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Working Paper Series 

Congressional Budget Office 

Washington, D.C. 

THE SLOWDOWN IN MEDICARE SPENDING GROWTH 

Chapin White (e-mail: chapin.white@cbo.gov) 

Congressional Budget Office 

Washington, D.C. 

July 2006 

2006-08 

Working papers in this series are preliminary and are circulated to stimulate discussion 

and critical comment. These papers are not subject to CBO’s formal review and editing 

processes. The analysis and conclusions expressed in them are those of the author and 

should not be interpreted as those of the Congressional Budget Office. References in 

publications should be cleared with the author. Papers in this series can be obtained at 

www.cbo.gov (select "Publications"  "By Subject Area"  "Working and Technical 

Papers").
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Abstract 

The rate of so-called “excess” growth in Medicare spending per beneficiary has varied 

widely over the last several decades, and growth has slowed substantially in recent years. 

(Excess growth is defined as growth beyond the combination of the general rate of 

economic growth and the rate of change in the age composition among beneficiaries.) 

The annual rate of excess growth fell from 5.5 percent over the period from 1975 to 1983 

to 0.9 percent over the period from 1992 to 2003. Changes in provider payment policies 

might help explain the observed slowdown. Those changes include the implementation of 

a prospective payment system for short-stay hospitals, and, more recently, the imposition 

of mechanisms to control aggregate Medicare physician spending. Possible alternative 

explanations—increases in managed care enrollment, changes in Medicare cost sharing, 

and a system-wide spending slowdown—do not account for the slowdown in Medicare 

spending. The slowdown is of an economically important magnitude and deserves further 

study. 
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Introduction 

The federal Medicare program, which provides near-universal health insurance to the 

elderly and also covers some non-elderly disabled, has been expanded substantially with 

the recent addition of the Part D drug benefit. Furthermore, the number of beneficiaries, 

after growing fairly slowly for many years, will soon begin to grow rapidly with the 

retirement of the “baby-boom” generation. This confluence of events has prompted 

analysts to warn that Medicare will face a serious financing problem in the coming 

decades (Medicare Trustees, 2006; Congressional Budget Office, 2005; Fuchs, 1998). 

This paper examines and interprets long-term historical trends in Medicare spending. 

This backward-looking analysis will, it is hoped, contribute to a larger process of 

examining and interpreting basic facts about the program. 

The analysis first describes the historical rate of excess growth for overall Medicare 

spending and for spending in three major service categories: hospital care, physician and 

clinical services, and post-acute care. “Excess growth” is defined as growth beyond the 

rate attributable to the combination of the rate of general economic growth and the rate of 

change in the age composition among Medicare beneficiaries. The key findings are that 

historical trends in excess growth differ sharply by time period and by type of service, 

and that the rate of spending growth has slowed in each service category in recent years. 

The analysis then examines the evidence for and against alternative explanations for the 

recent spending slowdown. The timing and magnitude of the spending slowdown are not 
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consistent with three possible explanations: growth in managed care enrollment, changes 

in Medicare cost sharing, and a system-wide spending slowdown (i.e., a slowdown 

affecting both Medicare beneficiaries and non-Medicare beneficiaries). The Medicare 

spending slowdown is consistent with an alternative explanation deserving further 

analysis: the gradual tightening in Medicare’s provider payment policies. The analysis 

concludes by showing that the observed slowdown in the historical rate of excess 

Medicare spending growth is of an economically important magnitude. 

Data and Methods 

“Medicare spending,” as used here, refers to total government payments for Medicarecovered services, excluding beneficiary cost-sharing and third-party payments. Medicare 

spending represents the amount that must be financed by the federal government out of 

tax revenues, beneficiary premiums, or debt. This study calculates a per-beneficiary 

measure of real Medicare spending, which equals inflation-adjusted Medicare spending 

divided by the number of Medicare beneficiaries. To account for general price increases, 

Medicare spending is inflated to 2003 dollars, using the implicit gross domestic product 

(GDP) price deflator (Bureau of Economic Analysis, 2004). To calculate the effect of 

changes in the age composition among Medicare beneficiaries, the number of 

beneficiaries within each age group (under 65, 65 to 69, 70 to 74, 75 to 79, 80 to 84, and 

85 and up) is combined with estimates of spending per beneficiary within each age group. 

A detailed description of the methods and data used in this analysis is included in the 

Technical Appendix. 
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The analysis focuses on 1975 to 2003 (the most recent year for which data are available). 

Within that historical period, three sub-periods are analyzed: 1975 to 1983, 1983 to 1992 

and 1992 to 2003. Those breakpoints are chosen to coincide with the introduction of two 

major Medicare payment system changes: the inpatient hospital prospective payment 

system in 1983 and a mechanism to control aggregate spending on physician services in 

1992. The period prior to 1975 is excluded because Medicare spending growth during the 

early start-up years of the program was highly volatile and the eligible population was 

expanded substantially.1

 Medicare spending by service category is taken from the 

National Health Expenditures (NHE) data (Centers for Medicare and Medicaid Services, 

2005).2

 The resident population is taken from U.S. Census historical data through 2000 

and projections through 2003 (Hobbs and Stoops, 2002). 

This paper analyzes total Medicare spending on health care services and analyzes 

separate subtotals for the three major Medicare service categories: hospital care, 

physician and clinical services (which includes office-based and outpatient services), and 

post-acute care (which includes skilled nursing facility, SNF, and home health 

 

1

 From 1966 (the first year in which Medicare had any spending) to 1975, annual growth in real Medicare 

personal health care spending per beneficiary was 17.0 percent (author’s calculation). The periods with the 

highest growth were the start-up years from 1966 to 1969, and the years 1973 to 1975 when eligibility was 

expanded to the non-elderly disabled population. 

2

 In the National Health Expenditures database, spending on these hospital-based post-acute care providers 

are included in “Hospital Care.” Using unpublished data from the CMS Office of the Actuary, spending on 

these hospital-based post-acute care providers is estimated for each year, and that amount is shifted from 

the “Hospital Care” category to the “Home Health” and “Nursing Home” categories. A detailed description 

of that shifting is available from the author. 
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spending).3

 The three service categories are analyzed separately because substantially 

different policies regarding cost sharing and regulatory and payment policy have been in 

effect across these service categories. Therefore, spending trends are not necessarily 

expected to be similar across these different types of providers. 

This analysis does not measure Medicare spending on pharmaceuticals because outpatient 

pharmaceuticals were not part of the Medicare benefits package until recently. The issues 

relating to Medicare spending on pharmaceuticals have been examined in detail 

elsewhere (Newhouse, 2004; Congressional Budget Office, 2004a). 

Defining Excess Spending Growth 

“Excess” spending growth represents the difference between real growth in Medicare 

spending per beneficiary and the combination of two factors: the change in the age 

composition among Medicare beneficiaries, and the increase in real GDP per capita.4 The 

 

3

 The share of Medicare spending accounted for by hospital care, physician and clinical services, home 

health care, and skilled nursing facilities was nearly 100 percent in the 1960s and 1970s, and has since 

dropped to about 94 percent (author’s calculation). The remaining 6 percent includes durable medical 

equipment, other (non-physician) professional services, dental care, and non-durable medical products. 

4

 Excess spending growth can be calculated in several different ways, all of which yield exactly the same 

growth rates–a fact can generate some confusion. In its most general form, excess growth is calculated as a 

residual using the following identity: 1+the annual rate of growth in nominal Medicare spending = 

(1+general price growth) * (1+population growth) * (1+growth in Medicare beneficiaries as a fraction of 

the population) * (1+change in the age composition among Medicare beneficiaries) * (1+real growth in 

gross domestic product per capita) * (1+excess growth). Note that excess growth can also be calculated as 

follows, by reformulating the above identity: 1+real growth in Medicare spending per capita = (1+growth 

in Medicare beneficiaries as a fraction of the population) * (1+change in the age composition among 

Medicare beneficiaries) * (1+real growth in gross domestic product per capita) * (1+excess growth). Or, 

equivalently, excess growth can be calculated as follows: 1+real growth in Medicare spending per 

beneficiary = (1+change in the age composition among Medicare beneficiaries) * (1+real growth in gross 

domestic product per capita) * (1+excess growth). The key point is that exactly the same measure of excess 

growth can be calculated based either on growth in nominal Medicare spending (identity 1), real growth in 

Medicare spending per capita (identity 2), or real growth in Medicare spending per beneficiary (identity 3). 
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concept of excess growth provides a convenient summary statistic for historical trends, 

and has been used elsewhere as the basis for official projections of Medicare spending. 

Until recently, the Medicare Trustees generated their intermediate projection of long-term 

Medicare spending growth by assuming an average excess growth rate of 1 percent 

(Medicare Trustees, 2006).5

 Seemingly slight differences in the assumed rate of excess 

growth—1 percent versus 2 percent, for example—yield substantial differences over the 

long term in the growth in Medicare spending. 

Suppose excess Medicare spending growth is 0 percent. In that case, real Medicare 

spending per beneficiary within each beneficiary age group would grow at the same rate 

as real GDP per capita. Note that, even with 0 percent excess growth, both real Medicare 

spending per beneficiary and the share of GDP devoted to Medicare spending would 

increase, but the increase in the GDP share would reflect only population aging. Under a 

1 percent excess growth scenario, real Medicare spending per beneficiary within each 

beneficiary age group would grow at the rate of real GDP per capita plus 1 percent. 

 

5

 The Medicare Trustees, in their most recent report, have revised their long-term projection methodology. 

They assume that the long-term average rate of excess growth will be 1 percent, but they allow for a 

varying time trend driven by changes in technology adoption and in the affordability to individuals of 

premiums and cost sharing. (Medicare Trustees, 2006) The Congressional Budget Office also uses “excess 

cost growth” to measure historical trends and project Medicare spending. CBO’s excess cost growth is 

conceptually the same as the excess spending growth used in this paper, although the details of calculation 

differ. 
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Results 

Real Medicare spending per beneficiary on personal health care increased from $1,787 in 

1975 to $6,705 in 2003 (both in 2003 dollars), an annual real growth rate of 4.8 percent. 

Of the 4.8 percent annual real growth, the change in the age composition of the elderly 

population accounted for 0.2 percent, and growth in GDP per capita accounted for 2.1 

percent. The remaining 2.5 percent represents excess growth. 

Table 1 provides more details on the historical growth in Medicare spending and the 

growth components from 1975 to 2003, for total Medicare spending, separately for each 

of the three service categories, and separately for three time periods. As shown in Table 

1, the rates of real growth in GDP per capita and the change in the age composition 

among Medicare beneficiaries were fairly stable across the time periods examined. For 

total Medicare spending and for each of the three Medicare spending categories, excess 

spending growth during the most recent period (1992 to 2003) is substantially lower than 

excess spending growth during either of the earlier periods (1975 to 1983 and 1983 to 

1992) and lower than the long-run (1975 to 2003) rate of excess spending growth. For 

example, excess Medicare spending growth averaged 2.5 percent over the period from 

1975 to 2003, but only 0.9 percent for the period from 1992 to 2003. 

Figures 1 through 3 illustrate trends in excess growth separately for each spending 

category.6

 As shown in Figure 1, excess growth in Medicare spending on hospital care 

 

6

 Rates of excess growth in Medicare spending fluctuate sharply from year to year, due to variability in 

Medicare spending growth and general economic conditions. Two techniques are used to smooth the trends 
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was quite high from the 1970s through the mid-1980s. Since the mid-1980s, however, 

excess growth in Medicare hospital spending has fluctuated around 0 percent, ranging 

from 3 percent to -4 percent. 

Figure 2 illustrates excess growth in real Medicare spending on physician and clinical 

services. During the 1970s and 1980s, excess growth was quite high, generally ranging 

between 4 percent and 8 percent. Beginning around 1990, excess growth moderated 

somewhat and since then has generally been between 0 percent and 4 percent. There was 

a substantial uptick in excess growth in 1999 through 2003. 

Figure 3 illustrates excess growth in Medicare post-acute spending, which includes home 

health and skilled nursing facility services. This category accounts for a small share of 

Medicare spending, and has the most volatile spending trends (note that the vertical axis 

for this figure uses a different scale from Figures 1 and 2). Extremely high rates of excess 

spending growth occurred during the 1990s, followed by a period of negative excess 

growth in the late 1990s and early 2000s. Similar to the trends in hospital spending, there 

was an uptick in excess growth in the last years of the analysis (2002 and 2003). 

 shown in Figures 1 through 3. First, I calculate excess growth using the long-term rate of growth in real 

GDP per capita (2.1 percent) rather than the year-by-year rate of growth in real GDP per capita. Second, 

excess growth rates are calculated over three-year periods. For example, the excess growth rate shown for 

1975 reflects the annual rate of excess growth from 1972 to 1975, the excess growth rate shown for 1976 

reflects the annual rate of excess growth from 1973 to 1976, etc. 
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Why Did Excess Growth in Medicare Spending Slow Down? 

One possible explanation for the slowdown in excess Medicare spending growth is that 

Medicare’s provider payment policies and regulations have changed over time and have 

affected growth rates. During the early history of the Medicare program, in the 1960s and 

1970s, policymakers were striving to attract participating providers and fees paid to 

providers were set very generously (Starr, 1982). Faced with rapidly increasing spending 

in the 1970s and 1980s, Congress began to change Medicare’s payment systems, with the 

goal of reining in spending growth (Foster, 2000). The implementation of the inpatient 

prospective payment system for hospitals in 1983 was the most substantial constraint 

imposed on provider payments to that point. Prior to 1983, hospitals were paid by 

Medicare under cost reimbursement; in that system, hospitals were rewarded financially 

for increasing the intensity of care they provided and the costs they incurred. Under the 

inpatient prospective payment system, which was introduced in 1983 and is still in effect, 

hospitals are not reimbursed for all costs they incur. Instead, hospitals are paid a fixed 

rate per discharge, adjusted for the patient’s diagnosis, which creates a strong incentive to 

limit costs per discharge. As seen in Figure 1, the implementation of the inpatient 

prospective payment system coincided with a substantial and sustained reduction in 

excess spending growth in Medicare hospital spending. 

Medicare payments to physicians have been tightened in several stages (Congressional 

Budget Office, 2004b). Prior to 1975, there was little spending restraint, and both the fees 

per physician visit and the volume of visits increased rapidly. After 1975, annual 
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increases in physician fees were limited to the general rate of inflation (as measured by 

the Medicare Economic Index), but spending continued to increase rapidly because of 

volume increases. The Congress froze fee levels from 1984 to 1986 and, later, in separate 

pieces of legislation (OBRA87, OBRA89, and OBRA90), selectively reduced fees for 

what was termed “overvalued” procedures. Those changes in the 1980s coincided with a 

slowdown in excess spending growth for physicians (see Figure 2). 

Because restraints on physician fees did not, by themselves, appear to succeed in 

restraining Medicare physician spending, in 1992 policymakers began to institute 

changes to the physician payment system. Those changes tied the increase in fee levels to 

the increase in volume. The goal was for growth in volume to result, in a mechanical 

way, in reductions in fee updates, thereby constraining total spending. At the time 

Medicare introduced the physician fee schedule in 1992, fee increases were tied for the 

first time to volume increases, using the Volume Performance Standard (VPS). But, the 

VPS turned out to generate considerable volatility in annual updates, and was replaced in 

1998 with the sustainable growth rate (SGR) formula. The SGR, which is used to update 

physician fees from year to year, targets an aggregate spending cap. That cap is set so that 

total Medicare fee-for-service spending on physician services will grow at a rate equal to 

the growth in real GDP per capita plus growth in the number of Medicare fee-for-service 

beneficiaries plus growth due to legislative or regulatory changes in the benefit package. 

If allowed to operate as constructed, the SGR aggregate cap would, assuming a constant 

benefit package, limit excess growth in Medicare physician spending to about 0 percent. 

Congress, however, has overridden the SGR-based updates several times in recent years, 
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with the result that the current level of aggregate spending significantly exceeds the 

aggregate cap. 

Spending trends in post-acute care appear to be highly volatile and highly sensitive to 

Medicare’s payment and regulatory policies. In 1988, the Department of Health and 

Human Services (HHS) settled a class action suit brought against it in federal district 

court (Duggan vs. Bowen). In the settlement, HHS agreed to clarify and ease its postacute benefit eligibility restrictions (Liu et al., 2003). Following that agreement, 

Medicare spending growth for post-acute care was extremely high (Fishman et al., 2003). 

The Medicare Catastrophic Coverage Act of 1988 (MCCA-1988), though in effect only 

for a short time, also prompted growth in Medicare spending by substantially increasing 

nursing facilities’ participation in the Medicare program (Vladeck, 1997). 

The Balanced Budget Act of 1997 (BBA-1997) constrained Medicare payments for 

hospitals and for post-acute care by reducing the growth in hospital payment rates and by 

mandating the implementation of new prospective payment systems for skilled nursing 

facilities and home health agencies. BBA-1997 also coincided with a regulatory 

tightening on fraud and abuse in the hospital, home health, and hospice benefits. 

Following these changes, excess growth in Medicare hospital spending declined 

substantially, and there was an even sharper drop in post-acute excess spending growth. 

For each of the three categories of Medicare spending, however, excess growth was 

relatively high in the years 2002 and 2003. Those spending increases were likely driven 

by Medicare policy changes in the Balanced Budget Refinement Act of 1999 (BBRA-
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1999) and the Benefits Improvement and Protection Act of 2000 (BIPA-2000). Those 

pieces of legislation expanded benefits to include some preventive services and contained 

wide-ranging payment increases meant to mitigate the negative impact of the BBA-1997 

on providers (Congressional Research Service, 2001a; b). 

What direct evidence is there that provider payment policy reforms might explain the 

observed slowdown in excess growth in Medicare spending? In the physician setting, the 

fact that Medicare spending growth was constrained following implementation of the fee 

schedule flows from the mechanics of the update formulas. By the design of the VPS and 

the SGR, aggregate Medicare payments are capped, and under the SGR total Medicare 

payments to physicians are limited to grow roughly in line with aging plus inflation plus 

real growth in GDP per capita. In the physician setting, the design of the current payment 

system should lead to a low rate of excess growth. The fact that excess growth in 

Medicare physician spending in recent years has not been lower reflects, in part, the fact 

that the design of the SGR system has been repeatedly overridden.7

In the hospital setting, there is no mechanical relationship linking payment rates to 

volume growth, but a cycle of cost constraint appears to have taken hold, probably due to 

 

7

 Several factors have contributed to excess growth over 0 percent for physician and clinical services since 

1992. First, the VPS, which was in place until 1998, did not explicitly set its spending targets based on 

overall economic growth. Second, the “physician and clinical services” spending category in the National 

Health Accounts includes payments for some outpatient procedures which are not paid for under the 

physician fee schedule. Third, the SGR mechanism does not impose a year-by-year cap on spending, but 

instead sets a target level of spending for each year and then adjusts the growth in fee levels up or down 

based on whether actual spending has fallen short of or exceeded the target. The rate of excess growth in 

physician payments under the SGR is not, therefore, guaranteed to be 0 percent in each year, but is meant 

to average roughly 0 percent over the long term. Fourth, actual physician spending has substantially 

exceeded the SGR target, resulting in scheduled reductions in physician payments, which have been 

averted by legislation that temporarily overrode the SGR formula. Fifth, the BIPA-2000 expanded the 

benefits package to include preventive benefits. 
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the imposition of the hospital prospective payment system. Early research on the effects 

of the hospital prospective payment system reported that it prompted hospitals to 

constrain the growth in their costs per discharge and that cost-constraining behavior was 

greater in hospitals that faced reductions in their payment levels. The same set of 

responses to prospective payment by Medicare has been documented more recently in the 

skilled nursing facility setting and in the home health setting (White, 2005; McKnight, 

2002; Mathematica Policy Research, 2001). Under prospective payment, when providers 

constrain their costs per unit, their payments are unaffected and their profits increase. 

High profits send a signal to the Congress that payment rates may be constrained without 

necessarily harming beneficiaries’ access to care. With prospective payment systems in 

place, providers tend to engage in a cycle of constraining their costs, thereby reducing the 

payments they receive in future years. 

Besides constraints on provider payments, there are several alternative explanations for 

the Medicare spending slowdown. One possible explanation is the increase in managed 

care enrollment both within and outside the Medicare program. Laurence Baker has 

argued that increasing system-wide enrollment in HMOs, combined with cost 

containment efforts by those organizations, has had spillover effects that have reduced 

Medicare fee-for-service spending (Baker, 1999; 1997). To test the magnitude of this 

spillover phenomenon, the estimated coefficients from Baker’s regressions of Medicare 

spending on HMO enrollment are combined with the observed levels of HMO enrollment 

to generate hypothetical levels of Medicare spending per beneficiary for each year, 

assuming that HMO enrollment was held constant at the 1975 level. Over the last three 
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decades, the system-wide HMO enrollment share increased substantially, from about 3 

percent in 1975, to about 25 percent in 2003 (National Center for Health Statistics, 2003). 

The coefficients from Baker’s analysis imply that the increase in HMO enrollment 

lowered the annual rate of excess growth in Medicare spending by about 0.09 percentage 

points from 1975 to 1983, by 0.17 percentage points from 1983 to 1992, and by 0.17 

percentage points from 1992 to 2003. To put it another way, Baker’s results imply that, if 

there had been no increase in system-wide managed care enrollment, excess spending 

growth would have been 0.09 percentage points higher in the period from 1975 to 1983, 

and 0.17 percentage points higher in the period from 1992 to 2003. This calculation 

shows, first, that Baker’s estimated magnitude of the HMO spillover effect is quite small 

in relation to the observed changes over time in the rate of excess growth and, second, 

that the estimated effect of increasing HMO enrollment on the rate of excess growth was 

not substantially greater in later periods. Together, those findings suggest that Baker’s 

HMO spillover effect cannot account for most of the observed slowdown in the rate of 

excess Medicare spending growth. 

Although increasing system-wide enrollment in managed care may have slightly reduced 

the rate of excess Medicare spending growth, the growth in managed care enrollment 

among Medicare beneficiaries probably increased somewhat the rate of growth in 

Medicare spending. Several researchers have argued that, because of inadequate risk 

adjustment in the payment system for Medicare managed care plans, Medicare pays more 

for managed care enrollees than Medicare would have paid for those enrollees if they had 

remained in the fee-for-service program (Brown et al., 1993; U.S. General Accounting 
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Office, 2000). Therefore, increases over time in managed care enrollment among 

Medicare beneficiaries probably increased total Medicare spending. To get a crude 

measure of the magnitude of this effect on rates of excess growth, the share of Medicare 

enrollees in HMOs in each year is multiplied by the amount of overpayment estimated by 

the U.S. Government Accountability Office (13 percent). Those estimates imply that, if 

no Medicare beneficiaries had enrolled in managed care, the annual rate of excess growth 

in Medicare spending per beneficiary would have been 0.05 percentage points lower from 

1975 to 1983, 0.05 percentage points lower from 1983 to 1992, and 0.06 percentage 

points lower from 1992 to 2003. That managed care overpayment effect is quite small in 

relation to the observed spending slowdown. 

To put the magnitudes of the managed care results in perspective, the increase in 

managed care enrollment among Medicare beneficiaries (based on GAO’s estimates) 

raised excess growth by less than one tenth of 1 percent in each period. Baker’s HMO 

spillover effect could account for excess growth in the more recent period (1992 to 2003) 

about 0.1 percentage point lower compared with the earlier period (1975 to 1983). 

However, the observed decline in the annual rate of excess growth, from 5.5 percent over 

the period from 1975 to 1983 to 0.9 percent over the period from 1992 to 2003, is so 

large that it swamps the estimates of the managed care effects. 

Another possible explanation for the spending slowdown comprises the changes in 

beneficiary cost sharing. Over the last several decades, Medicare’s cost-sharing 

requirements have been adjusted repeatedly. Medicare’s inpatient hospital deductible 
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more than tripled in real terms, from $256 in 1975 (in GDP-inflated 2003 dollars) to $840 

in 2003; the skilled nursing facility daily coinsurance increased by the same proportion, 

rising from $32 to $105. The deductible for physician services, on the other hand, 

declined substantially in real terms, from $167 in 1975 (in GDP-inflated 2003 dollars) to 

$100 in 2003 (U.S. House of Representatives, 2004). 

The more-than-tripling in real terms of the inpatient deductible and skilled nursing 

facility daily coinsurance may have reduced Medicare spending growth in two ways: 

first, by shifting some of the financing burden for hospital care from the Medicare 

program onto beneficiaries and third-party insurers and, second, by inducing lower levels 

of utilization. But several facts argue against the increase in inpatient cost sharing as an 

explanation for the observed slowdown in excess Medicare spending growth. First, the 

period of rapid increase in real cost sharing for hospital care occurred between 1975 and 

1990; after that point, the inpatient deductible actually fell in real terms. That pattern of 

increase in cost sharing for hospital care does not explain (and, in fact, would tend to act 

counter to) a spending slowdown in more recent years. Second, most Medicare 

beneficiaries are shielded from the inpatient deductible by supplemental insurance, and 

the fraction of Medicare beneficiaries with some type of supplemental insurance has 

grown over time. In 1977, 80 percent of elderly Medicare beneficiaries had some type of 

supplemental coverage; by 1999 the share of beneficiaries with supplemental coverage 

(including HMO) had risen to 88 percent (Cafferata, 1984; Laschober et al., 2002). 

Nearly all sources of supplemental coverage pay Medicare’s inpatient hospital 

deductible. Third, the results of the RAND Health Insurance Experiment (HIE) indicate 
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that the effect of cost sharing on the use of hospital care operates primarily by affecting 

the number of physician contacts. Though the RAND HIE does not provide direct 

evidence on the cross-elasticity of demand for inpatient care with respect to outpatient 

cost sharing, it seems reasonable to suppose that the decline in Medicare’s deductible for 

physician services increased hospitalizations, all else equal, and offset to some extent the 

increase in the inpatient deductible. Finally, the real income of the elderly has increased 

over the last three decades, blunting the impact on utilization of the increase in the 

hospital deductible. 

Yet another possible explanation for the slowdown in excess Medicare spending growth 

is that Medicare spending trends are simply following system-wide trends, and that there 

has been a slowdown in spending growth among populations other than Medicare 

beneficiaries. To test this possibility, published and unpublished data were gathered from 

earlier research on historical levels of spending per person among the elderly and nonelderly (Meara et al., 2004).8

 Those historical levels of spending per person were used to 

calculate rates of excess growth in health spending per person separately for the elderly 

and non-elderly. Nearly all of the elderly are enrolled in Medicare, while less than 3 

percent of the non-elderly are enrolled in Medicare. If the Medicare spending slowdown 

simply reflected system-wide trends, we would expect to find a similar slowdown in 

excess spending growth among the non-elderly. However, Figure 4 shows that the rate of 

excess growth in health spending among the non-elderly was actually fairly low (0.4 

percent) over the period from 1970 to 1977. Excess growth among the non-elderly 

 

8

 These spending measures, because they are based on national surveys, are available only for the years 

1970, 1977, 1987, 1996 and 2000. 
 page 19 

increased to 2.9 percent over the period from 1987 to 1996. The annual rate of excess 

spending growth among the elderly, on the other hand, has declined steadily over time, 

from 4.2 percent over the period from 1970 to 1977 to -1.3 percent over the period from 

1996 to 2000. These results indicate that the slowdown in Medicare spending growth was 

not paralleled by a similar slowdown among the non-elderly and was not simply a 

reflection of system-wide spending trends. 

A widely held belief among health economists in the U.S. is that technological change is 

the primary driver behind growth in health care spending. That view is not necessarily 

inconsistent with the theory that Medicare payment changes have affected the rate of 

spending growth. The early proponents of the technological change argument pointed out 

that the reimbursement environment affects incentives surrounding the development and 

diffusion of new technologies (Weisbrod, 1991; Cutler, 1995). 

Is the Slowdown in Excess Medicare Spending Growth of an Economically 

Important Magnitude? 

The rate of excess growth in Medicare spending fell from 5.5 percent over the period 

from 1975 to 1983 to 0.9 percent over the period from 1992 to 2003. Is that difference 

large enough to deserve further research attention? To examine that question, three 

hypothetical trends in Medicare spending as a share of GDP are generated over the period 

from 1975 to 2003, using the three rates of excess growth observed over each sub-period: 

1975 to 1983, 1983 to 1992, and 1992 to 2003. Each of those hypothetical trends starts 
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with actual Medicare spending as a share of GDP in 1975, and then increases at a rate 

determined by the actual rate change in Medicare beneficiaries as a fraction of the 

population and the actual rate of change in the age composition among Medicare 

beneficiaries, combined with the hypothetical rate of excess growth. 

Figure 5 compares the actual historical trend in Medicare spending as a share of GDP and 

the hypothetical shares of GDP using different excess growth rates. That figure shows 

that, if applied over long periods of time, the observed differences in historical rates of 

excess Medicare spending growth will generate very large differences in Medicare 

spending. If excess growth in Medicare spending had, beginning in 1975, continued at the 

actual rate that occurred over the period from 1975 to 1983, Medicare spending as a share 

of GDP would have reached 5.6 percent in 2003, more than twice as large as Medicare’s 

actual share of GDP in 2003 (2.5 percent). If, on the other hand, excess growth in 

Medicare spending throughout the period from 1975 to 2003 had matched the actual rate 

over the period from 1992 to 2003, Medicare spending as a share of GDP would equal 

only 1.6 percent in 2003, more than one-third less than the actual level. 

The differences across those hypothetical scenarios in Medicare spending as a share of 

GDP are very large relative to the current level of Medicare spending, and are even large 

relative to the total federal budget and the economy as a whole. The implication of the 

hypothetical scenarios in Figure 5 is that the slowdown Medicare spending growth is a 

large and important phenomenon that deserves further attention. 
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Discussion 

The key finding of this paper—that excess growth in Medicare spending has slowed 

substantially in recent years—is consistent with earlier research (Boccuti and Moon, 

2003; Levit et al., 2003; Meara, et al., 2004). One question that arises from that finding is 

whether the trends in Medicare spending were driven primarily by Medicare’s policies or 

were driven by system-wide forces such as technological change and an increase in 

managed care enrollment among the non-elderly. This analysis suggests that the 

Medicare spending slowdown was not simply a reflection of spending trends among nonMedicare beneficiaries and may have been driven primarily by changes in Medicare’s 

provider payment policy. The second question raised by this research is whether the 

observed slowdown in Medicare spending growth reflects a short-term aberration or a 

long-term shift. The answer to that question depends on whether the observed changes in 

the rate of excess growth represent an accumulation of shifts in the level of Medicare 

spending or represent a more fundamental shift in the underlying rate of growth. The 

analysis notes that excess growth has shown some increase recently. More research is 

needed on these topics.
 page 22 

Table 1. Components of Annual Growth in Medicare Spending per Beneficiary, by Type of 

Service and Time Period 

 Time Period 

(In percent) 1975-

1983 

1983-

1992 

1992-

2003 

All 

(1975-

2003) 

Real Growth in Medicare Spending per 

Beneficiary 

Hospital Care 7.0 2.9 2.1 3.7

Physician and Clinical Services 8.5 5.0 4.0 5.6

Post-Acute Care 9.7 14.6 6.5 10.0

All Personal Health Care 7.6 4.3 3.3 4.8

 

Real Growth in GDP per Capita 1.9 2.4 2.0 2.1

 

Change in the Age Composition among 

Medicare Beneficiaries 

Hospital Care 0.1 0.1 0.4 0.2

Physician and Clinical Services 0.0 0.1 0.1 0.1

Post-Acute Care 0.4 0.5 0.8 0.6

All Personal Health Care 0.1 0.1 0.3 0.2

 

Excess Growth in Real Medicare Spending per 

Beneficiary 

Hospital Care 4.9 0.3 -0.3 1.4

Physician and Clinical Services 6.5 2.4 1.9 3.3

Post-Acute Care 7.3 11.4 3.5 7.1

All Personal Health Care 5.5 1.8 0.9 2.5

Source: Author’s calculation. Note that the “Change in the Age Composition among Medicare 

Beneficiaries” component differs across spending categories because each spending category 

uses a different age-spending profile. 
 page 23 

Figure 1. Excess Growth in Medicare Hospital Spending

-4.0%

0.0%4.0%8.0%

1975 1980 1985 1990 1995 

Annual Rate of Excess Growth in Medicare Hospital Spending per Capita Inpatient Prospective Payment System Balanced Budget Act of 1997

Source: author’s calculations.
 page 24 

Figure 2. Excess Growth in Medicare Physician Spending

-4.0%

0.0%4.0%8.0%

1975 1980 1985 1990 1995 

Annual Rate of Excess Growth in Medicare Physician Spending per Capita Fee Schedule and Spen

Fee Freeze and Reductions

Source: author’s calculations.
 page 25 

Figure 3. Excess Growth in Medicare Spending on Post-Acute Care

-20.0%

0.0%

20.0%

1975 1980 1985 1990 1995 

Annual Rate of Excess Growth in Medicare Post-acute Spending per Capita Duggan v. Bowen, MCCA-1988 

Source: author’s calculations.
 page 26 

Figure 4. Annual Rates of Excess Growth in Health Spending per Person 

Selected Time Periods, Elderly and Non-Elderly

-2.0%-1.0%

0.0%1.0%2.0%3.0%4.0%5.0%

1970 - 1977 1977 - 1987 1987 - 1996 1

Non-elderly Elderly

Source: author’s calculations.
 page 27 

Figure 5. Medicare Spending as a Share of GDP, Historical and Hypothetic

0.0%1.0%2.0%3.0%4.0%5.0%6.0%

1975 1980 1985 1990 1995 2000 

Historical Assuming same excess growth as 1975-1Assuming same excess growth as 1983-1992 Assuming same excess growth as 1992-2

Source: author’s calculations. 
 page 28 

TECHNICAL APPENDIX 

Analytical Framework for Decomposing Growth in Medicare Spending 

Let Ts,y equal total nominal Medicare spending on service s in year y. Let Ts,y be defined as: 

= ∑

i

Ts, yBi, yM s,i, y (eq 1) 

where i indexes age group, Bi,y equals the number of Medicare beneficiaries in age group i in 

year y, and Ms,i,y equals nominal Medicare spending per beneficiary for service s in age group i in 

year y. 

By expanding equation (1), total Medicare spending can be expressed as follows: 















 = ∑

i y y

s i y

y

i y

s y y y y y P O

M

B

B

T N P O F , , , 1 , (eq 2) 

where Ny is the U.S. resident population in year y, Py is a price index, Oy is real output per capita, 

Fy is Medicare beneficiaries as a fraction of the resident population, Bi,y/By is the fraction of 

Medicare beneficiaries in age group i in year y, and Ms,i,y/Py is real Medicare spending on service 

s per beneficiary in age group i in year y. 

Let Gs,y1,y2 be the annualized growth in Ts,y between years y1 and y2: 
 page 29 

( )

1

, 1

, 2

, 1, 2

2 1

1

y y

s y

s y

s y y T

T

G

−

















+ = (eq 3) 

By combining equations (2) and (3), annualized growth can be expressed as the product of six 

components: 

( )

1

1

2

1

, , 1

2

, 2

2

, , 2

2

, 2

, , 1

1

, 1

, , 1

2

, 2

1

2

1

2

1

2

1

2

, 1, 2

2 1

1 1

y y

y

y

i y

s i y

y

i y

i y

s i y

y

i y

i

s i y

y

i y

i

s i y

y

i y

y

y

y

y

y

y

y

y

s y y

O

O

P

M

B

B

P

M

B

B

M

B

B

M

B

B

O

O

P

P

F

F

N

N

G

−









































































































+ =

∑

∑

∑

∑

 (eq 4) 

where 

( )

1

1

2 2 1 y y

y

y

N

N −

















 equals (1 + population growth) 

and 

equals (1 + growth in Medicare beneficiaries as a fraction of the 

population) 

and 

( )

1

1

2 2 1 y y

y

y

P

P −

















 equals (1 + inflation) 

and 

( )

1

1

2 2 1 y y

y

y

F

F −
















 page 30 

( )

1

1

2 2 1 y y

y

y

O

O −

















 equals (1 + real growth in output per capita) 

and 

( )

1

, , 1

1

, 1

, , 1

2

, 2 2 1 y y

i

s i y

y

i y

i

s i y

y

i y

M

B

B

M

B

B −





























∑

∑

 equals (1 + change in beneficiary age composition) 

and 

( )

1

1

2

1

, , 1

2

, 2

2

, , 2

2

, 2

2 1

1

y y

y

y

i y

s i y

y

i y

i y

s i y

y

i y

O

O

P

M

B

B

P

M

B

B −















































 ∑

∑

 equals (1 + excess growth) 

Note that, in practice, the first five terms are calculated, and then the excess growth term is 

calculated as a residual (i.e. 1 plus the rate of growth in nominal spending divided by the product 

of the other five components). 

Medicare spending for service s in year y can also be expressed in terms of real spending per 

beneficiary, Zs,y: 















 = = ∑

i y y

s i y

y

i y

y

y y y

s y

s y P O

M

B

B

O

N F P

T

Z , , , , 1 , (eq 5) 
 page 31 

The annual rate of growth in Zs,y can then be decomposed into the last three components listed in 

equation (4): real growth in output per capita, the change in the age composition among 

Medicare beneficiaries, and excess growth. 

Generating Hypothetical Levels of Medicare Spending as a Fraction of GDP

By modifying equation (2) slightly, we can define Qs,y as Medicare spending on service s as a 

fraction of GDP in year y: 

i y y

s i y

y

i y

s y y P O

M

B

B

Q F , , , 1 ,















 = ∑ (eq 6) 

Medicare spending as a fraction of GDP in year 2 can then be expressed in terms of the fraction 

of GDP in year 1. In equation (7), year 1 is used as a base year for generating the hypothetical 

fraction in year 2: 









































































=

∑

∑

∑

∑

1

2

1

, , 1

2

, 2

2

, , 2

2

, 2

, , 1

1

, 1

, , 1

2

, 2

1

2

, 2 , 1

1

y

y

i y

s i y

y

i y

i y

s i y

y

i y

i

s i y

y

i y

i

s i y

y

i y

y

y

s y s y

O

O

P

M

N

N

P

M

N

N

M

B

B

M

B

B

F

F

Q Q (eq 7) 

Equation (7) expresses Qs,y2 as the product of four components: the fraction of GDP in the base 

year (Qs,y1), the relative Medicare beneficiaries as a share of the population (Fy2/Fy1), the relative 
 page 32 

beneficiary age composition (the first term in square brackets), and 1 plus the cumulative excess 

growth (the last term in square brackets). One plus cumulative excess growth is calculated as 

(1 + the annual rate of excess growth)(y2 – y1). 

Data Sources and Methods 

Total nominal Medicare spending by service category and year for 1960 through 2003 is taken 

from the National Health Expenditures (NHE), which is produced and distributed by the Center 

for Medicare and Medicare Services (CMS) Office of the Actuary (Centers for Medicare and 

Medicaid Services, 2005). The NHE treats spending on hospital-based nursing homes and 

hospital-based home health agencies as part of the hospital care spending category. To make the 

results easier to interpret, spending on these hospital-based post-acute providers were shifted into 

the nursing home care category and the home health care category. The CMS Office of the 

Actuary provided unpublished data on the fractions of public spending (including Medicare, 

Medicaid and the State Children’s Health Insurance Program) for nursing home care and, 

separately, for home health care accounted for by hospital-based facilities (Centers for Medicare 

and Medicaid Services, 2002). These data were available only for 1990 through 2000. The 

fraction for nursing home care was around 12 percent in all years and the fraction for home 

health care was around 25 percent in all years. The fractions from 1990 were used impute the 

fractions for all previous years and the fractions from 2000 were used to impute the fractions for 

later years. Those fractions were then used to estimate Medicare spending on hospital-based 

nursing home care and home health care. For example, if 25 percent of public spending on home 

health care was accounted for by hospital-based facilities, then imputed spending on hospital-
 page 33 

based home health care equals non-hospital based home health care spending (provided in the 

NHE) multiplied by 25 percent divided by 75 percent (100 percent minus 25 percent). These 

imputed amounts were then shifted from the NHE hospital care category to the nursing home 

care category and home health care category. This shifting had little effect on hospital spending 

(relative to total hospital spending) but had a fairly large effect on total home health care 

spending and a modest effect on nursing home care spending. 

The population is defined as the U.S. resident population. Population totals by age group for 

1960 through 1990 are taken from published U.S. decennial census data (Hobbs and Stoops, 

2002). The actual population for 2000 and the projected populations for 2001 through 2003 by 

single-year age are taken from published data available from the U.S. Census (U.S. Census 

Bureau, 2004). The population projections reflects the “middle-series” assumptions of the U.S. 

Census Bureau. For historical years for which data were not available (i.e., between decennial 

censuses), population totals were linearly interpolated within five-year age groups. 

The gross domestic product (GDP) is used as the measure of total output, and the annual implicit 

GDP deflator is used as the price index. GDP and all Medicare spending totals are inflated to 

2003 dollars. 

Measurement of the historical number of Medicare beneficiaries is not as straightforward as it 

might seem. Published data are available on the number of Medicare beneficiaries, but these 

figures represent calendar-year enrollment (i.e. number of individuals enrolled at any point 

during a calendar year) rather than point-in-time enrollment. Note that mid-year point-in-time 
 page 34 

enrollment is the appropriate measure for calculating annual spending per person. Also note that 

the resident population figures from the U.S. Census are point-in-time measures. The calendaryear Medicare enrollment figures exceed point-in-time figures, with the difference being greatest 

among the oldest individuals (i.e., those with the highest mortality). CMS recently estimated that 

97 percent of the elderly were enrolled in Medicare (Health Care Financing Administration, 

2000). To avoid overstating the number of elderly Medicare beneficiaries, the point-in-time 

number of elderly beneficiaries was estimated as 97 percent of the U.S. elderly resident 

population within each age group. 

To estimate the number of non-elderly Medicare beneficiaries, published calendar-year figures 

from CMS were used (Centers for Medicare and Medicaid Services, 2003). These figures 

slightly overstate the point-in-time number of non-elderly beneficiaries, but the discrepancy is 

likely to be slight. 

The data described so far—population totals, the number of Medicare beneficiaries, the Medicare 

spending totals and GDP—can be used to calculate historical growth in nominal Medicare 

spending and the first four components of spending growth listed in equation (4). The calculation 

of the historical “beneficiary age composition” component requires additional calculations. 

Medicare beneficiaries were divided into six age groups: under 65, 65 to 69, 70 to 74, 75 to 79, 

80 to 84, and 85 and up. For each age group and each spending category Medicare spending per 

person was estimated using publicly available national spending surveys: the 1977 National 

Medical Care Expenditure Survey (NMCES), the 1987 National Medical Expenditure Survey 

(NMES) and the 1996 through 2000 waves of the Medical Expenditure Panel Survey (MEPS). 
 page 35 

Each of these national surveys records spending data for several categories of spending for a 

nationally representative sample of the United States non-institutionalized civilian population. 

Estimates were calculated using survey weights. To increase precision, the 1996 through 2000 

survey data were pooled. 

The national surveys, by design, do not collect information on nursing facility use or spending. 

To estimate Medicare spending on nursing facilities for each age group, unpublished Medicare 

claims data for 1998 were used. The claims-based estimate of Medicare nursing facility spending 

is added to the home health spending from the national surveys to estimate Medicare post-acute 

spending by age group. Medicare nursing facility spending data were not available for earlier 

years; only the 1998 estimates were available for Medicare spending on post-acute care. 

The “change in the age composition among Medicare beneficiaries” component was calculated 

using the per-person spending estimates by age group in a base year, the share of beneficiaries in 

each age group in the base year, and the share of beneficiaries in each age group in a final year. 

Note that to calculate the beneficiary aging component, the only relevant information comprises 

the relative spending (not absolute level of spending) among age groups in the base year and the 

change in the age composition among beneficiaries. Per-person spending estimates are calculated 

for 1977, 1987, and 1998 (see Appendix Table 1). The 1998 estimates are used for base years 

1988 through 2002, the 1987 estimates are used for base years 1978 through 1987, and the 1977 

estimates are used for all prior base years. Note that Medicare physician spending is very nearly 

equal across age groups, whereas post-acute spending is highly skewed toward older 

beneficiaries. Because of this difference, the population aging component of spending growth is 
 page 36 

larger for post-acute care spending than for other categories of spending. Once the beneficiary 

age composition component is calculated, the excess spending growth component is calculated 

as the difference between nominal Medicare spending growth and the sum of the other five 

components.
 page 37 

Appendix Table 1. Spending per Person Estimated Using National Spending Surveys 

Service Category Age group Year 

1977 1987 1998 

Under 65 $1,670.10 $2,348.50 $3,679.83

65 to 69 $1,273.45 $1,851.73 $2,156.75

70 to 74 $1,439.84 $1,958.64 $2,464.41

75 to 79 $2,246.34 $1,872.19 $3,381.86

80 to 84 $2,539.51 $3,029.98 $4,167.12

Hospital Care 

85 and up $2,676.52 $3,230.35 $4,324.31

Under 65 $681.55 $1,679.97 $1,467.82

65 to 69 $464.52 $878.03 $1,213.84

70 to 74 $579.46 $875.40 $1,405.17

75 to 79 $605.14 $1,242.77 $1,668.96

80 to 84 $481.97 $1,252.04 $1,576.99

Physician and Clinical Services 

85 and up $477.49 $943.38 $1,270.74

Under 65 n/a n/a $701.12

65 to 69 n/a n/a $273.13

70 to 74 n/a n/a $368.57

75 to 79 n/a n/a $719.51

80 to 84 n/a n/a $1,285.97

Post-Acute Care (Home Health 

Care plus Skilled Nursing Facility 

Care) 

85 and up n/a n/a $2,187.27

n/a - not available 

Source: author’s calculations.
 page 38 

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