rose at an average annual rate of about 5 percent.21 Over the 1998–

2003 SGR system period,22 the average growth in volume and intensity of 

services per Medicare beneficiary was higher than the average for the 

1992–1997 MVPS period—but substantially below that experienced before 

spending targets were introduced. Since the introduction of the SGR 

system, total spending on physician services is projected to grow by an 

average of 8 percent a year from 2000 through 2005. 

In 2003, Medicare spending for physician services totaled nearly 

$48 billion,23 which accounted for about one-sixth of program spending 

overall. We and others have argued for the need for additional fiscal 

discipline in Medicare.24 Within the next 10 years, the federal budget will 

experience significant increases in spending pressure, due primarily to 

known demographic trends and rising health care costs. Expected 

technological advances—involving new drugs and diagnostic procedures, 

among other things—may improve health outcomes but will likely 

increase the price tag of a Medicare program that is already unsustainable 

 19The MVPS spending target was based, in part, on a 5-year historical trend in volume and 

intensity reduced by a specified number of percentage points. Because of this design and 

the fact that volume and intensity growth dropped dramatically after the adoption of the 

MVPS system, the target for future volume and intensity increases fell too. 

20The SGR system was revised by the Medicare, Medicaid, and SCHIP Balanced Budget 

Refinement Act of 1999 (BBRA), (Pub. L. No. 106-113, App. F, §211(b), 113 Stat. 1501A-321, 

348-49) and by MMA (see §601(b), 117 Stat. 2301). 

21This recent growth in volume and intensity for physician services is higher than the 3 

percent a year that CMS OACT is projecting for 2005 through 2014. 

22In 2002, a year in which physicians’ fees fell by 5.4 percent, volume and intensity grew by 

6.1 percent, the largest growth in a single year since the fee schedule and spending targets 

were introduced. 

23This figure does not include spending associated with Medicare’s private plan option. 

24GAO, Medicare: Financial Challenges and Considerations for Reform, GAO-03-577T

(Washington, D.C.: Apr. 10, 2003); Congressional Budget Office, Medicare’s Long-Term 

Financial Condition, testimony before the Joint Economic Committee (Apr. 10, 2003); 

Office of Management and Budget, Analytical Perspectives, Budget of the United States 

Government, Fiscal Year 2005 (Washington, D.C.: Feb. 2, 2004); and Boards of Trustees of 

the Federal Hospital Insurance and the Federal Supplementary Medical Insurance Trust 

Funds, 2004 Report of the Boards of Trustees of the Federal Hospital Insurance and the 

Federal Supplementary Medical Insurance Trust Funds. 

Controlling Spending for 

Physician Services Part of 

Larger Challenge to 

Maintain Fiscal Discipline 

in Medicare 
Page 12 GAO-05-85 Medicare Physician Payments 

in its present form. In light of physician service expenditures’ significant 

contribution to aggregate spending, containing their growth plays an 

important role in helping to address the program’s long-range and 

fundamental financing problem. 

The SGR system is designed to impose fiscal discipline and to moderate 

spending for physician services by adjusting annual fee updates to bring 

spending in line with targets. The SGR system, similar to the predecessor 

MVPS system, relies on spending targets because earlier attempts to 

achieve fiscal discipline through limits on fee increases did not control the 

spending that resulted from volume and intensity growth. The SGR system 

uses a formula specified in statute to establish each year an allowed 

spending growth rate, a spending target, and a fee update. Like MVPS, the 

SGR system includes an allowance for volume and intensity increases but, 

unlike MVPS, ties the allowance to a measure of the growth of the national 

economy. 

As noted, spending targets were established—first under MVPS and later 

under the SGR system—because policymakers contended that the fee 

schedule alone would not have adequately constrained expenditure 

growth for physician services. The fee schedule limits payment for 

individual services but does not moderate spending growth resulting from 

volume and intensity increases. Although the SGR system’s spending 

target does not cap expenditures for physician services, it serves as a 

budgetary control by automatically lowering fee updates in response to 

excess spending due to volume and intensity growth. In addition, reduced 

fee updates serve as a signal to physicians collectively and to the Congress 

that spending due to volume and intensity has increased more than 

allowed. 

An additional reason for spending targets was advanced by PPRC in its 

1995 report to the Congress.25 PPRC explained that spending targets were 

intended, in part, to create a collective incentive for physicians. 

Specifically, the report stated that spending targets “provid[e] the medical 

profession with a collective incentive to reduce inappropriate care by, for 

instance, developing and disseminating practice guidelines that promote 

cost-effective practice styles.” 

 25Physician Payment Review Commission, 1995 Annual Report to Congress. 

SGR System Designed 

to Adjust Fee Updates 

to Bring Actual 

Spending for 

Physician Services in 

Line with Spending 

Targets 

Spending Targets for 

Physician Services Used to 

Encourage Fiscal 

Discipline 
Page 13 GAO-05-85 Medicare Physician Payments 

Every year, CMS must estimate the allowed rate of increase in spending 

for physician services and use that rate to construct the annual spending 

target for the following calendar year.26 The sustainable growth rate is the 

product of the estimated percentage change in (1) input prices for 

physicians’ services; 27, 28 (2) the average number of Medicare beneficiaries 

in traditional FFS; (3) national economic output, as measured by real 

(inflation-adjusted) GDP per capita; and (4) expected expenditures for 

physician services resulting from changes in laws or regulations. CMS’s 

current estimate of the sustainable growth rate for 2005 is 4.6 percent, 

based on the agency’s estimates of the four factors. (See table 1.) 

Table 1: CMS’s Estimate of the 2005 Sustainable Growth Rate and Its Determinants, 

as of March 2004 

Estimated 

percentage change

Sustainable growth rate determinants 

Input prices for physician servicesa 2.6

Traditional FFS Medicare enrollment -0.2

Real GDP per capita 2.2

Expenditures for physician services resulting from 

changes in laws and regulations 

0.0

Estimated 2005 sustainable growth rate 4.6b

Source: CMS OACT. 

a

For purposes of the sustainable growth rate, physician services include services paid for by the fee 

schedule as well as laboratory services and certain Medicare-covered Part B outpatient drugs. 

b

The sustainable growth rate is computed as the product of the percentage change in the four factors. 

The percentage changes are expressed in decimal form relative to 1.0. For example, a percentage 

change of 2.6 percent is expressed as 1.026. Therefore, the sustainable growth rate is computed as 

(1.026) x (0.998) x (1.022) x (1.0) = 1.046 , or 4.6 percent. 

 26This allowed rate is the sustainable growth rate from which the SGR system derives its 

name. For the purposes of this report, we use the abbreviation SGR when referring to the 

system and the full term of “sustainable growth rate” when referring to the allowed rate of 

increase. 

27CMS calculates changes in physician input prices based on the growth in the costs of 

providing physician services as measured by MEI, growth in the costs of providing 

laboratory tests as measured by CPI-U, and growth in the cost of Medicare Part B 

prescription drugs included in SGR spending. 

28Under the SGR and MVPS systems, the Secretary of Health and Human Services defined 

“physician services” to include “services and supplies incident to physicians’ services,” 

such as laboratory tests and most Part B prescription drugs. 

SGR System Sets 

Allowable Spending 

Growth and Targets for 

Physician Services 
Page 14 GAO-05-85 Medicare Physician Payments 

To set each year’s spending target, the SGR system increases the previous 

year’s spending target by the sustainable growth rate for the given year.29

For example, target spending for 2004 was $77.3 billion. Target spending 

for 2005 is 4.6 percent higher, or $80.9 billion. Under the SGR system, 

every annual target depends on the targets set in all previous years since 

the base year 1996.30 BBRA required CMS, in calculating each year’s SGR 

system spending target, to first revise the targets set for the 2 previous 

years using the most recent available data for all elements of the target—

that is, revisions to figures for input prices for physician services, FFS 

beneficiary enrollment, real GDP per capita, and expenditures due to 

relevant new laws and regulations.31, 32

Every fall, CMS determines whether the fee update for the following 

calendar year must be adjusted to help align spending with targets.33 To do 

so, the agency compares actual spending, measured cumulatively since 

1996, to the cumulative value of the annual targets, measured over the 

same period. If the two are equal, the fee update is set to equal the 

estimated increase in physicians’ average cost of providing services—as 

measured by MEI. Otherwise, a performance adjustment factor (PAF) is 

used to increase or decrease the update relative to MEI in order to help 

bring spending back in line with the targets. (See app. I for the formula 

used to calculate the PAF.) The PAF is subject to limits and may not cause 

the update to be set at more than 3 percent above MEI or 7 percent below 

MEI. In part because of these limits, adjustments to realign actual 

cumulative spending with cumulative targets are spread out over more 

than 1 year.34

 29The SGR system changed from a fiscal year basis to a calendar year basis in 2000. 

30The base year is the 12-month period ending March 31, 1997. 

31See BBRA, §211(b), 113 Stat. 1501A348-49. 

32Revisions to targets first affected fee updates in 2001. In setting the target for that year, 

CMS revised only the 2000 SGR target. According to CMS, the agency was not authorized to 

revise the 1998 or 1999 SGR targets. 

33Estimates of the fee update for the following year are made in the spring. The final fee 

update is announced in November. 

34The formula used in the SGR system spreads the recoupment of excess spending over 

several years. Statutory limits on the PAF can increase the time necessary to recoup excess 

spending. 

SGR System Adjusts Fee 

Updates to Align Spending 

with Target 
Page 15 GAO-05-85 Medicare Physician Payments 

For example, in projecting the update for 2005, CMS estimated that 

cumulative spending from 1996 through 2004 ($543.8 billion) exceeded the 

cumulative value of the annual targets during the same period 

($531.9 billion) by approximately $11.9 billion. The estimated $11.9 billion 

difference is due to two components of accumulated excess spending and 

needs to be offset: first, excessive growth in volume and intensity in 2003 

and 2004, and second, the additional spending attributable to MMA. MMA 

replaced a fee reduction for 2004 with a minimum 1.5 percent increase, but 

it did not adjust SGR system targets to account for the additional 

spending.35 Because of the large discrepancy between spending and the 

target, the SGR system calls for the maximum PAF reduction. In 

conjunction with an estimated MEI of 2.8 percent, the application of the 

PAF would produce a fee update of negative 4.4 percent.36 In addition to 

MEI and the PAF, fees are sometimes subject to other adjustments, 

including those set by law. For 2005, there is an additional adjustment of 

0.8 percent, which results in an estimated SGR system fee update for 2005 

of negative 3.6 percent. (See table 2.) However, this negative update will 

be overridden by an MMA-specified minimum update of 1.5 percent for 

2005. The resulting fee update is applied to the fee schedule’s “conversion 

factor,” a dollar amount that translates each service’s relative value into an 

actual disbursement amount. 37, 38

 35See MMA, §601(a)(1), 117 Stat. at 2300. 

36For 2005, the product of the change in input prices multiplied by the PAF is equal to 

[(1+.028) x (1 – 0.07)] –1 = -0.044, or - 4.4 percent. 

37The fee for each service is determined using a resource-based relative value scale in 

which the resources required for a service are valued in relation to the resources required 

to provide all other physician services adjusted for the differences in the costs of providing 

services across geographic areas. To arrive at a fee, the service’s relative value is multiplied 

by the dollar conversion factor. 

38The update to the dollar conversion factor represents the aggregate of increases and 

decreases across all services. Because the relative value of individual services can change 

yearly, fee changes for specific services may be different than the overall fee update. 
Page 16 GAO-05-85 Medicare Physician Payments 

Table 2: Estimated 2005 Fee Update, as of March 2004 

 Percentage change

Estimated 2005 fee update under SGR systema -3.6

Update based on: 

• Change in input prices for physician services (MEI)b

2.8

• PAF -7.0

• BBRA required adjustmentc

0.8

2005 fee update as specified in MMAd 1.5

Source: CMS OACT. 

a

Update is computed as the product of the change in input prices, the PAF, and the BBRA-required 

adjustment; all are expressed in decimal form. That is, 2005 fee update = [(1+0.028) x (1 – 0.07) x 

(1+ 0.008)] –1 = -0.036 or -3.6 percent. 

b

For purposes of the fee update, physician services include only services paid for under the fee 

schedule. 

c

This adjustment, required by the Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act 

of 1999 (BBRA), maintains the budget neutrality of a technical change to the conversion factor. 

d

The actual fee update for 2005 is the greater of the calculated update of –3.6 percent or 1.5 percent 

as legislated by MMA. 

Under SGR’s system of cumulative spending targets, excess spending that 

is not offset in one year accumulates in succeeding years until it is 

recouped. For 2005, MMA increased actual spending but did not adjust the 

target for this additional spending. Now the gap between actual spending 

and the target will result in an additional deficit that under the SGR system 

will have to be recouped through negative updates in future years. 

The parameters of the SGR system allow spending due to the volume and 

intensity of physician services to increase, but limit that growth to the 

same rate that the national economy (GDP) grows in real terms (that is, 

adjusted for inflation) over time on a per capita basis. Under the SGR 

system, if the volume and intensity of physician service use grows faster 

than the national economy, the annual increase in physician fees will be 

less than the estimated increase in the cost of providing services. 

Conversely, if volume and intensity grows more slowly, the SGR system 

permits physicians to benefit from fee increases that exceed the increased 

cost of providing services. To reduce the effect of yearly business cycles 

on physician fees, MMA required that economic growth be measured as 

the 10-year moving average change in real GDP per capita for each year 

SGR System Ties Allowed 

Increases in Volume and 

Intensity to Growth in 

National Economy 
Page 17 GAO-05-85 Medicare Physician Payments 

beginning in 2003.39 This measure is projected to range from 2.1 percent to 

2.5 percent during the 2005 through 2014 period. 

When the SGR system was established, GDP growth was seen as a 

benchmark that would allow for affordable increases in volume and 

intensity and also one that represented a significant improvement over the 

benchmark included in the previous MVPS system. In its 1995 annual 

report to the Congress, PPRC stated that limiting real expenditure growth 

to 1 or 2 percentage points above GDP would be a “realistic and affordable 

goal.”40 Ultimately, BBA specified the growth rate of GDP alone. This limit 

was an indicator of what the nation could afford to spend on volume and 

intensity increases. Whether this rate is a sufficient and appropriate 

allowance for volume and intensity increases is uncertain. Currently, 

volume and intensity is projected to grow by more than 4 percent per year, 

whereas the allowance for this growth under the SGR system is about 

2.3 percent annually. Such excess volume and intensity growth is a key 

contributing factor to negative fee updates. 

Physician groups are dissatisfied with SGR as a system to update 

physician fees and have raised various concerns about its key 

components. Noting that physicians are uniquely subject to a system of fee 

updates that are explicitly linked to spending controls, the groups contend 

that the SGR system has caused payment rates in recent years to fall 

behind physicians’ cost of providing services. The groups’ concerns with 

specific SGR system components center on the following issues: the 

fairness of including Medicare-covered outpatient drugs in the calculation 

of physician service expenditures; the appropriateness of tying allowable 

volume and intensity increases to the average growth in real GDP per 

capita; and the completeness, accuracy, and transparency of the method 

used to account for spending increases due to changes in laws and 

regulations. 

 39See MMA, §601(b), 117 Stat. at 2301. 

40Physician Payment Review Commission, 1995 Annual Report to Congress.

Various Concerns 

Raised about SGR 

System and Its 

Components 
Page 18 GAO-05-85 Medicare Physician Payments 

Physician groups are concerned that physicians are the only Medicare 

provider type whose annual payment updates are subject to a spending 

target system. Payment rate updates for hospitals and other institutional 

providers, they note, are typically based on changes in the cost of 

providing services. However, as CBO, MedPAC, and others have noted, 

physicians are different from other providers in certain ways, which helps 

to provide a rationale for the application of targets solely to physician 

expenditures. Specifically, they note that physicians determine the 

services they deliver to their patients and influence the care delivered by 

other providers. In addition, under Medicare payment policies, physicians 

receive a separate payment for each service they provide. Thus, they can 

boost income by increasing the volume or intensity of services they 

provide. For example, a physician may follow up a patient’s visit by 

scheduling another visit, even when such a follow-up visit is discretionary 

and could be substituted with a telephone call. In contrast, Medicare 

typically pays institutional providers a fixed amount for a bundle of 

services; under this arrangement, no inherent incentive exists to provide 

extra services, as doing so would not increase payments. 

One of physician groups’ chief concerns is that through fee schedule 

updates, the SGR system holds physicians accountable for the escalating 

growth in Medicare expenditures for the majority of Part B-covered 

drugs.41 (Drugs included in the SGR system are largely physician 

administered and do not include all Part B-covered drugs.) The groups 

contend that the SGR system should not include these drugs in the 

calculation of aggregate physician service expenditures or the spending 

targets. Although the targets account for increases in the drugs’ prices, the 

targets do not explicitly account for increases in their utilization or the 

substitution of more expensive drugs for less expensive ones. Physician 

groups note that the use of the outpatient drugs currently covered by 

Medicare is largely nondiscretionary and that physicians should not be 

penalized for prescribing these drugs. To the extent that expenditures for 

these Medicare-covered outpatient drugs grow faster than real GDP per 

capita—which is the SGR system’s allowance for volume and intensity 

increases—other physician spending must grow more slowly or aggregate 

 41Most of the Part B drugs that Medicare covers fall into three categories: those typically 

provided in a physician office setting (such as chemotherapy drugs), those administered 

through a durable medical equipment item (such as a respiratory drug given in conjunction 

with a nebulizer), and those that are patient-administered and covered explicitly by statute 

(such as certain immunosuppressives). 

Physicians Dissatisfied 

That Medicare Spending 

for Physician Services Is 

Subject to Spending 

Targets 

Physicians Question 

Fairness of Including 

Part B Outpatient Drugs in 

Calculation of Physician 

Service Expenditures 
Page 19 GAO-05-85 Medicare Physician Payments 

spending will exceed the targets and fee updates for physician services 

will be reduced. 

In 2002, Medicare covered approximately 450 outpatient prescription 

drugs. The drugs that account for most of Medicare’s Part B drug 

expenditures are physician administered, such as those for cancer 

chemotherapy, accounting for 80 percent of total Medicare spending for 

Part B drugs in 2001. In 2001, oncologists submitted about 42 percent of 

prescription drug claims, while urologists accounted for 17 percent. 

Part B prescription drugs are not covered by the physician fee schedule,42

but the expenditures for most Part B drugs are included in the SGR system 

expenditures because, at the time spending targets were first introduced, 

the Secretary of Health and Human Services (HHS) included these drugs 

as services and supplies “incident to” physicians’ services. Since that time, 

Medicare spending for all Part B drugs has grown substantially, from 

about $700 million in 1992 to an estimated $8.5 billion in 2002. Much of the 

spending growth has resulted from increases in utilization and the 

substitution of newer, more expensive medications. Because SGR-covered 

Part B drug expenditures have grown more rapidly than other physician 

service expenditures, drug expenditures as a proportion of allowable 

spending under the targets have grown from 8.7 percent in 2002 to an 

estimated 12.3 percent in 2004. Such rapid growth in drug expenditures 

increases the likelihood that actual spending will exceed SGR system 

targets. Moreover, because only payments for services included in the 

physician fee schedule are offset when physician service spending 

deviates from the spending targets, the increase in the share of total 

expenditures attributed to prescription drugs magnifies the adjustment 

that must be made to the update to bring spending in line with the targets. 

 42In general, payment for covered outpatient prescription drugs is made under Medicare 

Part B and is equal to either 85 percent or 95 percent of the average wholesale price, 

depending on the drug. MMA provided for the implementation of a new payment 

methodology beginning in 2005. See MMA, §303, 117 Stat. 2233-2255. The legislation also 

establishes a new voluntary prescription drug benefit program under a new Part D of Title 

XVIII of the Social Security Act that will be effective January 1, 2006. 
Page 20 GAO-05-85 Medicare Physician Payments 

Physician groups have expressed concern that the SGR system’s 

allowance for volume and intensity growth—the 10-year moving average 

growth in real GDP per capita—is both too low and inflexible. They 

contend that tying the allowance to GDP results in targets that do not 

adequately account for appropriate increases in the demand for physician 

services and changes in medical practice, such as the following: 

• A sicker beneficiary population. Physician groups reason that although 

health status drives demand for services, the GDP growth allowance 

would not account for any increases in physician spending that could be 

due to greater care demands per beneficiary. 

• Technological advances. The groups note that new, expensive medical 

technologies can provide meaningful health gains for Medicare 

beneficiaries but that these technology costs are likely to grow faster than 

GDP. 

• Site-of-service shifts. The groups note that patients with complex 

conditions formerly treated in hospitals are increasingly treated in 

physician offices and that treating such patients, who may require frequent 

office visits and costly procedures, is likely to contribute to volume and 

intensity growth. 

The MVPS system provided an explicit opportunity to address some of 

these concerns procedurally. In addition to the allowance for volume and 

intensity growth specified in statute, the MVPS system also provided 

specific authority for the HHS Secretary to recommend revising the 

allowed increase based on factors such as changes in technology and 

concerns about access to physician services. Under the MVPS system, the 

Secretary never exercised the authority to make recommendations other 

than implementing the MVPS default formula, but it still remained an 

option. 

The SGR system is designed to account for changes in law and regulation 

that could affect aggregate spending for physician services. For example, 

for 2005, CMS estimates that increased spending resulting from MMA’s 

coverage of a preventive physical examination for new beneficiaries, 

cardiovascular screening blood tests, and diabetes screening tests, among 

other new increases, will be almost fully offset by new MMA-required 

payment adjustments for Part B drugs, which will lower physician service 

spending. Physician groups we spoke with contend that the process for 

developing such estimates may not be accurate or complete. 

Physicians Concerned 

That Key Spending Drivers 

Are Not Included in SGR 

System’s Allowance for 

Volume and Intensity 

Growth 

Transparency Lacking in 

Process for Estimating 

Changes in Medicare 

Spending for Physician 

Services due to Laws and 

Regulations 
Page 21 GAO-05-85 Medicare Physician Payments 

Assessing the accuracy and completeness of these estimates is difficult, as 

CMS’s process for identifying the applicable statutory and regulatory 

changes and the methods used to arrive at dollar estimates are not fully 

transparent. Either data are lacking to quantify the effects of changes or 

consensus is lacking on the assumptions and interpretations made about 

the changes and their effects. Currently, CMS does not use a formal 

mechanism for soliciting input from physician groups or other experts 

before obtaining public comment when future fees are announced in the 

Federal Register.43 Physician groups contend that at least including 

physician representatives in the process of assessing changes in laws and 

regulations would improve CMS’s analysis of effects and would be more 

efficient than waiting for the public comment period. 

Fee updates under the SGR system have varied widely within an allowed 

range, principally because of annual fluctuations in the growth of the 

volume and intensity of services that physicians provide to beneficiaries. 

Two of the SGR system’s design characteristics—the cumulative nature of 

spending targets and the use of estimated data elements in the spending 

target—also serve to reduce the stability and predictability of updates. The 

MMA provision that revised the allowance for growth in service volume 

and intensity from real GDP per capita growth rates each year to a 10-year 

moving average will reduce some of the swings in future SGR system 

updates. 

Annual fluctuations in the growth of the volume and intensity of services 

that physicians provide to beneficiaries have been a principal cause of the 

instability of physician fee updates. Since the SGR system was 

implemented in 1998, volume and intensity growth has ranged from 

1.2 percent in 1999 to 6.1 percent in 2002. (See fig. 2.) It is uncertain how 

much physicians’ discretion in the provision of their services contributes 

to the fluctuation in volume and intensity growth. 

 43CMS is required to publish the final conversion factor update for the upcoming calendar 

year by November 1. In the period prior to publishing the final update—a period that 

usually runs from August to October—CMS collects public comments in response to its 

proposed rule. It is at this time that physician groups are able to submit formal comments 

on CMS’s estimate of this factor. 

Variable Growth in 

Provision of Physician 

Services and Certain 

SGR System Design 

Elements Reduce 

Stability and 

Predictability of 

Physician Fee 

Updates 

Fluctuating Volume and 

Intensity Growth Is a 

Principal Cause of 

Instability of Fee Updates 
Page 22 GAO-05-85 Medicare Physician Payments 

Several studies have found that physicians respond to reduced fee updates 

by increasing the volume and intensity of services they provide to help 

maintain their total Medicare income.44 In estimating future spending and 

fee updates, both CMS and CBO assume that physicians will compensate, 

through volume and intensity increases, for a portion of any fee 

reductions. Consequently, both CMS and CBO project that for example, a 

1 percent fee reduction would cause aggregate spending to fall by less 

than 1 percent. In addition, CBO assumes that physicians will respond to 

fee increases by reducing volume and intensity. 

Physician groups contend that volume and intensity growth is a necessary 

response to increased demand caused by factors outside of physicians’ 

control as noted earlier, such as the declining health status of Medicare 

beneficiaries, Medicare coverage of new benefits, and changing medical 

technology and practices that encourage beneficiaries to schedule more 

appointments with physicians. As long as the contributing factors are not 

fully understood and predictable, unexpected volume and intensity 

fluctuations will result in uncertain fee updates year to year. 

The cumulative nature of the SGR system’s spending targets increases the 

potential fluctuation of physician fee updates, as the system requires that 

excess spending in any year be recouped in future years. Conceptually, 

this means that if actual spending has exceeded the SGR system targets, 

fee updates in future years must be lowered sufficiently to both offset the 

accumulated excess spending and slow expected spending for the coming 

year. Conversely, the system also requires that if spending were to fall 

short of the targets, fees would need to be increased so that future 

spending would be raised to align with target spending. 

Estimation of the 2005 fee update illustrates how excess spending that is 

not addressed affects future fee updates. In 2004 actual expenditures 

under the SGR system are estimated to be $83.4 billion, whereas target 

expenditures for the same year will be $77.3 billion. As a result, 2005 fee 

updates need to offset a $6.1 billion deficit from excess spending in 2004 

(plus accumulated excess spending of $5.8 billion in past years) and to 

 44CMS OACT has analyzed the results of these studies. See Office of the Actuary, Centers 

for Medicare & Medicaid Services, “Physician Volume and Intensity Response 

Memorandum,” August 13, 1998. 

SGR System’s Cumulative 

Targets Increase Potential 

Fluctuation of Physician 

Fee Updates 
Page 23 GAO-05-85 Medicare Physician Payments 

realign the year’s expected spending with target spending.45 Because the 

SGR system is designed to offset accumulated excess spending over a 

period of years, the deficit for 2004 and preceding years will reduce fee 

updates for multiple years. 

According to projections made by CMS OACT, maximum fee reductions 

will be in effect from 2006 through 2012. Fee updates will be positive in 

2014. (See fig. 3.) 

 45The 2005 fee update will be higher than allowed by the SGR system owing to an MMA 

minimum update of 1.5 percent. 
Page 24 GAO-05-85 Medicare Physician Payments 

Figure 3: Projected MEI and Fee Update under Current Law 

Note: Projections are as of July 2004. 

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Percentage

Source: CMS OACT.

-6

-4

-2

0

2

4

6
Page 25 GAO-05-85 Medicare Physician Payments 

The stability of fee updates under the SGR system depends, in part, on 

CMS’s ability to accurately estimate current spending and annual changes 

in the four factors that determine the sustainable growth rate: input prices, 

FFS enrollment, the 10-year moving average of real GDP per capita, and 

expenditures due to changes in laws and regulations. If reality proves 

different from these estimates, then the estimates are revised to 

incorporate more complete data, thereby contributing to the year to year 

fluctuation in fee updates. For example, in the fall of 2004, when CMS 

determines the update for 2005, the agency must estimate cumulative 

expenditures through the end of 2004 based on incomplete data. If actual 

spending is underestimated, the 2005 update will be set higher than it 

would have been set without the estimation error. This underestimate will 

be corrected, because in setting a fee update, the SGR system requires 

CMS to revise the spending estimates and the sustainable growth rates for 

the 2 preceding years. Therefore, when more complete spending data 

become available, the agency will revise its previous cumulative spending 

estimates through 2004 and reduce future fee updates relative to what they 

would have been if spending had not been underestimated. 

Uncertainty in long-term projections of FFS enrollment, in conjunction 

with the cumulative nature of the SGR system’s targets, makes long-term 

estimates of fee updates less predictable. Because the SGR system offsets 

accumulated excess spending by reducing the update for the fee paid for 

each service, a decline in the number of services results in less spending 

being offset. For example, currently, CMS estimates that over the next 

10 years, enrollment in FFS will decline as more beneficiaries join private 

plans. CMS projects that the percentage of Medicare beneficiaries in the 

FFS program will decline from about 85 percent in 2005 to 67 percent in 

2014. With fewer beneficiaries in FFS, fewer services would be provided. 

Therefore, the SGR system would call for more severe update reductions 

to offset accumulated excess spending relative to what would have 

occurred if FFS enrollment had remained stable. In contrast, CBO 

projected that FFS enrollment will increase over the 10-year period at 

about the same rate as the increase in overall Medicare enrollment.46 With 

more beneficiaries in FFS, and thus more services provided, update 

reductions would not need to be as severe to offset accumulated excess 

spending. Therefore, under CBO’s FFS projection, positive fee updates 

would be expected to return sooner than under CMS’s FFS projection. 

 46In its March 2004 baseline CBO projected the percentage of beneficiaries in FFS would 

remain relatively flat at about 86 percent to 87 percent over the 2005–2014 period. 

Uncertainty in Estimates 

of Underlying SGR System 

Data Elements Decreases 

Stability and Predictability 

of Physician Fee Updates 
Page 26 GAO-05-85 Medicare Physician Payments 

MMA changed the SGR system formula to use a 10-year moving average of 

real GDP per capita, which is currently 2.3 percent. As noted in our 2002 

testimony, this change will eliminate much of the cyclical variation in this 

factor that occurred in previous years under the formula when the SGR 

system target was tied to the yearly change in real GDP per capita.47 (See 

fig. 4.) Including a more stable measure of economic growth in the SGR 

system formula will help increase the stability of fee updates. 

Figure 4: Annual Percentage Change in Real GDP Per Capita and 10-Year Moving Average Change in Real GDP Per Capita, 

1992–2003 

 47GAO, Medicare Physician Payments: Spending Targets Encourage Fiscal Discipline, 

Modifications Could Stabilize Fees, GAO-02-441T (Washington, D.C.: Feb. 14, 2002). 

Switching to the 10-Year 

Moving Average of Real 

GDP Per Capita Will 

Increase Stability and 

Predictability 

-1

0

1

2

3

4

5

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Percentage

Source: GAO’s analysis of data from the Bureau of Economic Analysis and the U.S. Census Bureau.

Annual change in real GDP per capita

Annual change in the 10-year moving average of real GDP per capita
Page 27 GAO-05-85 Medicare Physician Payments 

The projected sustained period of declining physician fees and the 

potential for beneficiaries’ access to physician services to be disrupted 

have heightened interest in alternatives for the current SGR system. In 

general, potential alternatives we identified cluster around two 

approaches. One approach would end the use of spending targets as a 

method for updating physician fees and encouraging fiscal discipline. The 

other approach would retain spending targets but modify the current SGR 

system to address perceived shortcomings. These modifications could 

include one or more of the following options: removing the Part B 

prescription drug expenditures that are currently counted in the SGR 

system; resetting the targets and not requiring the system to recoup 

previous excess spending; using annual, rather than cumulative, targets; 

raising the allowance for increased spending due to volume and intensity 

growth; and permitting some flexibility in setting the volume and intensity 

allowance. 

The alternatives discussed in this section—intended to be illustrative—

would all increase fees and thus aggregate spending—both government 

outlays and beneficiary cost sharing—for physician services relative to 

projected spending under current law.48 Most changes would require new 

legislation; one exception is the removal of Part B prescription drugs from 

the spending targets, which could be done administratively. We used CMS 

OACT’s projections to provide a sense of the magnitude of the effect that 

potential alternatives might have on physician fee updates, aggregate 

spending for physician services, and real spending for physician fee 

schedule services per beneficiary (indicating a level of services 

beneficiaries receive excluding prescription drugs and other non-feeschedule services, such as laboratory tests).49, 50 To simplify comparisons 

among the discussed alternatives and current law, all of the projections 

 48The projection under current law, which is used as a comparison to projections under 

various options, assumes that the fee updates determined by the SGR system will not be 

altered by any legislative action. However, many parties, such as the Medicare Trustees, 

believe it is unlikely that the projected negative fee updates will be allowed to take effect. 

49The projections are included to aid comparisons among the various options and are not 

intended to serve as predictions for what would occur if the SGR system was replaced or 

modified. In addition, there is a degree of uncertainty surrounding any projection and that 

uncertainty tends to increase with the number of years for which the projection is made. 

50For some of these options we present, CBO has developed budget scores, which are 

specific cost estimates that include only federal expenditures and exclude spending from 

other sources, such as beneficiary cost sharing. When available, we present CBO’s cost 

estimates for the options. 

Alternatives for 

Updating Physician 

Fees Would Eliminate 

Spending Targets or 

Revise Current SGR 

System 
Page 28 GAO-05-85 Medicare Physician Payments 

use the same assumptions regarding volume and intensity growth for 

physician services and future FFS enrollment.51

In its March 2001 report to the Congress, MedPAC recommended 

eliminating the SGR system of spending targets and replacing it with an 

approach that would base annual fee updates on changes in the cost of 

efficiently providing care.52 Under this approach, efforts to control 

aggregate spending would be separate from the mechanism used to update 

fees. The advantage of eliminating spending targets would be greater fee 

update stability. However, CMS OACT estimates that this approach, 

compared with the current law projection, would result in cumulative 

expenditures that are 22 percent greater over a 10-year period. 

MedPAC reported that its recommendation could be implemented, in part, 

by basing the update on forecast changes in MEI. It suggested that other 

adjustments to the update might be necessary, for example, to ensure 

overall payment adequacy or correct for previous MEI forecast errors. In 

subsequent annual reports to the Congress, MedPAC has continued to 

recommend a physician fee update based on MEI.53 In its March 2004 

report, for example, MedPAC stated that current Medicare payments for 

physician services were adequate and recommended an update of 

approximately 2.6 percent for 2005 to “help maintain physician willingness 

and ability to furnish services to Medicare beneficiaries.”54 MedPAC’s 

recommendation contrasts with the 1.5 percent minimum update provided 

for by MMA and the negative 3.6 percent update specified by the SGR 

system. In 2004 testimony, MedPAC stated that fee updates for physician 

services should not be automatic, but should be informed by changes in 

beneficiaries’ access to services, the quality of services provided, the 

appropriateness of cost increases, and other factors. 

 51Volume and intensity growth for physician services alone is projected to be 3 percent per 

year. Overall volume and intensity growth—that is, including outpatient prescription drugs 

and other services included under the SGR system—is projected at about 4 percent per 

year. 

52Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment 

Policy (Washington, D.C.: March 2001). 

53Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment 

Policy (Washington, D.C.: March 2002, 2003, and 2004). 

54Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment 

Policy (Washington, D.C.: March 2004). 

Eliminate Spending 

Targets, Base Fee Updates 

on Physician Cost 

Increases 
Page 29 GAO-05-85 Medicare Physician Payments 

Basing the update on MEI would result in positive and relatively stable fee 

updates. (See fig. 5.) According to CMS OACT simulations, such an 

approach would likely produce fee updates that ranged from 2.1 percent to 

2.4 percent over the period from 2006 through 2014. Because physician 

fees would increase each year during the entire period, rather than 

decreasing each year until positive updates returned in 2014 as they would 

under the current SGR system, Medicare spending for physician services 

would rise. For the 10-year period from 2005 through 2014, CMS OACT 

estimates that this approach would result in cumulative expenditures that 

are 22 percent greater than projected under current law.55 (See fig. 6.) CMS 

OACT projects that under current law the net present value of total 

Medicare spending (both federal and beneficiary) over the next 75 years 

on all Part B services will be $16.9 trillion. If physician fee updates are 

based on the change in MEI, CMS OACT estimates that the net present 

value of total Medicare spending (both federal and beneficiary) over the 

next 75 years on Part B services would equal $19.1 trillion. Real spending 

per beneficiary would increase from $2,157 in 2005 to $2,802 in 2014, 

compared with real spending per beneficiary under current law, which 

would decrease to $1,774 in 2014. (See fig. 7.) 

 55In May 2004 testimony before the Subcommittee on Health, House Committee on Energy 

and Commerce, CBO estimated that if this option went into effect in 2005, it would raise 

net federal mandatory outlays by about $95 billion over the 2005–2014 period. CBO’s 

estimates differ from those of CMS OACT in that CBO’s estimates exclude beneficiary cost 

sharing and are based on different underlying assumptions about the various factors that 

affect the SGR system. 
Page 30 GAO-05-85 Medicare Physician Payments 

Figure 5: Projected MEI and Fee Updates under Current Law and under Option of Eliminating Spending Targets and Tying Fee 

Updates to MEI 

Note: Projections are as of July 2004. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.

Fee updates would equal MEI under option
Page 31 GAO-05-85 Medicare Physician Payments 

Figure 6: Projected Aggregate Spending under Current Law and under Option of Eliminating Spending Targets and Tying Fee 

Updates to MEI 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. 

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

22% greater 

cumulative spending
Page 32 GAO-05-85 Medicare Physician Payments 

Figure 7: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Option of Eliminating Spending Targets and Tying Fee Updates to MEI 

Notes: Projections are as of July 2004. Real spending per beneficiary for physician fee schedule 

services includes both government outlays and beneficiary cost sharing and is adjusted by MEI. 

Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part B 

outpatient drugs—is excluded. 

Although MedPAC’s recommended update approach would limit annual 

increases in the price Medicare pays for each service, the approach does 

not contain an explicit mechanism for constraining aggregate spending 

resulting from increases in the volume and intensity of services physician 

provide. In 2001, when MedPAC first recommended eliminating the SGR 

system, it stated that volume and intensity increases had not been a major 

concern since 1992. It added, however, that if volume and intensity growth 

reemerged as a concern, Medicare might address the problem by trying to 

achieve appropriate use of services through outcomes and effectiveness 

research, disseminating practice guidelines and other tools for applying 

this research, and developing evidence-based measures to assess the 

application of the research findings. 

Since MedPAC’s 2001 report, volume and intensity growth has increased 

considerably. (See fig. 2.) Subsequent MedPAC reports and testimony have 

discussed trends in the use of physician services and have identified 

particular services—such as diagnostic imaging—that are growing rapidly, 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 33 GAO-05-85 Medicare Physician Payments 

but the reports have not made recommendations for addressing volume 

and intensity growth. However, in 2004 testimony, MedPAC stated that it 

planned to study the efficacy of private insurers’ strategies for controlling 

spending for high-growth services and whether Medicare might be able to 

emulate them.56

Another approach for addressing the perceived shortcoming of the current 

SGR system would retain spending targets but modify one or more 

elements of the system. The key distinction of this approach, in contrast to 

basing updates on MEI, is that fiscal controls designed to moderate 

spending would continue to be integral to the system used to update fees. 

The advantage of retaining spending targets as part of the system for 

updating fees is that the system would automatically work to moderate 

spending if volume and intensity growth began to increase above 

allowable rates. Although many options are possible under this approach, 

six are discussed below. All six would produce fee updates that are higher 

during the 10-year period from 2005 through 2014 than those projected 

under current law but would also result in higher aggregate spending 

ranging from 4 percent to 23 percent more, depending on the modification. 

 56Medicare Payment Advisory Commission, Payment for Physician Services in the 

Medicare Program, testimony before the Subcommittee on Health, House Committee on 

Energy and Commerce (May 5, 2004). 

Retain Spending Targets, 

Modify Current SGR 

System 
Page 34 GAO-05-85 Medicare Physician Payments 

The Secretary of HHS could, under current authority, consider excluding 

Part B drugs from the definition of services furnished incident to physician 

services for purposes of the SGR system. As discussed earlier, 

expenditures for these drugs have been growing rapidly, which, in turn, 

has put downward pressure on the fees paid to Medicare physicians. 

However, according to CMS OACT simulations, removing Part B drugs 

from the SGR system beginning in 2005 would not prevent several years of 

fee declines and would not decrease the volatility in the updates. Fees 

would decline by about 5 percent per year from 2006 through 2010. (See 

fig. 8.) There would be a positive update in 2011—3 years earlier than is 

projected under current law. From 2012 through 2014, fees would increase 

by approximately 5 percent per year. CMS OACT estimates that removing 

Part B drugs from the SGR system would result in cumulative spending 

over the 10-year period from 2005 through 2014 that is 5 percent higher 

than is projected under current law.57 (See fig. 9.) Real spending per 

beneficiary would increase from $2,157 in 2005 to $2,240 in 2014, 

compared with real spending per beneficiary under current law, which 

would decrease to $1,774 in 2014. (See fig. 10.) 

 57In May 2004 testimony, CBO estimated that this option would raise net federal mandatory 

outlays by about $15 billion through 2014. CBO’s estimates differ from those of CMS OACT 

in that CBO’s estimates exclude beneficiary cost sharing and are based on different 

underlying assumptions about the various factors that affect the SGR system. 

Remove Part B Drugs from the 

SGR System 
Page 35 GAO-05-85 Medicare Physician Payments 

Figure 8: Projected MEI and Fee Updates under Current Law and under Option of Not Including Any Part B Drugs in the SGR 

System Beginning in 2005 

Notes: Projections are as of July 2004. Projected updates under the option will be equal to projected 

updates under current law through 2010. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 36 GAO-05-85 Medicare Physician Payments 

Figure 9: Projected Aggregate Spending under Current Law and under Option of Not Including Any Part B Drugs in the SGR 

System Beginning in 2005 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. The line depicting the projection 

under current law includes all spending included in the SGR system. Under the option of not including 

any Part B drugs in the SGR system, spending for Part B drugs will occur even though it is not 

included in the SGR formula. To ensure comparability between the two projections, we included 

aggregate spending for both remaining SGR-covered services and Part B drugs in the line depicting 

the projection under the option. 

0

50

100

150

200

250

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

}

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

5% higher 

cumulative spending
Page 37 GAO-05-85 Medicare Physician Payments 

Figure 10: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Option of Not Including Any Part B Drugs in the SGR System Beginning in 2005 

Notes: Projections are as of July 2004. Real spending per beneficiary for physician fee schedule 

services includes both government outlays and beneficiary cost sharing and is adjusted by MEI. 

Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part B 

outpatient drugs—is excluded. 

In 2002, we testified that physician spending targets and fees may need to 

be adjusted periodically as health needs change, technology improves, or 

health care markets evolve.58 Such adjustments could involve specifying a 

new base year from which to set future targets. Currently, the SGR system 

uses spending from 1996, trended forward by the sustainable growth rate 

computed for each year, to determine allowable spending. 

MMA avoided a fee decline in 2004, and a projected fee decline for 2005, 

by stipulating a minimum update of 1.5 percent in each of those 2 years, 

but the law did not similarly adjust the spending targets to account for the 

additional spending that would result from the minimum update. 

Consequently, under the SGR system the additional MMA spending and 

 58GAO-02-441T. 

Base Future SGR System 

Targets on Actual Spending 

from a Recent Year 

0

500

1,000

1,500

2,000

2,500

3,000

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Page 38 GAO-05-85 Medicare Physician Payments 

other accumulated excess spending will have to be recouped through fee 

reductions beginning in 2006. If policymakers believe that the resulting 

negative fee updates are inappropriately low, one solution is to use actual 

spending from a recent year as a basis for setting future SGR system 

targets. Using such an approach, policymakers could essentially forgive 

the accumulated excess spending attributable to MMA and other factors. 

The effect would be to increase future updates and, as with other 

alternatives presented here, overall spending. 

According to CMS OACT simulations, forgiving the accumulated excess 

spending as of 2005—that is, resetting the cumulative spending target so 

that it equals cumulative actual spending—would raise fees in 2006. (See 

fig. 11.) However, because volume and intensity growth is projected to 

exceed the SGR system’s allowance for such growth, negative updates 

would return beginning in 2008 and continue through 2013. Resulting 

cumulative spending over the 10-year period from 2005 through 2014 

would be 13 percent higher than is projected under current law. (See fig. 

12.) Real spending per beneficiary for physician services would grow from 

$2,157 in 2005 to $2,334 in 2014, compared with real spending per 

beneficiary under current law, which would decrease to $1,774 in 2014. 

(See fig. 13.) 
Page 39 GAO-05-85 Medicare Physician Payments 

Figure 11: Projected MEI and Fee Updates under Current Law and under Option of Resetting the Cumulative Spending Target 

Equal to Cumulative Actual Spending as of 2006 

Notes: Projections are as of July 2004. Projection under option of eliminating accumulated excess 

spending assumes that the physician fee update would equal MEI in 2006. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 40 GAO-05-85 Medicare Physician Payments 

Figure 12: Projected Aggregate Spending under Current Law and under Option of Resetting the Cumulative Spending Target 

Equal to Cumulative Actual Spending as of 2006 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. Projection under option of 

eliminating accumulated excess spending assumes that the physician fee update would equal MEI in 

2006. 

Projected spending under option

Projected spending under current law

Source: GAO analysis of data from CMS OACT.

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Dollars in billions

} 13% higher 

cumulative spending
Page 41 GAO-05-85 Medicare Physician Payments 

Figure 13: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Option of Resetting the Cumulative Spending Target Equal to Cumulative Actual Spending as of 2006 

Notes: Projections are as of July 2004. Projection under option of eliminating accumulated excess 

spending assumes that the physician fee update would equal MEI in 2006. Real spending per 

beneficiary for physician fee schedule services includes both government outlays and beneficiary cost 

sharing and is adjusted by MEI. Spending for non-fee-schedule services—laboratory services and 

certain Medicare-covered Part B outpatient drugs—is excluded. 

One option for reducing the fluctuation in fee updates would be to 

eliminate the cumulative aspect of the SGR system’s spending targets and 

return to a system of annual targets, as was used under MVPS. As 

previously discussed, the cumulative aspect of the SGR system’s spending 

targets—although rigorous as a budgetary tool—can produce updates that 

swing from the maximum fee reduction to the maximum fee increase. In 

contrast, MVPS’s annual spending target approach traded off some fiscal 

control for increased fee stability. The MVPS update for a year depended, 

in part, on whether actual spending 2 years earlier had exceeded or fallen 

short of the annual spending target for that year. For example, the MVPS 

Eliminate the Cumulative 

Aspect of Spending Targets 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 42 GAO-05-85 Medicare Physician Payments 

update for 1996, which was determined in 1995, was affected by the 

relationship between actual and target spending in 1994. In principle, 

under MVPS excess spending from a single year, up to a limit specified by 

its update formula, was required to be recouped. Excess spending that 

could not be made up within those limits would, in essence, be forgiven.59

According to CMS OACT simulations, eliminating the cumulative aspect of 

the SGR system would result in fee updates that vary less than projected 

updates under current law. For example, under an MVPS-like system of 

annual targets, from 2006 through 2014, the largest negative update would 

be negative 0.6 percent instead of negative 5.0 percent under current law, 

and the largest positive update would be 0.9 percent instead of 3.9 percent. 

(See fig. 14.) Fees would be essentially flat over the period, instead of 

swinging from large fee declines to fee increases as they are expected to 

do under the SGR system. Relative to spending projected under current 

law, under an MVPS-like system total spending would be greater each year 

from 2006 through 2014. CMS OACT estimates that cumulative 

expenditures over the 10-year period from 2005 through 2014 would be 

15 percent higher than under current law. (See fig. 15.) Real spending per 

beneficiary would increase from $2,157 in 2005 to $2,442 in 2014, 

compared with real spending per beneficiary under current law, which 

would decrease to $1,774 in 2014. (See fig. 16.) 

 59Both the SGR and MVPS systems provided for updates that could exceed MEI if spending 

fell below their respective targets. 
Page 43 GAO-05-85 Medicare Physician Payments 

Figure 14: Projected MEI and Fee Updates under Current Law and under Option of Eliminating the Cumulative Aspect of 

Spending Targets 

Note: Projections are as of July 2004. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 44 GAO-05-85 Medicare Physician Payments 

Figure 15: Projected Aggregate Spending under Current Law and under Option of Eliminating the Cumulative Aspect of 

Spending Targets 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. 

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

15% higher 

cumulative spending
Page 45 GAO-05-85 Medicare Physician Payments 

Figure 16: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Option of Eliminating the Cumulative Aspect of Spending Targets 

Notes: Projections are as of July 2004. Real spending per beneficiary for physician fee schedule 

services includes both government outlays and beneficiary cost sharing and is adjusted by MEI. 

Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part B 

outpatient drugs—is excluded. 

If policymakers agree with physician groups that the current SGR system’s 

allowance for volume and intensity growth does not adequately account 

for appropriate spending increases that result from technological 

innovation or changes in medical practice, the allowance could be 

increased by some factor above the percentage change in real GDP per 

capita. As stated earlier, the current SGR system’s allowance for volume 

and intensity growth is approximately 2.3 percent per year—the 10-year 

moving average in real GDP per capita—while projected volume and 

intensity growth is higher—about 3 percent per year for physician services 

alone, and about 4 percent per year including Part B drugs. To offset the 

increased spending associated with the higher volume and intensity 

growth, the SGR system will reduce updates below the increase in MEI. In 

its 1997 report to the Congress, PPRC recommended adopting an 

Modify Allowance for Volume 

and Intensity Growth 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 46 GAO-05-85 Medicare Physician Payments 

allowance equal to real GDP per capita plus 1 or 2 percentage points “to 

allow for advancements in medical capabilities.”60

According to CMS OACT simulations, increasing the allowance for volume 

and intensity growth to GDP plus 1 percentage point would likely produce 

positive fee updates beginning in 2012—2 years earlier than is projected 

under current law. (See fig. 17.) Because fee updates would be on average 

greater than under current law during the 10-year period from 2005 

through 2014, Medicare spending for physician services would rise. CMS 

OACT estimates that cumulative expenditures over the 10-year period 

would increase by 4 percent more than under current law.61 (See fig. 18.) 

Real spending per beneficiary would change little from $2,157 in 2005 to 

$2,158 in 2014, compared with real spending per beneficiary under current 

law, which would decrease to $1,774 in 2014. (See fig. 19.) 

 60Physician Payment Review Commission, 1997 Annual Report to Congress (Washington, 

D.C.: 1997), 248. 

61In May 2004 testimony, CBO estimated that this option would raise net federal mandatory 

outlays by about $35 billion over the 2008–2014 period. CBO’s estimates differ from those 

of CMS OACT in that CBO’s estimates exclude beneficiary cost sharing and are based on 

different underlying assumptions about the various factors that affect the SGR system. 
Page 47 GAO-05-85 Medicare Physician Payments 

Figure 17: Projected MEI and Fee Updates under Current Law and under Option of Increasing Volume and Intensity Growth 

Allowance to GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Projected updates under the option will be equal to projected 

updates under current law through 2010. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 48 GAO-05-85 Medicare Physician Payments 

Figure 18: Projected Aggregate Spending under Current Law and under Option of Increasing Volume and Intensity Growth 

Allowance to GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. 

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

} 4% higher 

cumulative spending
Page 49 GAO-05-85 Medicare Physician Payments 

Figure 19: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Option of Increasing Volume and Intensity Growth Allowance to GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Real spending per beneficiary for physician fee schedule 

services includes both government outlays and beneficiary cost sharing and is adjusted by MEI. 

Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part B 

outpatient drugs—is excluded. 

Congress could also modify the SGR system’s allowance for volume and 

intensity growth by providing flexibility similar to that afforded by the 

MVPS system. Although that earlier system of spending targets specified a 

default volume and intensity increase, it also allowed the HHS Secretary to 

recommend a different increase if changes in medical technology, 

beneficiary access to physician services, or other factors warranted an 

allowance that was higher or lower than the default increase. 

Two alternatives illustrate the effects of combining individual options. For 

example, together the Congress and CMS could modify the SGR system by 

removing Part B drugs, resetting the base, and increasing allowed volume 

and intensity growth to GDP plus 1 percentage point.62 According to CMS 

 62We use GDP plus 1 percentage point as the allowance for volume and intensity growth for 

illustrative purposes only. 

Combine Options 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 50 GAO-05-85 Medicare Physician Payments 

OACT simulations, this combination of options would result in positive 

updates ranging from 2.2 percent to 2.8 percent for the 2006–2014 period. 

(See fig. 20.) CMS OACT projects that the combined options would 

increase aggregate spending by 23 percent over the 10-year period (see fig. 

21.) and that real spending per beneficiary for physician services would 

increase from $2,157 to $2,866, compared with real spending per 

beneficiary under current law, which would decrease to $1,774 in 2014. 

(See fig. 22.) 
Page 51 GAO-05-85 Medicare Physician Payments 

Figure 20: Projected MEI and Fee Updates under Current Law and under Combination of Options of Resetting the Cumulative 

Spending Target Equal to Cumulative Actual Spending as of 2006, Not Including Any Part B Drugs in the SGR System 

Beginning in 2005, and Using GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Projection under combination of options of resetting the 

cumulative spending target equal to cumulative actual spending as of 2005, removing Part B drugs 

from the SGR system beginning in 2005, and using GDP plus 1 percentage point assumes that the 

physician fee update would equal MEI in 2006. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 52 GAO-05-85 Medicare Physician Payments 

Figure 21: Projected Aggregate Spending under Current Law and under Combination of Options of Resetting the Cumulative 

Spending Target Equal to Cumulative Actual Spending as of 2006, Not Including Any Part B Drugs in the SGR System 

Beginning in 2005, and Using GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. Projection under combination of 

options of resetting the cumulative spending target equal to cumulative actual spending as of 2005, 

not including any Part B drugs in the SGR system beginning in 2005, and using GDP plus 1 

percentage point assumes that the physician fee update would equal MEI in 2006. The line depicting 

the projection under current law includes all spending included in the SGR system. Under the option 

of not including any Part B drugs in the SGR system, spending for Part B drugs will occur even 

though it is not included in the SGR formula. To ensure comparability between the two projections, 

we included aggregate spending for both remaining SGR-covered services and Part B drugs in the 

line depicting the projection under the option. 

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

23 percent 

higher cumulative } spending
Page 53 GAO-05-85 Medicare Physician Payments 

Figure 22: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Combination of Options of Resetting the Cumulative Spending Target Equal to Cumulative Actual Spending as of 2006, Not 

Including Any Part B Drugs in the SGR System Beginning in 2005, and Using GDP Plus 1 Percentage Point 

Notes: Projections are as of July 2004. Projection under combination of options of resetting the 

cumulative spending target equal to cumulative actual spending as of 2005, removing Part B drugs 

from the SGR system beginning in 2005, and using GDP plus 1 percentage point assumes that the 

physician fee update would equal MEI in 2006. Real spending per beneficiary for physician fee 

schedule services includes both government outlays and beneficiary cost sharing and is adjusted by 

MEI. Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part 

B outpatient drugs—is excluded. 

Another example of combined options could involve removing Part B 

drugs and implementing an MVPS-like system of annual targets, but not 

increasing the volume and intensity allowance. CMS OACT simulations 

project that this combination would result in fee updates that range from 

0.8 percent to 1.3 percent over the period from 2006 through 2014. (See fig. 

23.) Over the 10-year period from 2005 through 2014, cumulative spending 

for physician services would exceed those projected under current law by 

18 percent. (See fig. 24.) Real spending per beneficiary for physician 

services would increase from $2,157 to $2,615, compared with real 

spending per beneficiary under current law, which would decrease to 

$1,774 in 2014. (See fig. 25.) 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 54 GAO-05-85 Medicare Physician Payments 

Figure 23: Projected MEI and Fee Updates under Current Law and under Combination of Options of Not Including Any Part B 

Drugs in the SGR System Beginning in 2005 and Eliminating the Cumulative Aspect of Spending Targets 

Note: Projections are as of July 2004. 

-6

-4

-2

0

2

4

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI

Projected fee update under current law

Projected fee update under option

Percentage

Source: CMS OACT.
Page 55 GAO-05-85 Medicare Physician Payments 

Figure 24: Projected Aggregate Spending under Current Law and under Combination of Options of Not Including Any Part B 

Drugs in the SGR System Beginning in 2005 and Eliminating the Cumulative Aspect of Spending Targets 

Notes: Projections are as of July 2004. Aggregate spending includes all expenditures for physician 

services—both government outlays and beneficiary cost sharing. The line depicting the projection 

under current law includes all spending included in the SGR system. Under the option of not including 

any Part B drugs in the SGR system, spending for Part B drugs will occur even though it is not 

included in the SGR formula. To ensure comparability between the two projections, we included 

aggregate spending for both remaining SGR-covered services and Part B drugs in the line depicting 

the projection under the option. 

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected spending under current law

Projected spending under option

Dollars in billions

Source: GAO analysis of data from CMS OACT.

18% higher 

cumulative spending
Page 56 GAO-05-85 Medicare Physician Payments 

Figure 25: Projected Real Spending for Physician Fee Schedule Services per FFS Beneficiary under Current Law and under 

Combination of Options of Not Including Any Part B Drugs in the SGR System Beginning in 2005 and Eliminating the 

Cumulative Aspect of Spending Targets 

Notes: Projections are as of July 2004. Real spending per beneficiary for physician fee schedule 

services includes both government outlays and beneficiary cost sharing and is adjusted by MEI. 

Spending for non-fee-schedule services—laboratory services and certain Medicare-covered Part B 

outpatient drugs—is excluded. 

Medicare faces the challenge of moderating the growth in spending for 

physician services while ensuring that physicians are paid fairly so that 

beneficiaries have appropriate access to their services. Under the current 

SGR system, fees are projected to fall by about 5 percent per year for the 

next several years. Total payments to physicians will continue to rise 

because of expected increases in volume and intensity. However, on a per 

capita basis, real spending per beneficiary will decline, raising concerns 

that a sustained period of falling fees could discourage some physicians 

from participating in the Medicare program and serving beneficiaries. 

These concerns have prompted policymakers to consider alternative 

approaches for updating physician fees. 

Concluding 

Observations 

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected real spending for physician services per FFS beneficiary under current law

Projected real spending for physician services per FFS beneficiary under option

Dollars

Source: GAO analysis of data from CMS OACT.
Page 57 GAO-05-85 Medicare Physician Payments 

One approach under consideration for solving the problem of declining 

fees is for Medicare to abandon the use of spending targets and separate 

the program’s attempts to control spending from its method for adjusting 

physician fees each year. This is the approach that has been recommended 

by MedPAC. Although projected future fee increases would be positive 

and relatively stable, eliminating spending targets would increase 

spending. The extent to which spending growth would be moderated 

would depend upon the efficacy of separate efforts to address growth in 

volume and intensity. 

Similarly, the other approach of retaining spending targets but modifying 

the SGR system to overcome its current perceived shortcomings, would 

also increase spending. These alternative approaches could also be 

augmented by separate efforts to moderate spending. Alternatives under 

this approach seek to preserve the fiscal discipline of spending targets 

while providing for reasonable fee updates. These alternative approaches 

could also be augmented by other efforts to moderate spending. To the 

extent that the growth in spending is moderated, physicians would benefit 

from an increase in fees that would be triggered under a spending target 

system. 

Almost any change to the SGR system is likely to increase Medicare 

spending above the amount that is currently projected. Either of the two 

broad types of approaches discussed above—replacing the SGR system 

and revising the SGR system—could be implemented in a way that would 

likely generate positive fee updates. Therefore, the choice between the 

two approaches under consideration may hinge on whether primary 

importance should be given to stable fee increases or to the need for fiscal 

discipline within the Medicare program. 

In written comments on a draft of this report, CMS agreed with our 

concluding observations that appropriately updating the physician 

payment rates requires a balance between adjusting physician fees in a 

stable and predictable manner and encouraging fiscal discipline with 

scarce Medicare resources. CMS expressed its commitment to ensuring 

that Medicare beneficiaries have access to high-quality health care and 

noted that achieving this goal requires paying physicians appropriately. 

Agency and Industry 

Comments and Our 

Evaluation 

Agency Comments 
Page 58 GAO-05-85 Medicare Physician Payments 

CMS mentioned several administrative actions it has taken to improve 

Medicare’s payments to physicians, including specific adjustments to MEI 

that have both made the index a more accurate representation of inflation 

in physician practice costs and resulted in higher payments to physicians. 

In addition, the agency committed to considering further administrative 

actions and discussed ongoing efforts to implement various provisions of 

MMA that may reduce adverse incentives in the current payment system, 

allow the program to pay for higher quality care, and uncover innovative 

methods to control spending growth in the future. We have reprinted 

CMS’s letter in appendix III. 

We obtained oral comments from officials representing the American 

Medical Association (AMA), the Medical Group Management Association 

(MGMA), the American College of Physicians (ACP), and the Alliance for 

Specialty Medicine (ASM). In discussing the draft report with these 

groups, their overall reaction was that the report was a good analysis of 

the problems with the SGR system; however, they raised a number of 

concerns about the draft report. The bulk of their comments focused on 

OACT’s estimates of aggregate spending on physician services, the SGR 

system’s use of MEI as a measure of input price inflation for physician 

services, and the draft’s discussion of physicians’ concerns about the SGR 

system. The rest of their comments pertained to either issues related to 

physician behavior or to topics outside the scope of our review. A 

summary of the physician groups’ comments and our evaluation is 

provided below. 

Representatives from all four groups commented on CMS OACT’s 

estimates illustrating each option’s additional aggregate spending over a 

10-year period relative to current law spending over the same period. The 

groups were confused by the difference between CMS OACT’s estimates 

and CBO’s budget impact estimates, which were available for some of the 

options. CBO’s budget scores—that is, cost estimates that show the impact 

of legislative changes on the federal budget—include only federal 

expenditures and exclude spending from other sources, such as 

beneficiary cost sharing. In contrast, CMS OACT’s aggregate spending 

estimates include both federal outlays and beneficiary cost sharing. 

Because any changes to the SGR system that result in increased spending 

would not only affect taxpayers but also Medicare beneficiaries (through 

increased cost sharing and part B premiums), we believe it is appropriate 

to include the estimated increase in aggregate spending. Nevertheless, 

because our focus is on the relative costliness of each option, we revised 

the draft to highlight the proportional difference between current law 

Industry Association 

Comments 
Page 59 GAO-05-85 Medicare Physician Payments 

spending and the spending estimated for each option. In addition, we now 

include CBO’s budget scores for each option, where available. 

All four physician groups also expressed concern that the draft report did 

not discuss the use of MEI as a measure of input price inflation for 

physician services. The groups contended that MEI does not contain 

sufficiently current data on physician practice costs, stating that it does 

not account for or keep pace with the cost of items such as information 

technology. Examining MEI and other indices included in the SGR system 

was outside the scope of our report. Moreover, in responding to public 

comments on a federal regulation, CMS stated that the various expense 

categories constituting MEI capture all practice expenses and are based on 

the most recent available data. 63

The physician groups commented that the projected payment reductions 

of 5 percent a year from 2006 through 2014 are unrealistically severe and 

that the draft report did not sufficiently emphasize the access problems 

that beneficiaries would experience in the event of these cuts. They 

further noted that the Congress has regularly made adjustments to the 

SGR system and would probably act again. We noted in the draft report 

that policymakers, physicians, and others are concerned about the impact 

that the projected fee reductions would have on beneficiary access to 

physician services, noting that the Medicare Trustees and other parties 

believe it is unlikely that the projected fee reductions will take place. 

Representatives from both ACP and ASM asserted that we should include 

a discussion about the effect of the spending targets on physician behavior 

and volume and intensity. They noted that evidence is lacking that directly 

correlates the introduction of both spending targets and the physician fee 

schedule in 1992 with the corresponding drop in volume and intensity in 

that year. They believe this reduction was likely caused by something 

other than the spending target, such as initiatives aimed at correctly 

coding claims for physician services. ACP stated that for the Congress to 

evaluate any alternatives, there must be a discussion of how the SGR 

system affects the volume and intensity of physician services. As noted in 

the draft report, we do not claim that spending targets and the fee 

schedule influenced individual behavior and reduced the volume and 

intensity of physician services in the early 1990s, we noted that PPRC 

claimed that a spending target system would provide a collective incentive 

 63See 68 Fed. Reg. 63196, 63239-45. 
Page 60 GAO-05-85 Medicare Physician Payments 

for physicians to develop practice guidelines and control unnecessary 

utilization. Further, in the draft report we described spending targets as a 

method for automatically imposing fiscal discipline, not as a tool to modify 

the behavior of individual physicians. 

Representatives from ACP further noted that while the draft report 

included a discussion of geographic variation in physician service use, it 

did not mention that the SGR system is a blunt instrument in that it applies 

nationally to all physicians. In a year in which fees are reduced, physicians 

in regions that could be characterized as low spending would receive the 

same fee reduction as physicians in higher-spending regions. We agree that 

the SGR system does not distinguish between physicians whose 

discretionary practice patterns result in higher Medicare spending and 

those physicians whose practice patterns do not. As we stated in the draft 

report, at the time PPRC recommended expenditure targets, it initially 

envisioned a national target that would apply to all physician services and 

later the evolution of separate targets that would apply to regions, 

categories of physician services, or both. 

The physician groups raised additional topics that were beyond the scope 

of our study. For example, AMA contended that Medicare’s new 

preventive benefits and government-sponsored health campaigns create a 

government-induced demand among beneficiaries for services that, in 

turn, could increase volume and intensity of service use. To date, studies 

have not been conducted on whether new benefits and federal health 

campaigns have directly affected Medicare beneficiaries’ use of physician 

services. Our report notes, however, that the SGR system’s allowance for 

volume and intensity growth, unlike that of the MVPS system, is inflexible 

and would not take such factors into account. ACP noted that increased 

spending on physician services may be appropriate, as it may result in 

other program savings, such as reduced spending for hospital care. 

Whether such savings have been or can be achieved would require 

research outside this study’s scope. 

We are sending copies of this report to the Secretary of Health and Human 

Services and interested congressional committees. We will also provide 

copies to others on request. In addition, this report is available at no 

charge on the GAO Web site at http://www.gao.gov. 
Page 61 GAO-05-85 Medicare Physician Payments 

If you or your staff have questions about this report, please contact me at 

(202) 512-7101 or James Cosgrove at (202) 512-7029. Other contributors to 

this report include Jessica Farb, Hannah Fein, and Jennifer Podulka. 

A. Bruce Steinwald 

Director, Health Care—Economic 

 and Payment Issues 
Page 62 GAO-05-85 Medicare Physician Payments 

List of Committees 

The Honorable Charles E. Grassley 

Chairman 

The Honorable Max Baucus 

Ranking Minority Member 

Committee on Finance 

United States Senate 

The Honorable Joe L. Barton 

Chairman 

The Honorable John D. Dingell 

Ranking Minority Member 

Committee on Energy and Commerce 

House of Representatives 

The Honorable William M. Thomas 

Chairman 

The Honorable Charles B. Rangel 

Ranking Minority Member 

Committee on Ways and Means 

House of Representatives 

The Honorable Michael Bilirakis 

Chairman 

The Honorable Sherrod Brown 

Ranking Minority Member 

Subcommittee on Health 

Committee on Energy and Commerce 

House of Representatives 

The Honorable Nancy L. Johnson 

Chairman 

The Honorable Pete Stark 

Ranking Minority Member 

Subcommittee on Health 

Committee on Ways and Means 

House of Representatives 
Appendix I: Calculation of the Performance 

Adjustment Factor 

Page 63 GAO-05-85 Medicare Physician Payments 

Each year, CMS follows a statutory formula to compute a performance 

adjustment factor (PAF) and determines whether the physician fee update 

should be adjusted relative to the percentage change in the Medicare 

Economic Index (MEI) and, if so, by how much. (See fig. 26.) The PAF 

takes into account the difference between actual and target expenditures. 

If spending has equaled the targets, the PAF is equal to 1 and the update 

will equal the percentage change in MEI. If spending has been below the 

targets, the PAF is greater than 1, thus increasing the update. If spending 

has been above the targets, the PAF is less than 1, thus reducing the 

update. The PAF is a blend of the relative difference between target and 

actual spending in the current year, accounting for 75 percent, and the 

relative cumulative difference in expenditures from April 1996 through the 

current year, accounting for 33 percent. The weights were developed by 

the Centers for Medicare & Medicaid Services’ (CMS) Office of the Actuary 

(OACT) and included in statute to minimize the volatility of both fee 

updates and the time required to align actual spending with the targets. 

Applying these weights causes the difference between cumulative actual 

expenditures and cumulative target expenditures to be adjusted over 

several years rather than during a single year. As a result, the fee update is 

less volatile than would be the case if the full adjustment were made in 

1 year. The PAF is subject to statutory limits and may not cause the fee 

update to be set at more than 3 percent above MEI or 7 percent below 

MEI. These limits may further increase the time necessary to align 

spending with targets. 

Figure 26: Formula Used to Determine the Performance Adjustment Factor in 2005 

Appendix I: Calculation of the Performance 

Adjustment Factor 

+

Actual2004

Target2004–Actual2004 PAF2005 = x 0.75

Actual2004x (1+SGR2005) 

Cumulative Target4/96-12/04 - Cumulative Actual4/96-12/04 x 0.33

Source: CMS OACT.
Appendix II: Corrections to Prior Estimates 

Caused the SGR System’s Cumulative Targets 

to Produce Negative Updates 

Page 64 GAO-05-85 Medicare Physician Payments 

Since the introduction of the fee schedule in 1992 through 2001, physicians 

generally experienced real increases in their fee updates—that is, fee 

updates increased more than the increase in the cost of providing 

physician services, as measured by MEI. Specifically, during that period, 

fee updates increased by 39.7 percent, whereas MEI increased by 

25.9 percent. In 2002, however, the sustainable growth rate (SGR) system 

reduced fees by 4.8 percent,1

 despite an estimated 2.6 percent increase in 

the costs of providing physician services. (See fig. 27.) 

 1

Some annual fee updates are adjusted for additional factors. For example, a budget 

neutrality adjustment is used to account for changes in the calculations used to determine 

the amount of resources associated with physician services. In 2002, CMS reduced the 

update by an additional 0.64 percent resulting in a total fee decline of 5.4 percent. 

Appendix II: Corrections to Prior Estimates 

Caused the SGR System’s Cumulative Targets 

to Produce Negative Updates 
Appendix II: Corrections to Prior Estimates 

Caused the SGR System’s Cumulative Targets 

to Produce Negative Updates 

Page 65 GAO-05-85 Medicare Physician Payments 

Figure 27: Percentage Change in MEI, SGR Fee Schedule Update, and Medicare Physician Services Spending per Beneficiary, 

1998–2005 

Notes: Spending per beneficiary represents Medicare spending for beneficiaries in the traditional FFS 

program, net of beneficiary cost sharing. Spending for end-stage renal disease patients is not 

included. The physician fee schedule update figures shown do not reflect additional required 

adjustments, such as those for legislated changes and for budget neutrality. 

a

The 1.7 percent fee update went into effect in March 2003. 

b

The physician fee updates of 1.5 percent for 2004 and 2005 were specified by the Medicare 

Prescription Drug, Improvement, and Modernization Act of 2003. 

In 2002, corrections to prior estimation errors caused the SGR system’s 

cumulative targets to begin producing negative updates. The SGR system 

reduced fees in 2002 because estimated spending for physician services—

cumulative since 1996—exceeded the target by about $8.9 billion, or 

13 percent of projected 2002 spending. In part, the fee reduction occurred 

because CMS revised upward its estimates of previous years’ actual 

2.2 2.3 2.4 2.0

2.6

3.0 2.9 2.7 2.3 2.3

5.5

4.8

-4.8

1.7 1.5 1.5

4.9

4.0

9.9 10.1

1.9

6.3

7.1

4.7

-6

-4

-2

0

2

4

6

8

10

12

1998 1999 2000 2001 2002 2003a 2004b 2005b

MEI

Physician fee update

Spending per beneficiary

Source: GAO analysis of data from the Boards of Trustees of the Federal HI and SMI Trust Funds.

Percentage
Appendix II: Corrections to Prior Estimates 

Caused the SGR System’s Cumulative Targets 

to Produce Negative Updates 

Page 66 GAO-05-85 Medicare Physician Payments 

spending. Specifically, CMS found that its previous estimates had omitted 

a portion of actual spending for 1998, 1999, and 2000. In addition, in 2002 

CMS lowered the 2 previous years’ spending targets based on revised gross 

domestic product (GDP) data from the Department of Commerce. Based 

on the new higher spending estimates and lower targets, CMS determined 

that fees had been too high in 2000 and 2001. In setting the 2002 physician 

fees, the SGR system reduced fees to recoup previous excess spending. 

The update would have been about negative 9 percent if the SGR system 

had not limited its decrease to 7 percent below MEI. Because the previous 

overpayments were not fully recouped in 2002, and because of volume and 

intensity increases, by 2003, physicians were facing several more years of 

fee reductions to bring cumulative Medicare spending on physician 

services in line with cumulative targets. 

Despite its recognition of errors, CMS had determined that its authority to 

revise previous spending targets was limited. In 2002, CMS noted that the 

1998 and 1999 spending targets had been based on estimated growth rates 

for beneficiary FFS enrollment and real GDP per capita; actual experience 

had shown these growth rates to be too low. If the estimates could have 

been revised, the targets for those and subsequent years would have been 

increased. However, at the time that CMS acknowledged these errors, the 

agency concluded that it was not allowed to revise these estimates.2

Without such revisions, the cumulative spending targets remained lower 

than if errors had not been made. 

In late 2002, the estimate of the sustainable growth rate called for a 

negative 4.4 percent fee update in 2003. With the passage of the 

Consolidated Appropriations Resolution of 2003,3

 CMS determined that it 

was authorized to correct the 1998 and 1999 spending targets. Because 

SGR system targets are cumulative measures, these corrections resulted in 

an average 1.4 percent increase in physician fees for services for 2003.4

 2

BBRA required CMS to use the most recent data to revise the estimates used to set the 

spending targets, beginning with the estimated spending target in 2000. BBRA, §211(b)(5), 

113 Stat. 348-49. 

3

See Pub. L. No. 108-7, Div. N. Title IV, §402, 117 Stat. 11, 548. 

4

The law allowed for a recalculation of prior years’ spending targets, which resulted in a 1.7 

increase in fees applied to spending on physician services provided on or after March 1, 

2003. Over 12 months, the increase averaged 1.4 percent. The Congressional Budget Office 

estimated that this provision would increase the baseline for Medicare spending by $800 

million in 2003 and $53.4 billion over the 2003–2013 period. 
Appendix II: Corrections to Prior Estimates 

Caused the SGR System’s Cumulative Targets 

to Produce Negative Updates 

Page 67 GAO-05-85 Medicare Physician Payments 

The Medicare Prescription Drug, Improvement, and Modernization Act of 

2003 (MMA) averted additional fee reductions projected for 2004 and 2005 

by specifying an update to physician fees of no less than 1.5 percent for 

those 2 years.5

 The MMA increases replaced SGR system fee reductions of 

4.5 percent in 2004 and an estimated 3.6 percent in 2005. The fee increases 

will result in additional aggregate spending. Because MMA did not make 

corresponding revisions to the SGR system’s spending targets, its fee 

increases will require the SGR system to offset the additional spending by 

reducing fees beginning in 2006. In addition, recent growth in spending 

due to volume and intensity, which has been larger than SGR system 

targets allow, will further compound the excess spending that needs to be 

recouped. 

 5

See MMA, §601(a), 117 Stat. 2300. 
Appendix III: Comments from the Centers for 

Medicare & Medicaid Services 

Page 68 GAO-05-85 Medicare Physician Payments 

Appendix III: Comments from the Centers for 

Medicare & Medicaid Services 
Appendix III: Comments from the Centers for 

Medicare & Medicaid Services 

Page 69 GAO-05-85 Medicare Physician Payments (290342) 
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Presorted Standard

Postage & Fees Paid

GAO

Permit No. GI00