GAO

United States General Accounting Office

Testimony

Before the Committee on Finance, U.S. Senate

For Release on Delivery

Expected at

10 a.m.

Wednesday,

March 10, 1999

MEDICARE AND BUDGET 

SURPLUSES

GAOs Perspective on the 

Presidents Proposal and 

the Need for Reform

Statement of David M. Walker

Comptroller General of the United States

GAO/T-AIMD/HEHS-99-113

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

Mr. Chairman and Members of the Committee:

It is a pleasure to be here today to discuss the Presidents recent proposal

for addressing Medicare and use of the projected budget surpluses over the

next 15 years. As you know, I testified last month on the implications of the

Presidents surplus proposals for Social Security. Today, I will briefly

reprise our views on the overall fiscal consequences of the proposal,

discuss what it does and does not do for the Medicare program, and

examine the importance of and difficulty in making fundamental changes

to this complex program.

Regarding the Presidents proposal:

 It would significantly reduce debt held by the public from current levels,

thereby also reducing net interest costs, raising national savings, and

contributing to future economic growth. This element of the Presidents

proposal would have positive short- and long-term effects on the

economy.

 It provides a grant (or in the Presidents word, a gift) of a new set of

Treasury securities for the Medicare Hospital Insurance (HI) program

which would extend the life of the HI trust fund from 2008 to 2020. It is

important to note, however, that these new Treasury securities would

constitute a new unearned claim on general funds for the HI program--a

marked break with the payroll tax-based financing structure of the

program. This would be a significant change that could serve to

undermine the remaining fiscal discipline associated with the selffinancing trust fund concept.

 It has no effect on the current and projected cash-flow deficits that have

faced the HI program since 1992deficits that taxpayers will continue to

finance through higher taxes, lower spending elsewhere or lower

paydowns of publicly held debt than the baseline. Importantly, the

Presidents proposal would not provide any new cash to pay for medical

services.

 It does not include any meaningful program reform that would slow

spending growth in the HI program. In fact, the transfer of these new

Treasury securities to the HI program could very well serve to reduce a

sense of urgency for reform. At the same time, it could strengthen

pressure to expand Medicare benefits in a program that is

fundamentally unsustainable in its present form.

The current Medicare program is both economically and fiscally

unsustainable. This is not a new message--the Medicare Trustees noted in
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the early 1990s that the program is unsustainable in its present form. They

also noted the need for dramatic and fundamental reform of the program to

assure its solvency. With regard to Medicare:

 The programs continued growth threatens to crowd out other spending

and economic activity of value to our society. Even if we save the entire

surplus, Medicare is projected to more than double its share of the

economy by 2050.

 Meaningful reform of this program is urgently needed and such reform

will require hard choices. The program changes enacted in 1997

illustrate how difficult even incremental reform is to adopt. Major

change requires reshaping the nations perspective on health care

consumption and drawing distinctions between what the nation needs,

wants, and can afford both at the national and individual level.

 To be effective and sustainable, reforms must begin soon and be

comprehensive in nature. However, the history of entitlement reforms

tell us that, to be enduring, such reforms must be introduced gradually

after widespread public education in order to garner sufficient support

from the systems multiple stakeholders.

Context: Long-term 

Outlook Is Important

It is important to look at the Presidents proposal in the context of the fiscal

situation in which we find ourselves. After nearly 30 years of unified

budget deficits, we look ahead to projections for surpluses as far as the

eye can see. At the same time, we know that we face a demographic

tsunami in the future that poses significant challenges for Social Security,

Medicare, and our economy as a whole. In this context, it is noteworthy

that the President has proposed a longer term framework for resource

allocation than has been customary in federal budgeting.

Although all projections are uncertainand they get more uncertain the

farther out they gowe have long held that a long-term perspective is

important in formulating fiscal policy for the nation. Each generation is in

part the custodian for the economy it hands the next and the nations longterm economic future depends in large part on todays budget decisions.

This perspective is particularly important because our model and that of

the Congressional Budget Office (CBO) continue to show that absent a

change in policy, the changing demographics to which I referred above will

lead to renewed deficits. This longer term problem provides the critical

backdrop for making decisions about todays temporary budget surpluses.
Page 3 GAO/T-AIMD/HEHS-99-113

Surpluses are the result of a good economy and difficult policy decisions.

They also provide a unique opportunity to put our country on a more

sustainable path for the long term, both for the nations fiscal policy and

selected entitlement programs. Current decisions can help in several

important respects: (1) current fiscal policy decisions can help expand the

future capacity of our economy by increasing national savings and

investment, (2) engaging in substantive reforms of retirement and health

programs can reduce future claims, (3) by acting now, we have the

opportunity of phasing in changes to Social Security and Medicare

programs over a sufficient period of time to enable our citizens to adjust,

and (4) failure to achieve needed reforms in the Social Security and

Medicare programs will drive future spending to levels that will eventually

squeeze out most or all discretionary spending, including national

defense spending. If we let the achievement of a temporary budget surplus

lull us into complacency about the budget, then in the middle of the 21st

century we could face daunting demographic challenges without having

built the economic capacity or program and policy reforms to handle them.

The Proposal Before turning to Medicare specifically, it is important to describe the

Presidents overall proposal for using the surpluses over the next 15 years.

The proposals effects on Medicare are part of a broader initiative to save a

major share of the surplus to reduce the debt held by the public and

thereby enhance future economic capacity for the nation.

The President proposes to use a significant portion of the total projected

unified budget surpluses over the next 15 years to reduce debt held by the

public. He also proposes to take some related steps to address the

financing problems facing both the Medicare and Social Security programs.

His approach to this, however, is extremely complex and confusing.

Specifically, the President proposes to allocate about two-thirds of the

projected surplus over the next 15 years to reduce publicly held debt. This

portion of his proposal would increase our future economic capacity. At

the same time, the President proposes to transfer a like amount to the

Social Security and Medicare trust funds in the form of nonmarketable

Treasury securities. In effect, the Presidents proposal would trade debt

held by the public for debt held by the Social Security and Medicare trust

funds. The administration has defended this approach as a way of assuring

both a reduction in debt held by the public and as securing a first claim

for both Social Security and Medicare on what they call the debt-reduction

dividend to pay future benefits for those two programs. The HI program
Page 4 GAO/T-AIMD/HEHS-99-113

would receive nearly $700 billion in additional Treasury securities −

representing nearly 15 percent of total surpluses over the 15 years. 1 This

transfer is projected to extend the life of the HI trust fund from 2008 to

2020.

The Presidents proposal has raised important questions about how the

federal government can promote long-term economic security by using

todays surplus resources to save for the future. In the federal unified

budget, the only way to save for the future is to run a unified budget surplus

or purchase a financial asset. When there is a cash surplus it is used to

reduce debt held by the public. Therefore, to the extent that there is an

actual cash surplus, debt held by the public falls. This is exactly what

happened in fiscal year 1998 when the debt held by the public was reduced

by $51 billion.

In the federal budget, trust funds are not vehicles to park real savings for

the future. They are simply budget accounts used to record receipts and

expenditures earmarked for specific purposes. A private trust fund can set

aside money for the future by increasing its assets. State governments

similarly can park surplus resources in real pension funds and other

trust funds that are routinely invested in assets (e.g., readily marketable

securities) outside the government. However, under current law, when a

trust fund like HI ran a surplus of payroll tax revenues over benefit

payments, the excess was invested in Treasury securities and used to meet

current cash needs of the government. These securities are an asset to the

trust fund, but they are a claim on the Treasury. When a trust fund runs a

cash deficit, like HI has been doing since 1992, it redeems these securities

to pay benefit costs exceeding current payroll tax receipts. 2 Medicare will

be able to do this until 2008 under current law when its trust fund securities

will be exhausted. However, in order to redeem these securities, the

government as a whole must come up with the cash by either increasing

taxes, reducing spending, or raising borrowing from the public above the

baseline.

Increasing the balances of Treasury securities owned by HI trust funds

alone would increase the formal claim that the trust funds have on future

general revenues since the trust funds securities constitute a legal claim

1With the additional interest these new securities would earn, total assets held by the HI trust fund

would go up by over $1 trillion.

2This may mean either using interest or the principal itself to cover the difference.
Page 5 GAO/T-AIMD/HEHS-99-113

against the Treasury. However, increasing the HI trust fund balances alone,

without underlying reform, does nothing to make the program more

sustainable. From a macro perspective, the critical question is not how

much a trust fund has in assets, but whether the government as a whole has

the economic capacity to finance the trust funds claims to pay benefits now

and in the future. From a micro perspective, trust funds can provide a vital

signaling function for policymakers about underlying fiscal imbalances in

covered programs. However, extending a trust funds paper solvency

without reforms to make the underlying program more sustainable can, in

effect, obscure the warning signals that trust fund balances provide.

Government Financing The Presidents proposals would enhance the nations future economic

capacity by significantly reducing debt held by the public from the current

level of 44 percent of gross domestic product (GDP) to 7 percent over the

15-year period. The President notes that this would be the lowest level

since 1917. Nearly two-thirds of the projected unified budget surplus

would be used to reduce debt held by the public. Because the surplus is

also to be used for other governmental activities, the amount of debt

reduction achieved would be less than the baseline (i.e., a situation in

which none of the surplus was used), but nonetheless the outcome would

confer significant short- and long-term benefits on the budget and the

economy.

Our previous work on the long-term effects of federal fiscal policy has

shown the substantial benefits of debt reduction. 3 One of these is lowering

the burden of interest payments in the budget. Today, net interest

represents the third-largest program in the budget, after Social Security

and Defense. Interest payments, of course, are a function of both the

amount of debt on which interest is charged and the interest rate . At any

given interest rate, reducing publicly held debt reduces net interest

payments within the budget. For example, CBO estimates that the

difference between spending the surplus and saving the surplus is

$123 billion in annual interest payments for debt held by the public by

2009--or almost $500 billion cumulatively between now and then.

Compared to spending the entire surplus, the Presidents proposal would

also substantially reduce projected interest payments . Lower interest

payments lead to larger surpluses; these in turn lead to lower debt which

3Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, October 22, 1997).
Page 6 GAO/T-AIMD/HEHS-99-113

leads to lower interest payments and so on: The miracle of compound

interest produces a virtuous circle. The result would be to provide

increased budgetary flexibility for future decisionmakers who will be faced

with enormous and growing spending pressures from the aging population.

For the economy, lowering debt levels increases national saving and frees

up resources for private investment. This in turn leads to increased

productivity and stronger economic growth over the long term. Over the

last several years, we and CBO have both simulated the long-term

economic results from various fiscal policy paths. These projections

consistently show that reducing debt held by the public increases national

income over the next 50 years, thereby making it easier for the nation to

meet future needs and commitments. Our latest simulations done for the

Senate Budget Committee, as shown in figure 1, illustrate that any path

saving all or a significant share of the surplus in the near term would

produce demonstrable gains in per capita GDP over the long run. 4 This

higher GDP in turn would increase the nations economic capacity to

handle all its commitments in the future.

4The on-budget balance path assumes that any surplus in the non-Social Security part of the budget is

spent on either a tax cut or spending increases or some combination but assumes the current law path

for the Social Security trust fund (SSTF). Thus, the surplus in the Social Security trust fund remains

untouched until it disappears in 2013 after which the unified budget runs a deficit equal to the SSTF

deficit. The save the surplus path assumes no changes in current policies and that budget surpluses

through 2024 are used to reduce debt held by the public. The no surplus path assumes that permanent

increases in discretionary spending and tax cuts deplete the surpluses but keep the budget in balance

through 2009. Thereafter, deficits reemerge as spending pressures grow.
Page 7 GAO/T-AIMD/HEHS-99-113

Figure 1: GDP Per Capita Under Alternate Fiscal Policy Simulations

Source: GAO Analysis. 

While reducing debt held by the public appears to be a centerpiece of the

Presidents proposaland has significant benefitsas I noted above, the

transfer of a portion of the unified surpluses to the HI trust fund is a

separate issue. The transfer is not technically necessary: Whenever

revenue exceeds outlays and the cash needs of the Treasury, debt held by

the public falls.

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60,000

65,000

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

On-budget balance Save the surplus No surplus

1998 level

Per capita 1998 dollars
Page 8 GAO/T-AIMD/HEHS-99-113

The Presidents proposal appears to be premised on the belief that the only

the way to sustain surpluses is to tie them to Social Security and Medicare.

He has merged two separate questions: (1) How much of the surplus should

be devoted to reducing debt held by the public? and (2) How should the

nation finance these two programs in the future? The President has

proposed to save the surplus by, in effect, hiding it in the Social Security

and HI trust funds. The additional nonmarketable Treasury securities

transferred to the Social Security and Medicare trust funds are recorded as

a subtraction from the unified budget surplusa new budgetary concept.

Accordingly, the surplus disappears under this novel scoring approach

since these transfers approximate the surplus the President is proposing to

save by reducing publicly held debt.5

Let me turn now to the question of how the Presidents proposal would

affect Medicare financing.

Impact on Medicare 

Financing

The mechanics of the proposed transfer of surpluses to the Medicare

program are, like the transfers to Social Security, complex and difficult to

follow. In form they are similar, but the effects on Medicare would be

somewhat different. Unlike Social Security, Medicares HI program has

been experiencing a cash flow deficit since 1992current payroll taxes and

other revenues have been insufficient to cover benefit payments and

program expenses. Accordingly, Medicare has been drawing on its special

Treasury securities, along with interest on those accumulated balances,

acquired during the years when the program generated a cash surplus. In

effect, these general fund payments can be viewed as repaying the loan of

cash that the trust fund provided the rest of government when the Medicare

program was in surplus. In fiscal year 1999, the HI program will run a cash

deficit of $8 billion. As noted earlier, in order to redeem these securities,

the government must either raise taxes, cut spending, or increase

borrowing from the public. In essence, Medicare has already crossed the

point where it is a net claimant on the Treasurya threshold that Social

Security is not currently expected to reach until 2013. Stated differently,

the bleeding of the HI trust fund has already started based on the programs

annual cash flow deficits.

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

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

The current financing flows for the HI program are depicted in figure 2

below. As the figure shows, to help pay benefits in fiscal year 1999, the HI

trust fund receives an $8 billion general fund payment for interest it earned

on its treasury securities from its past cash surpluses. The HI fund also

receives $5 billion for a portion of the income taxes paid on Social Security

benefits.

Figure 2: Medicare Flows Under Current Law

*Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security 

Benefits.

Source: GAO Analysis.

Under the Presidents proposal, the above scenario would continue.

However, as shown in figure 3, at the point where total tax receipts are

allocated to pay for government activities, a new financing step would be

added to transfer a portion of the projected unified budget surpluses to

the Medicare HI trust fund. The Treasury would do this by issuing a new

set of securities for the HI trust fund. Unlike the current securities owed

the trust fund, these new securities are not supported by payroll tax

surpluses in the program; rather, they represent what amounts to a grant or

gift. However, it is important to remember that these new securities equal a

Benefits

Claims for interest

earned on past surpluses

Cash for benefit

payments and additional

special treasuries

Payroll Taxes*

Unified surplus would pay down

the debt held by the public

Hospital Insurance

Trust Fund General Fund

Discretionary

Spending

Other

Mandatory

Spending

Other Taxes

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

portion of the excess cash that would be used to reduce the debt held by

the public. The administration argues that the new securities are, in effect,

supported by the enhanced economic resources gained by reducing

publicly held debt. Nonetheless, we should remember that under the

current law baselinei.e., with no changes in tax or spending policythis

would happen without crediting additional securities to either the Social

Security or Medicare trust funds.

Figure 3: Medicare Flows Under President’s Proposal

*Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security 

Benefits.

Source: GAO Analysis.

The financial consequences of this transfer are depicted in figure 4 below.

This graph first shows that by providing the additional Treasury securities,

the solvency of the Hospital Insurance trust fund would be extended from

2008 to 2020. However, the figure also shows that the Presidents proposal

does nothing to alter the imbalance between the programs tax receipts and

benefit payments. It has been in cash deficit since 1992 and remains in a

cash deficit even with the new Treasury securities. Thus, the President

Payroll Taxes*

Unified surplus would pay down

the debt held by the public

Hospital Insurance

Trust Fund General Fund

Discretionary

Spending

Other

Mandatory

Spending

Other Taxes

Benefits

Unified Budget

Transfer for

Trust Fund

New Special

Treasuries

Claims for interest

earned on past surpluses

Cash for benefit

payments and additional

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

proposes to provide additional claims on the Treasury, not additional cash

to pay benefits.

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

Source: GAO Analysis.

Notwithstanding the fact that no real cash is exchanged, the transfer of

additional securities to Medicare is a discretionary act with major

economic consequences for the future financing of the HI program. As

with Social Security, this proposal represents a fundamental shift in the

way the HI program is financed. It moves it away from payroll financing

toward a formal commitment of future general fund resources for the

program for the future. The general fund obligation would begin far earlier

than for Social Security. Specifically, the HI trust fund would begin

drawing on the general fund to redeem these new securities in 2008well

before the full reduction in publicly held debt and associated benefits to the

general fund will have been realized under the Presidents plan. In addition,

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this is 24 years before the Social Security Trust Fund would begin drawing

on the additional Treasury securities that the President is proposing to

grant to that program.

The transfer would constitute an explicit general fund subsidy for the HI

programa subsidy whose magnitude is unprecedented for this program.

This is true because the newly transferred securities would be in addition

to any buildup of historical payroll tax surpluses. Securities held by the

trust fund have always represented the value of the loan of its surpluses to

the Treasury--annual cash flows in excess of benefits and expenses, plus

interest. Under the Presidents proposal, the value of securities held by the

HI trust fund would exceed that supported by earlier payroll tax surpluses

and constitute a new and unearned claim on the general fund for the future.

In effect, the proposal would shift the financing of the HI Trust Fund to

look more like that for the Part B Supplemental Medical Insurance (SMI)

Trust Fund. The SMI portion of Medicare obtains 75 percent of its revenues

from a general fund subsidy, with the remainder supported by beneficiaries

premiums.

This is a major change in the underlying theoretical design of the HI

program. Whether you believe it is a major change actually depends on

what you assume about the likely future use of general revenues under the

current circumstances. For example, current projections are that the HI

Fund will exhaust its securities to pay the full promised benefits in 2008. If

you believe that this shortfall wouldwhen the time camebe made up

with general fund moneys, then the shift embedded in the Presidents

proposal merely makes that explicit. If, however, you believe that there

would be changes in the benefit or tax structure of the fund instead, then

the Presidents proposal represents a very big change. In this case, less of

the long-term shortfall would be addressed through future changes in the

HI program itself and more would financed through higher taxes or

spending cuts elsewhere in the federal budget as a whole. Thus, the

question of bringing significant general revenues into the financing of the

HI program is a question that deserves full and open debate. The debate

should not be overshadowed by the accounting complexity and budgetary

confusion of the Presidents proposal.

In our view, the proposal carries some significant risks that should be

carefully considered by the Congress. One risk is that the transfers to both

the Medicare and Social Security trust funds would be made regardless of

whether the expected budget surpluses are actually realized. The amounts

to be transferred apparently would be written into law as either a fixed
Page 13 GAO/T-AIMD/HEHS-99-113

dollar amount or as a percent of taxable payroll rather than as a percent of

the actual unified surplus in any given year. These transfers would have a

claim on the general fund even if the actual surplus fell below the amount

specified for the transfers. However, it is important to emphasize that any

proposal to allocate surpluses is vulnerable to the risk that those projected

surpluses may not materialize. Proposals making permanent changes to

use the surplus over a long period are especially vulnerable to this risk.

The history of budget forecasts should remind us not to be complacent

about the certainty of these large projected surpluses. In its most recent

outlook book, CBO compared the actual deficits or surpluses for 1988-1998

with the first projection it produced 5 years before the start of each fiscal

year. Excluding the estimated impact of legislation, CBO says its errors

averaged about 13 percent of actual outlays. Such a shift in 2004 would

mean a surplus $250 billion higher or lower; in 2009, the swing would be

about $300 billion. Accordingly, we should consider carefully any

permanent commitments that depend on the realization of a long-term

forecast.

The Compelling Need 

for Fundamental 

Program Reform

A more significant risk of the Presidents proposal is that by appearing to

extend financial stability for Medicare, it could very well undercut the

incentives to engage in meaningful and fundamental reform of the HI

programreform that is vital to making the HI program sustainable over

the long term. Unlike Social Security, the HI program is already in a

negative cash flow positionpayroll taxes support 89 percent of spending

now and will cover less than one half 75 years from now. Even in the short

term, the HI programs annual outlays grow by several times the rate of

general inflation. Although its growth has slowed in recent years, it remains

one of the most volatile and uncontrollable programs in the federal budget.

According to CBO, the growth of Medicareboth HI and SMI-- will

increase its share of the economy by nearly a full percentage point over the

next 10 years, from 2.5 percent to 3.3 percent of GDP in 2009. By contrast,

the share devoted to Social Security is projected to remain relatively flat

during this period rising from 4.4 percent of GDP in 1999 to 4.7 percent in

2009.

Over the long term, the programs growth rates are more daunting. Absent

any changes, the combined Medicare program (i.e., HI and SMI) is

projected to more than double its share of the economy by 2050from 2.7

percent now to 6.8 percent based on the Medicare Trustees most recent

best estimated assumptions. When coupled with Medicaid, federal health
Page 14 GAO/T-AIMD/HEHS-99-113

care costs will grow to nearly 10 percent of GDP by 2050, as depicted in

figure 5. The progressive absorption of a greater share of the nations

resources for health is, like Social Security, a reflection of the rising share

of elderly in the population. However, health care growth rates also reflect

the escalating cost growth of health care at rates well exceeding general

rates of inflation. Increases in the number and quality of health services

fueled by the explosive growth of medical technology has spurred much of

this extraordinary cost growth in health care. Consequently, Medicare

represents a much greater and more complex fiscal challenge than even

Social Security over the longer term.

Figure 5: Medicare and Medicaid as a Share of GDP

Source: GAO’s “save the surplus” long-term simulation based on HCFA’s 1998 intermediate 

projections for Medicare spending and CBO’s May 1998 projections for Medicaid spending.

The Presidents proposal to strengthen the HI program is more perceived

than real. Specifically, while the HI trust fund will appear to have more

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

resources as a result of the Presidents proposal, in reality nothing about

the program has really changed. The proposal does not represent program

reform but rather a supplemental means to finance the current program.

Stated differently, the reform proposed has more form than substance.

What is most alarming is that the Presidents proposal could induce a sense

of false complacency about the financial health of the HI program. The

impending insolvency of the HI program sends important signals to

policymakers that the program needs to be made more affordable through

benefit changes, revenue increases, or both. The 2008 date has become an

important cue to policymakers that could provide the impetus needed to

make the hard choices necessary to promote the solvency and

sustainability of the HI program for the long term. Extending the life of the

HI trust fund without substantive program reform could be a recipe for

delay and denial that could increase the ultimate fiscal and social cost of HI

program reform. At a minimum, the Presidents proposal is likely to create

a public misperception that something meaningful is being done to reform

the Medicare program.

Changes to the HI program should be made sooner rather than later. The

longer meaningful action is delayed, the more severe such actions will have

to be in the future. Since Medicare is the fastest growing sector of the

federal budget, early action to reduce its costs will have compounding

fiscal benefits. Even if the rate of growth is not changed, reducing the base

level of spending can produce outyear dividends for the programs

finances. Moreover, acting now would allow changes to benefits and health

care delivery systems to be phased in gradually so that stakeholders and

participants can adjust their saving or retirement goals accordingly.

When viewed together with Social Security, the programs financial burden

on the future economy takes on daunting proportions. As figure 6 shows,

the cost of these two programs would nearly double as a share of the

payroll tax base over the long term. Assuming no other changes, these

programs would constitute an unimaginable drain on the earnings of our

future workers, even without including the financing challenges of the SMI

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

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

Note: Taxable payrolls of the two trust funds are different. For analytic purposes, they have been 

combined by the Social Security Trustees.

Source: 1998 Social Security Trustees’ Report.

There is another reason to take early action to reform both Social Security

and Medicare costs. Reducing the future costs of these programs is vital to

reclaiming our nations future capacity to address other important needs in

the public sector. To move into the future without changes in the Social

Security, Medicare, and Medicaid programs is to envision a very different

role for the federal government. Assuming no financing or benefit changes,

our long-term model (and that of CBO) shows a world in 2050 in which

Social Security, Medicare, and Medicaid absorb a much greater share of the

federal budget. (See figure 7.) Budgetary flexibility declines drastically

and there is increasingly less room for programs for national defense, the

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Page 17 GAO/T-AIMD/HEHS-99-113

young, infrastructure, and law enforcementi.e., essentially no

discretionary programs at all. Eventually, again assuming no program or

financing changes, Social Security, health and interest consume nearly all

the revenue the federal government takes in by 2050. This is true even if

we assume that the entire unified budget surplus is saved and these

continued surpluses reduce interest from current levels. As shown in

figure 8, the picture is even more dramatic if we assume the entire unified

budget surplus is used.6 In that scenario, lower GDP and higher interest

payments lead to a world in which revenues cover only Social Security,

health, and interest in 2030. And in 2050 revenues do not cover Social

Security and federal health expenditures alone! Although views about the

role of government differ, it seems unlikely that many would advocate a

government devoted solely to sending Social Security checks and health

care reimbursements to the elderly.

6Our "no surplus" simulation is not a forecast but rather an illustration of the implications of taking

fiscal actions that eliminate projected surpluses and the fiscal pressures posed by the aging of the baby

boom generation. This simulation shows ever-increasing deficits that result in declining investment, a

diminishing capital stock, and a collapsing economy. In reality, these economic consequences would

inevitably force policy changes to avert such a catastrophic outcome.
Page 18 GAO/T-AIMD/HEHS-99-113

Figure 7: Composition of Spending as a Share of GDP Under “Save the Unified Surplus” Simulation

Source: GAO Analysis.

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50

60

70

80

1998 2030 2050

Social Security Medicare & Medicaid Net Interest All other spending

Revenue

Percentage of GDP
Page 19 GAO/T-AIMD/HEHS-99-113

Figure 8: Composition of Spending as a Share of GDP Under “No Unified Surplus” Simulation

Source: GAO Analysis.

0

10

20

30

40

50

60

70

80

1998 2030 2050

Social Security Medicare & Medicaid Net Interest All other spending

Revenue

Percentage of GDP
Page 20 GAO/T-AIMD/HEHS-99-113

Mounting Pressures on 

Medicare Spending 

Pose Challenges for 

Long-term Program 

Viability

It is clear that real and substantive reform of Medicare is essential to

achieving the long-term solvency and sustainability for the program itselfit

is not a question of whether, but when and how. However, multiple factors

complicate and magnify the challenges involved in achieving such

fundamental program reform.

Substantial growth in Medicare spending will continue to be fueled by

demographic and technological change. Medicares rolls are expanding

and are projected to increase rapidly with the retirement of the baby boom

generation. For example, todays elderly make up about 13 percent of the

total population; by 2030, they will comprise 20 percent as the baby boom

generation ages. Individuals aged 85 and older make up the fastest growing

group of Medicare beneficiaries. So, in addition to the increased demand

for health care services due to sheer numbers, the greater prevalence of

chronic health conditions associated with aging will further boost

utilization.

Compounding the cost pressures of serving a larger and needier Medicare

population are the costs associated with the scientific breakthroughs for

treating medical conditions and functional limitations. Technological and

treatment advances have resulted in more services being provided to more

beneficiaries. These services can restore health, reduce pain, increase

functioning, and extend lives. Medical miracles abound, such as

medications that reduce the permanent damage resulting from heart

attacks, hip replacements that improve the health and quality of life for

many, and therapy regimens that promote recovery from what previously

would have been debilitating strokes. The frequency and intensity of some

high-tech services, however, may be of limited clinical value or fail to

improve the quality of beneficiaries lives.

These technological advances feed the publics expectations that more

health care is better. Some expect virtually unlimited services to treat any

condition. However, the actual costs of health care consumption are not

transparent. Third-party payers generally insulate consumers from the cost

of care decisions. In traditional Medicare, for example, the impact of the

cost-sharing provisions designed to curb the use of services is muted,

because about 80 percent of beneficiaries have some form of supplemental

health care coverage (such as Medigap insurance) that pays these costs.

The demographic spiral will increase health care needs over the

foreseeable future, while technological changes have begun expanding
Page 21 GAO/T-AIMD/HEHS-99-113

health care demand. But of this demand, how much are needs and how

much are wants? The distinction is blurred by the effect of scientific

advances making available new treatmentswhich may not be universally

applicable or necessarily effectivewhile individuals continue to be

insulated from the full costs of care. At the same time, financial incentives

to expand service use fail to be held in check by reasonable assessments of

what society can afford.

While these financial questions loom, pressure is mounting to update

Medicares outdated benefit design. However, doing so carries with it the

potential to exacerbate Medicares spending trajectory. Consider the case

of prescription drug coverage. In 1965, when the program was first

established, outpatient prescription drugs were not nearly as important a

component of health care as they are now. Used appropriately,

pharmaceuticals can cure diseases, improve quality of life, and substitute

for more expensive services. Most private insurance options and Medicaid

programs recognize these advantages by including pharmaceutical

coverage in their benefit packages. Many seek to similarly modernize

Medicares benefits. However, this desired expansion comes at a time

when pharmaceutical companies are increasingly marketing their products

directly to consumersraising the specter that wants will grow well

beyond actual needs. Thus, the question of whether to include prescription

drugs in Medicares benefit package illustrates the importance of

affordability counterweights to moderate notions of health care wants.

BBA Reforms 

Overshadowed by 

Magnitude of the 

Problem 

The kinds of reforms needed to put Medicare on a more sustainable footing

for the future will require hard choices. Real changes in providers incomes

and services to beneficiaries will undoubtedly be necessary. Substantive

reform, not simple financing shifts among funds within the budget--which

have been all too frequent in the past as a way to delay the inevitable day of

reckoning--will be required to address this daunting problem.

Lets not kid ourselves--this will not be easy. The Balanced Budget Act of

1997 (BBA) illustrates how challenging reforms can be for this program.

BBA contains what are probably the most significant changes to Medicare

since its inception more than 30 years ago, yet it was never intended to

substitute for long-term reform. The changes will extend the HI trust funds

solvency to 2008 before the baby boomers even begin to draw on the

program. The changes will also result in an estimated $385 billion in lower

program expenditures over a 10-year period through a combination of

savings from constrained provider fees, increased beneficiary payments,
Page 22 GAO/T-AIMD/HEHS-99-113

and structural reforms. To make even these incremental changes to

Medicare required substantial effort on the part of the Congress.

Effective implementation of BBA has proved daunting to the Health Care

Financing Administration (HCFA), as we have recently testified. 7

Moreover, to the extent that these changes have produced new winners and

losers among health care providers, pressures to undo the related changes

are growing. Examples include the following.

 Introduction of prospective payment for certain Medicare services :

Prospective payment systems will alter how reimbursements are made

to skilled nursing facilities, home health agencies, hospital outpatient

departments, and rehabilitation facilities. Rather than paying largely

whatever costs providers incur, the objective is to fix rates, giving

providers incentives to deliver care and services more efficiently. Our

work in this area shows that weaknesses in the design and

implementation details could substantially erode the expected savings.

Furthermore, over the past year, the Congress has faced intense

industry pressure to revisit certain BBA provisions that constrain

payments to particular groups of providers.

 Creation of Medicare+Choice: BBA established this new program to

encourage the expansion of managed care. It represents a first step

toward the restructuring of Medicare from two perspectives. The first

addresses cost growth through increased reliance on private sector

expertise and resources to control costs. The Medicare+Choice

provisions addressing health plan and beneficiary participation reflect

in part the expectation that increased managed care enrollment will

help slow Medicare spending. To date, Medicare managed care has

failed to meet that promise and, owing to payment methodology flaws,

has actually cost the government more than if enrolled beneficiaries had

remained in traditional fee-for-service Medicare. BBA attempts to

correct this problem by mandating several adjustments to Medicares

payments to managed care plans. These are adjustments that industry

representatives have sought to delay and that they claim will lead to less

rather than greater plan participation in Medicare+Choice. 8

7HCFA Management: Agency Faces Multiple Challenges in Managing Its Transition to the 21st Century

(GAO/T-HEHS-99-58, February 11, 1999).

8See Medicare Managed Care: Better Risk Adjustment Expected to Reduce Excess Payments Overall

While Making Them Fairer to Individual Plans (GAO/T-HEHS-99-72, February 25, 1999).
Page 23 GAO/T-AIMD/HEHS-99-113

The second perspective touches on beneficiary expectations. In principle,

managed care can reshape consumer behavior. The intent of

Medicare+Choice is to provide beneficiaries a greater menu of plan choices

that offer additional benefits, like prescription drugs, not covered in

traditional Medicare. Simultaneously, however, plans will attempt to

manage care, thus resulting in beneficiaries facing limits on both traditional

and additional services. In this way, Medicare+Choice would demonstrate

that resources are constrained and that expanding choice must involve

trade-offs.

BBA illustrates the temptation to proceed down the slippery slope of

federal Treasury funding rather than sticking with the more difficult task of

attempting meaningful program or financing reforms. The act calls for

reallocating a portion of home health spending from the HI program to the

SMI program. This is essentially an accounting exercise that moves

obligations from the HI trust fund account to SMI. While this reallocation

could position policymakers to develop additional structural reforms for

this benefit, the movement of home health payments from HI to SMI alone

generates little net savings. Similarly, 1993 legislation increased the taxable

portion of Social Security benefits and, for all practical purposes, shifted

this additional revenue to the HI trust fund. These two shifts illustrate a

pattern of taking from Peter to pay Paul.

The lessons learned so far from the BBA experience are twofold. First,

passing the legislation is a bold first step, but remaining resolute and

effectively implementing the provisions constitute an equally challenging

second step. Second, relative to the reforms necessary to align Medicare

spending with the nations priorities for all spending, BBAs changes may

represent only a minor excision when major surgery is required to assure

the HI programs solvency. BBA did result in reduced costs and cut the

long-term actuarial imbalance significantly. Nonetheless, the HI and SMI

programs together are still projected to grow by nearly a full percentage

point of GDP over the next 10 years.

The pressures that continue to drive health care spending upward are

exacerbated by the undefined boundaries between what the nation and

individuals want, need, and can afford.

Conclusions Budget surpluses provide a valuable opportunity to capture significant

long-term gains to both improve the nations capacity to address the

looming fiscal challenges arising from demographic change and aid in the
Page 24 GAO/T-AIMD/HEHS-99-113

transition to a more sustainable Medicare program. The Presidents

proposal should prompt a discussion about the importance of the trust

fund concept in disciplining spending for Medicare. The Presidents

proposal is both wide-ranging and complex, and it behooves us to clarify

the consequences for both our national economy and the Medicare

program.

A substantial share of projected budget surpluses over the next 15 years

would be used to reduce publicly held debt, providing demonstrable gains

for our economic capacity to afford our future commitments. Saving a

good portion of todays surpluses can help future generations of workers

better afford the ballooning costs of these commitments, but we must also

reform the programs themselves to make these commitments more

affordable and sustainable over the long term.

The transfer of surplus resources to the HI trust fund, which the

administration argues is necessary to lock in surpluses for the future,

would nonetheless constitute a major shift in financing for the Medicare

program. However, it would not constitute real Medicare reform because it

does not modify the programs underlying commitments for the future.

Moreover, the proposed transfer may very well make it more difficult for

the public to understand and support the hard choices necessary for the

programs future viability.

While meaningful reform is urgently needed, it will require reshaping the

nations perspective on health care consumption and draw clearer

distinctions between needs, wants, and affordability. Complicating this

effort is the nations strong commitment to maintaining and even enhancing

the quality of and access to services. Further, we have a history of

technological development, which may in some cases make health care

delivery more efficient or effective, but sometimes has driven spending up

without contributing significantly to the quality or length of life.

Irrespective of whether the Presidents proposal is enacted or not, the

Medicare program is in need of fundamental reform to assure its solvency

and sustainability over the long term. There will be many proposals to

modify Medicare and to implement fundamental change. I would suggest

the following five criteria for evaluating these proposals.

 Affordability: Changes should ensure that the Medicare program

consumes a reasonable share of our productive resources and that it

does not unduly encroach on other necessary public programs or
Page 25 GAO/T-AIMD/HEHS-99-113

private sector activities. Retaining the self-financing feature of the HI

trust fund will help instill the necessary fiscal discipline that I fear could

be eroded through general fund subsidies for the program. Shifting

excess expenditures from one sector of the budget to another or

transferring the burden to different payers or future generations should

not be construed as actions that will make the trust fund solvent or

future program commitments sustainable. Rather, there needs to be a

fundamental rethinking of the incentives in the current program that

promote increased intensity and utilization of services without

sufficient consideration of their costs. Proposals that involve early

action on modifications to the program to take advantage of the

compounding fiscal dividends of savings that are achieved sooner

should be preferred.

 Equity: Reforms should not impose a disproportionate burden on

particular groups of beneficiaries or providers. It may be that correcting

the distortions created by our current system requires substantial

reductions in utilization by certain groups of beneficiaries or of certain

types of services. Graduated implementation could make the burden of

such shifts less onerous.

 Adequacy: Beneficiaries should have appropriate access to health care

services, regardless of their individual ability to pay. Further, the

tradition of technology development, which has contributed greatly to

health and health care in this country, needs to be maintained in a

manner that supports cost-effective and clinically meaningful

innovations that enhance the quality and length of life.

 Feasibility: Reforming an entitlement defined in specified benefits

rather than dollar terms must involve changing the behavior of

beneficiaries and providers. A proposal must contain the correct array

of incentives to achieve necessary behavioral change. It must also

involve mechanisms that an entity like HCFA can implement and

monitor. There must also be provisions for a safety valve to recalibrate

aspects when the intermediate goals are not achieved.

 Acceptance: Beneficiaries, taxpayers, and providers must reach a

consensus on any major changes to ensure their long-term viability. The

path for getting there must begin with steps that will make program

costs, which today are barely opaque, much more transparent to the

public. Sufficient beneficiary and provider education to the realities of

the trade-offs involved may facilitate their acceptance. Further, a

phased approach could help ease any disruptions in services or incomes

while garnering public approval.
Page 26 GAO/T-AIMD/HEHS-99-113

Applying such criteria will require a detailed understanding of the possible

outcomes and issues associated with the various elements of proposals.

We will be happy to work to provide the data, information, and analysis

needed to help policymakers evaluate the relative merits of various

proposals and move toward agreement on much needed Medicare reforms.

The time has come for meaningful Medicare reform. Delay will only serve

to make the necessary changes more painful down the road. We must be

straight with the American people--achieving the goal of saving Medicare

will require real options and tough decisions to increase program revenues

and/or decrease program expenses. There is no free lunch.

We have an historic opportunity to deal with the temporary surpluses

available today, and how we do so could position us better to deal with the

future. We also have an obligation to execute our fiduciary responsibilities

regarding the nations fiscal health. This involves demonstrating prudent

management of the projected unified surpluses. At the same time, we

cannot let the comfort afforded by these temporary surpluses lull us into

complacency. Instead, we must capitalize on this opportunity to engage in

serious entitlement reform.

We at GAO stand ready to help the Congress as you develop effective,

equitable, and affordable solutions for Medicare reform. Working together,

we can make a positive and lasting difference for our country and the

American people.

Mr. Chairman, this concludes my statement. I would be happy to answer

any questions that you or the Members of the Committee may have.

(935309) Letr
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