For Release on Delivery

Expected at

2 p.m.

Monday,

March 27, 2000

GAO/T-AIMD-00-126

MEDICARE REFORM

Issues Associated With

General Revenue

Financing

Statement of Paul L. Posner

Director, Budget Issues

Accounting and Information Management Division

Testimony

Before the Special Committee on Aging, U.S. Senate

United States General Accounting Office

GAO
Page 1 GAO/T-AIMD-00-126

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss the use of general fund

revenues as part of Social Security and Medicare reform. As you

requested, I will focus my remarks specifically on general revenue

financing of the Medicare program. Despite some very positive, short-term

developments regarding our economy, the federal surplus, and Medicare

spending, the bigger picture remains virtually unchanged. Long-term cost

pressures facing the program are considerable. Even before adding a

prescription drug benefit, for example, projected program spending

threatens to absorb unsustainable shares of the nation’s budgetary and

economic resources. The Office of the Actuary at the Health Care

Financing Administration has estimated the actuarial imbalance for the

Hospital Insurance (HI) portion of Medicare at $2.9 trillion through 2074–

this is the present value of the amount by which future payments exceed

projected revenues for the program. In testimony before this and other

congressional committees, the Comptroller General has expressed

concern about the expanded use of general revenues in program financing

and the need for comprehensive reform that will address the program’s

long-term sustainability.1 My statement today will underscore these

concerns.

It is tempting to push aside this gloomy forecast in light of recent surplus

projections. However, the recent good news on the budget does not mean

that difficult budget choices are a thing of the past. First, it is important to

recognize that, by their very nature, projections are uncertain. This is

especially true today because, as the Congressional Budget Office (CBO)

notes, it is too soon to tell whether recent boosts in revenue reflect a

major structural change in the economy or a more temporary divergence

from historical trends. Indeed, CBO points out that assuming a return to

historical trends and slightly faster growth in Medicare would change the

on-budget surplus to a growing deficit. This means we should treat surplus

predictions with caution.

Moreover, while the size of future surpluses could exceed or fall short of

projections, demographic and cost trends will, in the absence of

meaningful reform, drive Medicare spending to levels that will prove

unsustainable for future generations of taxpayers. Accordingly, we need to

1See Medicare: Program Reform and Modernization Are Needed But Entail Considerable Challenges (GAO/THEHS/AIMD-00-77, Feb. 8, 2000); Medicare Reform: Leading Proposals Lay Groundwork, While Design

Decisions Lie Ahead (GAO/T-HEHS/AIMD-00-103, Feb. 24, 2000); Medicare Reform: Observations on the

President’s July 1999 Proposal (T-AIMD/HEHS-99-236, July 22, 1999).
Page 2 GAO/T-AIMD-00-126

view this period of projected prosperity as an opportunity to begin

addressing the structural imbalances in Medicare, Social Security, and

other entitlement programs before the approaching demographic tidal

wave makes the imbalances more dramatic and possible solutions much

more difficult and painful.

As the foregoing suggests, the stakes associated with Medicare reform are

high not only for the program but also for the rest of the federal budget,

both now and for future generations. Without meaningful reform, the longterm financial outlook for the Medicare program is bleak. Current policy

decisions can help us prepare for the challenges of an aging society in

several important ways: (1) by reducing public debt to increase national

saving and investment, (2) by reforming entitlement programs to reduce

future claims and free up resources for other competing priorities, and

(3) by establishing a more sustainable Medicare program that delivers

effective and affordable health care to our nation’s seniors.

Leading reform proposals that address comprehensive reform such as

those of the President and Breaux-Frist include the use of general funds as

part of their financing mechanisms. While some precedent exists for the

use of general funds in federal trust funds, we need to ask how such

general fund infusions can be structured so as to facilitate, not impede,

needed reform and fiscal discipline.

In this context, I would like to make a few summary points before delving

into the specifics of Medicare’s financial health and issues raised by

increased reliance on general revenue financing.

• To qualify as meaningful reform, any proposal should make a significant

down payment toward ensuring Medicare’s long-range financial integrity

and sustainability—the most critical issue facing Medicare. Reform efforts

ought not to be piecemeal. Financial reforms such as general revenue

financing should not be considered alone but as part of a broader reform

package. Recent history with Medicare reform shows that benefit

expansions are compelling while fiscal controls and constraints are

difficult to enact and sustain.

• General fund infusions may well be a necessary part of program reform,

but caution is warranted in considering the commitment of additional

general revenues. General revenue financing can extend the solvency of

the program but does not alone do anything to make the program more

sustainable in the long term. In fact, without underlying reforms, general

revenue financing could very well serve to reduce the sense of urgency to
Page 3 GAO/T-AIMD-00-126

make needed program changes that impending trust fund bankruptcy

provides to policymakers.

• In addition, some consideration should be given to a process to guard

against the risk that growing program financial needs will routinely be met

with additional general fund infusions, thereby further mortgaging the

future and crowding out other national needs. Accordingly, any additional

general revenue infusions should be coupled with mechanisms to monitor

costs over time and to alert policymakers of the need to take timely action

when total projected costs exceed thresholds or triggers related to some

indicator of sustainability.

Health care costs compete with other legitimate priorities in the federal

budget, and their projected growth threatens to crowd out future

generations’ flexibility to decide which competing priorities will be met .In

making important fiscal decisions for our nation, policymakers need to

consider the fundamental differences between wants, needs, and what

both individuals and our nation can afford. This concept applies to all

major aspects of government, from major weapons system acquisitions to

issues affecting domestic programs. It also points to the fiduciary and

stewardship responsibility that we all share to ensure the sustainability of

Medicare for current and future generations within a broader context of

providing for other important national needs and economic growth. Given

the size of Medicare’s projected funding needs, it is realistic to expect that

reforms intended to bring down future costs will have to proceed

incrementally. The time to begin the difficult but necessary steps to

reclaim our fiscal future is now, when we have budget surpluses and a

demographic “holiday” with retirees a far smaller proportion of the

population than they will be in the future.

Before I turn to a more detailed description of Medicare’s financial

structure including the Hospital Insurance (HI) trust fund, it is helpful first

to look more generally at what the term “trust fund” means in the context

of the federal budget.

The federal budget consists of several fund types: the general fund, special

funds, public enterprise funds, intragovernmental funds, and trust funds.2

All of these except trust funds are considered to be “federal funds.” All

unified budget transactions fall within either of two fund groups: (1)

federal funds and (2) trust funds.

2There are both revolving and nonrevolving trust funds, but that difference is not relevant to this analysis.

Federal Trust Funds
Page 4 GAO/T-AIMD-00-126

Although some budget summary tables show only about a dozen major

trust funds, in fiscal year 1998 there were 112 trust funds.3 These covered a

wide range of purposes: from social insurance (Social Security and

Medicare), employee compensation (pensions and health benefits),

insurance, natural resources and environmental cleanup to transportation.

Social Security is by far the largest trust fund, followed by federal

employee retirement funds (civilian and military) and the Medicare trust

funds.

In the federal budget, the term “trust fund” neither means what it does for

a private trust fund nor indicates unique characteristics within the federal

budget.4 The manager of a private trust has a fiduciary obligation to the

beneficiary and must manage the trust’s assets on behalf of that

beneficiary according to the stipulations of the trust. The manager cannot

unilaterally alter the terms of that trust. In contrast, the federal

government both owns the assets of most trust funds and can, through

legislation, raise or lower the fund’s collections or payments, or alter the

purposes of the trust fund.

Unlike a private trust fund, which can set aside money for the future by

increasing its assets, federal trust funds are not vehicles to park “real”

savings for the future. They are simply budget accounting mechanisms

used to record receipts and expenditures earmarked for specific purposes.

This is unlike state governments, which 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.

Under current law, when a federal trust fund like the HI trust fund runs a

surplus of payroll tax revenues over benefit payments, that surplus must

be 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, as the

HI trust fund did between 1992 and 1998, it redeems these securities to pay

benefit costs exceeding current payroll tax receipts. Medicare will be able

to do this until 2015 under current law when the HI trust fund securities

are projected to be exhausted. However, in order to redeem these

securities, the government as a whole must come up with cash by

3Based on GAO analysis. This count represents trust funds and trust fund groupings for similar purposes.

4Within the federal budget, there is no substantive difference between a trust fund and a special fund. Both are

internal accounting devices used to track the collection and use of funds earmarked for specific purposes. The

only difference between a “special” fund and a “trust” fund is the word “trust” in the legislation establishing the

account. In fiscal year 1998 there were 102 special funds.
Page 5 GAO/T-AIMD-00-126

increasing taxes, reducing spending, reducing projected surpluses, or

borrowing more from the public if projected surpluses are not realized.

Since the trust fund’s securities constitute a legal claim against the

Treasury, increasing the balances of Treasury securities held by the HI

trust fund would extend its solvency and increase the formal claim that HI

has on future general revenues. 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 fund’s claims to

pay benefits now and in the future and at what cost for other competing

claims for scarce resources. 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 fund’s

solvency without reforms to make the underlying program more

sustainable can obscure the warning signals that trust fund balances

provide, thereby creating a false sense of security and delaying needed

reform.

Without meaningful reform, the long-term financial outlook for the

Medicare program is bleak. Under the Trustees’ 1999 intermediate

projections, HI and Supplementary Medical Insurance (SMI) expenditures

taken together are expected to increase dramatically, rising from about 12

percent in 1999 to about a quarter of all federal revenues by mid-century,

even without adding to the benefit package. Over the same time frame,

Medicare’s expenditures are expected to double as a share of the

economy, from 2.5 to 5.3 percent, as shown in figure 1.

Medicare’s Financial

Condition

Medicare Is Fiscally

Unsustainable in the Long

Term
Page 6 GAO/T-AIMD-00-126

Figure 1: Medicare Spending as a Percentage of Gross Domestic Product

(GDP) 1999 to 2073

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital Insurance Trust

Fund and 1999 Annual Report, Federal Supplementary Insurance Trust Fund.

Absent reform, the financial burden of Medicare and Social Security on

future taxpayers becomes unsustainable. As figure 2 shows, the cost of

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

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

programs would constitute an unimaginable drain on the earnings of our

future workers.
Page 7 GAO/T-AIMD-00-126

Figure 2: Social Security and Medicare HI Costs as a Percentage of Taxable

Payroll, 1999 to 2074

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital Insurance Trust

Fund, and 1999 Annual Report, Board of Trustees of the Federal Old Age and Survivors

Disability Insurance Trust Funds.

While the problems facing the Social Security program are significant,

Medicare’s challenges are even more daunting. To bring Social Security

into actuarial balance today would require raising the payroll tax by 2.07

percentage points–a 17-percent increase–whereas the HI payroll tax would

have to be raised by 1.46 percentage points–a 50-percent increase–to

restore actuarial balance to the HI trust fund. This analysis, moreover,

does not incorporate the financing challenges associated with the SMI and

Medicaid programs.

When viewed from the perspective of the entire budget and the economy,

the growth in Medicare and Social Security spending will become

progressively unsustainable over the longer term. Our updated budget

simulations show that to move into the future without making changes in

the Social Security, Medicare, and Medicaid programs is to envision a very

different role for the federal government. Assuming, for example, that the

Congress and the President adhere to the often-stated goal of saving the

Social Security surpluses, our long-term model shows a world by 2030 in

which Social Security, Medicare, and Medicaid increasingly absorb

available revenues within the federal budget. Under this scenario, these

programs would require more than three-quarters of total federal revenue.

(See fig. 3.) Budgetary flexibility would be drastically constrained and

0

5

10

15

20

25

30

1999

2002

2005

20082011201420172020202320262029

2032

2035

2038

20412044204720502053205620592062

2065

206820712074

Percent of taxable payroll

Current Level
Page 8 GAO/T-AIMD-00-126

little room would be left for other federal spending priorities such as

national defense, the young, infrastructure, and law enforcement.

Figure 3: Composition of Spending as a Share of GDP Under the “Eliminate

Non-Social Security Surpluses” Simulation

*The “Eliminate non-Social Security surpluses” simulation can only be run through 2066

due to the elimination of the capital stock.

Notes:

1. Revenue during the simulation period is lower as a share of GDP than the 1999 level

due to unspecified permanent policy actions that reduce revenue and increase

spending to eliminate the non-Social Security surpluses.

2. Medicare expenditure projections follow the Trustees’ 1999 intermediate

assumptions. The projections reflect the current benefit and financing structure.

Source: GAO’s January 2000 analysis.

The levels of public saving assumed in the simulation exceed both U.S.

historical levels and those sustained by most other countries we have

studied. Essentially, saving just the Social Security surplus would

eliminate debt held by the public—an outcome with benefits for both the

budget and the economy. But it would require sustained fiscal sacrifice

unlike any seen in our modern experience. Under this simulation, debt

held by the public would not only be eliminated; the U.S. would be

investing federal surpluses in nongovernmental assets for several years.

Moreover, the levels of public saving assumed in the simulation will not by

themselves be enough in the long term to promote the kind of economic

growth to which we have become accustomed. Even assuming these

significant and unprecedented levels of fiscal restraint over many years,

entitlement spending will still encumber an unsustainable share of federal

resources in the future.

0

10

20

30

40

50

60

1999 2030 2050 2074*

Percent of GDP

So cial Secu rity Medicare & Med icaid Net interest All o th er spend in g

Revenue
Page 9 GAO/T-AIMD-00-126

As with Social Security, the progressive absorption of a greater share of

the nation’s resources for health care is in part a reflection of the

increasing growth in the elderly population, but Medicare cost growth

rates also reflect the escalation of health care costs at rates well exceeding

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

care services have been fueled by the explosive growth of medical

technology. Moreover, the actual costs of health care consumption are not

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

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

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

muted because about 80 percent of beneficiaries have some form of

supplemental health care coverage (such as Medigap insurance) that pays

these costs. For these reasons, among others, Medicare represents a much

greater and more complex fiscal challenge than even Social Security over

the longer term.

Under the current Medicare structure, the program consists of two parts.

Medicare’s HI Trust Fund, also known as part A, is financed primarily by

payroll taxes paid by workers and employers.5 SMI, also known as part B,

is financed largely through general revenues. Currently, the financial

health of Medicare is often gauged by the solvency of the HI trust fund.

This measure, however, presents an incomplete picture of total program

solvency. In addition, because of the nature of federal trust funds, the HI

trust fund balances do not provide meaningful information about program

sustainability—that is, the government’s fiscal capacity to pay benefits

when the program’s cash inflows fall below benefit expenses.

The 1999 Trustees’ annual report showed that Medicare’s HI component

was, on a cash basis, in the red from 1992 to 1998; in fiscal year 1998,

earmarked payroll taxes covered only 89 percent of HI spending. Although

the Office of Management and Budget has recently reported a $12 billion

cash surplus for the HI program in fiscal year 1999 due to lower than

expected program outlays, the Trustees’ report issued in March 1999

projected continued cash deficits for the HI trust fund. (See fig. 4.)

5Old-Age and Survivors Insurance and Disability Insurance (OASDI) beneficiaries whose adjusted gross

income exceeds certain threshold amounts must pay income taxes on up to 85 percent of their annual benefits.

The Omnibus Budget Reconciliation Act of 1993 increased the maximum amount of Social Security benefits

subject to income tax from 50 to 85 percent and provided that the additional revenues would be credited to the

HI trust fund. Revenue from this source totaled $5.1 billion in fiscal year 1998.

Medicare’s Current

Program and Financing

Structure
Page 10 GAO/T-AIMD-00-126

Figure 4: Financial Outlook of the Hospital Insurance Trust Fund, 1990 to

2025

Source: GAO analysis of data from the Office of the Actuary, Health Care Financing

Administration.

Much of the public debate focuses on trust fund balances—and the 1999

Trustees’ report estimates that the HI trust fund will remain solvent

through 2015. However, the more important measure is the net cash

impact of the trust fund on the government as a whole. From this

perspective, when the HI trust fund has an annual cash deficit, as it did

from 1992 through 1998, Medicare is a net claimant on the Treasury—a

threshold that Social Security is not currently expected to reach until 2014.

To finance these cash deficits, Medicare drew on its special issue Treasury

securities acquired during the years when the program generated a cash

surplus. In essence, for Medicare to “redeem” its securities, the

government must raise taxes, cut spending for other programs, or reduce

projected surpluses. Figure 5 depicts the relationship of the HI trust fund

to the unified budget and the general fund under current law when the

trust fund has a cash surplus.

-200

-150

-100

-50

0

50

100

150

200

19901995200020052010

2015

20202025

Dollars in billions

Cash Surplus/Deficit Fund Balance

Cash Deficit 1992
Page 11 GAO/T-AIMD-00-126

Figure 5: Hospital Insurance Trust Fund Flows Under Current Law

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

Security benefits.

Note: If the trust fund has a cash surplus, debt held by the fund increases because special

Treasuries are issued to the fund. If the fund is in deficit, the flow is reversed with the fund

redeeming special Treasuries and receiving cash from the general fund to make benefit

payments.

Source: GAO analysis.

In contrast to HI, SMI, also known as part B, is financed through general

revenues and beneficiary premiums. The history of SMI financing

illustrates the difficulties of maintaining fiscal discipline. Originally the

part B premium was set at a level to finance 50 percent of SMI program

costs. However, less than 10 years later, the method for setting the SMI

premium was tied to changes in the cost of living, resulting in premiums

dropping below 25 percent of program costs. Under current law, the

premium is now set at 25 percent of program costs, with general revenues

paying the remaining 75 percent.

Currently, the financial health of the entire Medicare program is generally

gauged by the solvency of the HI trust fund–not the imbalance between

total program revenue and total program spending (both HI and SMI).

Clearly HI trust fund solvency is an incomplete measure, and since SMI is

projected to grow faster than HI in the coming decades, the HI trust fund

Benefits

Cash surplus loaned to

general fund

Special Treasuries for

•cash loan

•interest

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
Page 12 GAO/T-AIMD-00-126

risks becoming an increasingly inadequate signal of future fiscal

imbalances. This measure could in fact become misleading if additional

general revenue were used in program financing.

When outlays outstrip revenues in the HI fund, it is tempting to shift some

expenditures to SMI. Such cost shifting extends the solvency of the HI

Trust Fund but does nothing to address the fundamental financial health

of the program. Worse, it masks the problem and may cause fiscal

imbalances to go unnoticed. For example, in 1997 the Balanced Budget Act

modified the home health benefit, which resulted in shifting a portion of

home health spending from the HI trust fund to SMI. Although this shift

extended HI trust fund solvency, it increased the draw on general

revenues in SMI while generating little net savings. Ultimately, the critical

question is not how much a trust fund has in assets, but whether the

government as a whole can afford the promised benefits now and in the

future and at what cost to other claims on scarce resources.

A consensus appears to be emerging that substantive financing and

programmatic reforms are necessary to put Medicare on a sustainable

footing for the future. The current Medicare program, without

improvements, is ill-suited to serve future generations of seniors and

eligible disabled Americans. On the one hand, the program is fiscally

unsustainable in its present form, as the disparity between program

expenditures and program revenues is expected to widen dramatically in

the coming years. On the other, the program is outmoded in that it has not

been able to adopt modern, market-based management tools, and its

benefit package contains gaps in desired coverage. Thus, while financial

questions loom, pressure is mounting to update Medicare’s outdated

benefit design. However, doing so carries with it the potential to

exacerbate Medicare’s spending trajectory.

Given the aging of our society and the increasing cost of modern medical

technology, it is inevitable that the demands on the Medicare program will

grow. The National Bipartisan Commission on the Future of Medicare

noted that the program will require additional resources as the percent of

the population eligible for benefits increases. One major uncertainty in

Medicare’s future financing needs, the Commission noted, is the inability

to predict the evolution of the health care delivery system or the impact

that technology will have on health care costs. At the same time the

Commission emphasized the urgent need for reforms that will slow the

growth in Medicare spending.

Use of General Funds

in Medicare Reform

Raises Design Issues
Page 13 GAO/T-AIMD-00-126

Consider the case of prescription drug coverage. In 1965, when the

Medicare 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 in some cases. Most

private insurance options recognize these advantages by including

pharmaceutical coverage in their benefit packages. Many seek to similarly

modernize Medicare’s benefits. However, this desired expansion comes at

a time when prescription drug spending is increasing rapidly. From 1993 to

1998, prescription drug spending grew at an average annual rate of 12.4

percent compared with 5 percent average annual growth in health care

expenditures overall. A recent study has suggested that expanding

Medicare’s benefit package to include prescription drugs could add

between 7.2 and 10 percent annually to total program costs,6 and CBO

estimates the cost of the President’s proposed prescription drug benefit at

$149 billion in additional federal spending between 2003 and 2010.7

Although the case for adding a prescription drug benefit to Medicare is

appealing, any benefit expansion needs to be targeted, include appropriate

cost controls, and other program reforms that will begin to close the gap

between existing promised and funded benefits.

Given the size of Medicare’s projected funding needs, it is realistic to

expect that reforms to bring down future costs will have to proceed in an

incremental and iterative fashion. Comprehensive Medicare reform

cannot, once implemented, be put on automatic pilot. Recent experience

implementing changes shows that reform is a dynamic process requiring

vigilance and flexibility.

Last year, when the Comptroller General testified before the Congress on

the financing of the HI trust fund, he said that additional general revenues

may very well be necessary, but such a change would represent a marked

departure from payroll tax financing with implications that warrant

explicit and serious debate.8 Leading reform proposals that address

comprehensive reform such as those of the President and Breaux-Frist

include the use of general funds as part of their financing mechanisms.

While some precedent exists for the use of general funds in federal trust

6M.E. Gluck, National Academy of Social Insurance Medicare Brief: A Medicare Prescription Drug Benefit

(April 1999), p. 8. http://www.nasi.org/Medicare/medbr1.htm

7CBO, An Analysis of the President’s Budgetary Proposals for Fiscal Year 2001: A Preliminary Report

(March 9, 2000), p. 4.

8 Medicare and Budget Surpluses: GAO’s Perspective on the President’s Proposal and the Need for Reform

(GAO/T-AIMD/HEHS-99-113, March 10, 1999).
Page 14 GAO/T-AIMD-00-126

funds, we need to ask how such general fund infusions can be structured

so as to facilitate, not impede, needed reform and fiscal discipline.

The proposed changes to Medicare financing raise some important issues

that are not unique to the Medicare program but arise whenever general

revenues are commingled with other types of revenues such as payroll

taxes and beneficiary premiums in a federal trust fund. Whatever the

financing structure of Medicare, a continuing need will exist for a signal of

future fiscal imbalances to alert policymakers of the need to take timely

and prudent action. In addition, some consideration should be given to a

process that could guard against the risk that growing program financial

needs will routinely be met with additional general fund infusions, thereby

further mortgaging the future and crowding out other national needs. Such

a process could also be used to periodically re-assess the mix of differing

sources of program financing.

In the remainder of this testimony I would like to examine design issues

raised by leading reform proposals’ expanded use of general revenue,

focusing on the implications for program fiscal discipline and

consequences for the unified budget.

The President’s proposal is intended to make Medicare more efficient,

modernize the benefit package, and extend the program’s long-term

solvency. The proposal consists of several programmatic changes. Private

health plans would set their own premiums for a standard package of

benefits, competing on the basis of price and quality. Beneficiaries who

joined relatively inexpensive plans would pay little or nothing. Those who

joined relatively expensive plans would pay more. The system is intended

to make beneficiaries more sensitive to the cost consequences of their

decisions. The proposal maintains the traditional Medicare fee-for-service

program and includes measures intended to improve its efficiency and

strengthen future financing.9 The proposal also includes a prescription

drug benefit.

9For example, the plan would create a preferred provider option that would reward beneficiaries with

lower cost-sharing requirements when choosing certain providers; expand use of centers of

excellence, in which providers that specialize in certain procedures receive a global fee for all services

provided rather than a separate fee for each service; extend certain Balanced Budget Act (BBA)

provisions that reduce provider payment rate increases; impose a 20-percent copayment for clinical

laboratory services; and index the part B deductible for inflation. See Medicare Reform: Observations

on the President’s July 1999 Proposal (GAO/T-AIMD/HEHS-99-236, July 22, 1999) and Medicare

Reform: Leading Proposals Lay Groundwork, While Design Decisions Lie Ahead (GAO/

T-HEHS/AIMD-00-103, Feb. 24, 2000).

The President’s Proposal
Page 15 GAO/T-AIMD-00-126

In addition the proposal would earmark a portion of the projected nonSocial Security surpluses for Medicare. According to the Office of

Management and Budget, the proposal would use $432 billion, or 58

percent of the projected on-budget surpluses, over the next 10 years for

Medicare. Of the $432 billion, $299 billion (40 percent of the on-budget

surplus) would be transferred to the HI trust fund and used to reduce debt

held by the public. The proposal would use $98 billion of projected onbudget surpluses to pay for the proposed prescription drug benefit. The

remaining $35 billion would be used to establish a reserve fund. This fund

is to be used for debt reduction or, in the event that the President and the

Congress agree, for a policy that provides protections against catastrophic

drug costs for Medicare beneficiaries or policies that otherwise strengthen

the Medicare program.

The proposed transfer of surpluses would extend the solvency of the HI

trust fund from 2015 to 2025 and preserve the divided financing structure

(HI and SMI). It would not, however, address the sustainability of the

Medicare program and may, in fact, serve to decrease the likelihood of

needed reform. The transfer would also represent a significant departure

in how HI is financed. Established as a payroll tax funded program, HI

would now receive an explicit grant of funds from general revenues not

supported by underlying payroll tax receipts. That is, the value of

securities held by the HI trust fund would exceed that supported by earlier

payroll tax surpluses, and these additional securities would constitute a

new claim on the general fund for the future. Figure 6 depicts the flow of

funds for the HI program under the President’s proposal.
Page 16 GAO/T-AIMD-00-126

Figure 6: Hospital Insurance Trust Fund Flows Under the President’s

Proposal

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

Security benefits.

Note: If the trust fund has a cash surplus, debt held by the fund increases because special

Treasuries are issued to the fund. If the fund is in deficit, the flow is reversed with the fund

redeeming special Treasuries and receiving cash from the general fund to make benefit

payments.

Source: GAO analysis.

According to the Administration, the underlying rationale for the transfers

is that Medicare should be guaranteed a share of the benefits resulting

from the fiscal improvement that debt reduction and lower interest costs

would bring about.

With regard to its more general budgetary significance, the President’s

proposal is part of a broader initiative that would save a major share of the

surplus, including all of the Social Security surplus, to reduce debt held by

the public. According to the Administration’s projections, this initiative

will reduce interest payments from $230 billion in 1999 to nearly zero in

2013 when publicly held debt would be virtually eliminated. The reduction

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

Proposed

Transfer of

General Revenue -

Additional

Special Treasuries

Special Treasuries for

•cash loan

•interest

Cash surplus loaned to

general fund
Page 17 GAO/T-AIMD-00-126

in publicly held debt proposed by the President would confer significant

short- and long-term benefits to the budget and the economy. Our work on

long-term budget outlooks illustrates the benefits of maintaining surpluses

for debt reduction. Today, interest on the debt represents the third largest

expenditure in the federal budget. Reducing the publicly held debt reduces

these costs, freeing up budgetary resources for other programmatic

priorities. For the economy, lowering debt increases national saving and

frees up resources for private investment. This in turn leads to stronger

economic growth and higher incomes over the long term.

The size of the imbalances between Medicare’s outlays and payroll tax

revenues for the HI program may well justify the need for additional

financing from general revenues. However, the mechanism the President

has proposed entails significant risks if considered on its own without

being coupled to reforms. Indeed, I would note that the President has also

included certain reforms as part of his proposal. Without underlying

reform, increasing the HI trust fund balances would do nothing to make

the program—HI or SMI—more sustainable. In fact, the transfer would

interfere with the signaling function that trust fund mechanisms can serve

for policymakers about underlying fiscal imbalances in covered programs.

The greatest risk is that the proposed transfer will reduce the sense of

urgency that impending trust fund bankruptcy provides to policymakers

by artificially extending the solvency of the HI program through 2025—

well into the peak of the baby boomers’ retirement. Furthermore, the SMI

portion of Medicare, projected to grow even faster than HI, is unaffected

by this transfer.

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

program. Whether you believe it is a major change in reality 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

trust fund will exhaust its securities to pay the full promised benefits in

2015. If you believe that this shortfall would be made up with general

funds when the time came, then the shift embedded in the President’s

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 President’s 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 be financed through higher taxes or

spending cuts elsewhere in the federal budget as a whole. Again, we have

recognized that the President has now coupled his financing proposal with

substantive Medicare reforms. It is critical that these two elements not be

severed.
Page 18 GAO/T-AIMD-00-126

Another issue the proposal raises is whether the transfers 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 a

fixed dollar amount rather than as a percent of the actual on-budget

surplus in any given year. These transfers would have a claim on future

general revenues even if the actual on-budget surplus fell below the

amount specified for the transfers. 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.

Like the President’s, the Breaux-Frist proposal (S. 1895) would effect both

structural and substantive change to Medicare financing. Breaux-Frist

addresses the principal elements of reform using a competitive premium

approach to contain costs and modernize program benefits.10 The proposal

would also eliminate the HI trust fund by merging it with SMI to create a

single unified Medicare trust fund. This change would eliminate the

potential for cost shifting between the two programs as well as the use of

the HI trust fund as a measure of program solvency. Instead, the proposal

would establish a new concept for measuring “programmatic insolvency”

as the point at which general fund contributions exceed 40 percent of total

program expenditures. Under Breaux-Frist, the Trustees would be

required to report annually on the percentage of total expenditures

financed by general fund contributions and identify the first fiscal year (if

any) in which the program was projected to become “programmatically

insolvent.” Congressional approval would then be required to authorize

any additional contributions to the Medicare trust fund.

In these and certain other respects, the Breaux-Frist proposal

incorporated recommendations made by the National Bipartisan

Commission on the Future of Medicare. The Commission called attention

10Under Breaux-Frist, each participating health plan (including traditional fee-for-service Medicare, which

would be administered by the Health Care Financing Administration) would determine its own premium for a

benefit package that must cover all benefits offered by traditional Medicare. The percentage of the premium

paid by the beneficiary would be set through a formula that compares a plan’s premium with a national average

of all plan premiums. Beneficiaries who joined relatively inexpensive plans would pay little or nothing. Those

who joined relatively expensive plans would pay more. The system is intended to make beneficiaries more

sensitive to the cost consequences of their decisions. Because plans would compete for market share, they

would have an incentive to operate efficiently and attract beneficiaries by setting premiums that reflect that

efficiency. The proposal includes provisions to ensure low-income beneficiaries access at little or no cost.

Breaux-Frist would require plans to offer high option coverage that would modernize Medicare’s benefit

package by providing outpatient prescription drug and stop-loss benefits. The incremental cost of high option

coverage would be subsidized for low-income beneficiaries while other beneficiaries would pay such costs

themselves. An independent Medicare board would be established to administer the program as a whole.

The Breaux-Frist Proposal
Page 19 GAO/T-AIMD-00-126

to the inadequacy of the HI trust fund as a measure of total program

solvency, noting that the portion of Medicare expenditures paid by general

funds has increased over time relative to the share paid by payroll taxes

and beneficiary premiums. According to the Commission, a new measure

of solvency was needed that would couple the uncertainty inherent in the

task of gauging program financing in light of the difficulty in predicting

future health care technology with the real need for the public to evaluate

the cost of Medicare and how we should choose to fund this program over

time.

The 40-percent threshold for general fund contributions proposed by

Breaux-Frist would provide a mechanism that would require policymakers

to revisit Medicare reform if program financing demands continue to grow

in the coming decades as the proportion of the population eligible for

benefits grows. This mechanism could prompt future Congresses to

periodically revisit Medicare financing issues and enact needed reforms. In

concept the use of a threshold holds the potential to enhance future

federal budgetary flexibility by calling attention when Medicare’s share of

general revenues is about to exceed specified levels. If coupled with an

effective oversight process, a threshold mechanism could also prompt

Congress to debate the appropriate proportions of general fund

contributions, payroll taxes, and premiums for Medicare financing in the

context of contemporary economic and budgetary environments.

Current spending projections show that absent reform that addresses total

program cost, this limit would be reached in less than 10 years. (See fig. 7.)

These data underscore the need for reform to include appropriate

measures of fiscal sustainability as well as a credible process to give

policymakers timely warning when fiscal targets are in danger of being

overshot.
Page 20 GAO/T-AIMD-00-126

Figure 7: Projected Funding Gap Under a 40-Percent Threshold for General

Revenue Contributions

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital Insurance Trust

Fund and 1999 Annual Report, Federal Supplementary Insurance Trust Fund.

As I discussed earlier, the introduction of general revenue financing to

trust fund programs raises some important design issues, one of which is

that such financing interferes with the signaling function that the trust

fund account structure provides. Accordingly, it would be desirable to put

in place some mechanism to constrain general revenue contributions or at

least to signal that they are growing and ought to be addressed. Both

Breaux-Frist and the President’s proposals include elements designed to

moderate future Medicare spending, but their approaches are untested. It

would be imprudent to adopt a financing structure relying on general

revenues without a mechanism to gauge spending and revenues and sound

an early warning if policy course corrections are warranted.

The Breaux-Frist approach would deem the trust fund “programmatically

insolvent” if the general revenue transfer needed to make payments

exceeded 40 percent of total Medicare expense for the fiscal year. While

this establishes a “trigger” for insolvency, it does not specify what would

happen if insolvency occurs. Both a trigger and some resulting specified

course of action would be necessary to ensure that imbalances between

trust fund receipts and payments are addressed before they become an

unending drain on general revenues.

Given that Medicare cost growth has generally been faster than growth in

the rest of the budget, a trigger that permits the dollar amount of general

Designing a Threshold for

General Fund

Contributions

Funding gap 2008
Page 21 GAO/T-AIMD-00-126

revenue financing to float upward as Medicare expenses increase would

allow increasingly larger shares of general revenues from other

government programs. To avoid this potentially unencumbered draw on

general revenue a number of different indicators might be explored as

possible triggers to action. For example, a trigger could be defined as

when the general revenue transfer reaches some specified percent of total

federal revenues. Such a trigger could limit general revenue support to a

certain share of federal revenue rather than letting it grow at the same rate

as Medicare expenses as in Breaux-Frist. Other possible triggers could be

a specified floor in the trust fund, such as the balance falling below 1

year’s worth of payments; the percentage of gross domestic product

devoted to Medicare; or program spending per enrollee.

Whatever the trigger, the key question would be what happens when the

trigger limits are reached. One approach in designing such a trigger would

be to couple it with specified actions to occur if the trigger is reached. A

“hard” trigger would include specific provisions that would automatically

go into effect if the trigger is reached. Perhaps more realistically, a “softer”

trigger could require the Congress or the President to take some action or

to re-affirm acceptance of the Medicare cost growth and provide

additional general revenues to cover it. This would at least ensure that the

Congress and the President periodically review and decide how to address

cost growth if it occurs.

Several alternatives might be considered for implementing such a trigger.

For example, reaching a trigger could require the President to propose

how to deal with the growth and the Congress to vote on the proposal,

either accepting it or developing an alternative. Or the congressional

budget process could be used to require the Congress to deal with

Medicare cost growth by establishing a point of order against a budget

resolution that includes a Medicare spending path that exceeds a specified

trigger measure. Raising the point of order could require the Congress to

propose changes to Medicare to bring it within the specified measure or

vote to accept the cost growth. If program changes are desired,

reconciliation instructions could be included in the budget resolution. The

President would be brought into the process as it progressed because

changes to Medicare would require enactment of a law. In fact, the current

budget process contains a similar point of order against worsening the

financial condition of the Social Security trust funds.

Discipline cannot be instilled by a process change alone; leaders must be

committed to enforcing discipline for it to be effective. The trust fund

mechanism has shown that when such processes or mechanisms are

viewed as credible, they can help focus the debate and promote timely
Page 22 GAO/T-AIMD-00-126

actions. If the signaling feature of trust funds is to be weakened by general

revenue injections, it is imperative that some other process discipline be

developed, either as I have suggested or in some other way. We will be

happy to work with your staff to further develop any of the ideas I have

mentioned or others that may be proposed to inject the necessary

discipline.

In determining how to reform the Medicare program, much is at stake—

not only the future of Medicare itself but also assuring the nation’s future

fiscal flexibility to pursue other important national goals and programs. As

the Comptroller General has said, the greatest risk lies in doing nothing to

improve the program’s long-term sustainability or, worse, in adopting

changes that may aggravate the long-term financial outlook for the

program and the budget.

It is my hope that we will think about the unprecedented challenge facing

future generations in our aging society. Relieving them of some of the

burden of today’s financing commitments would help fulfill this

generation’s fiduciary responsibility. It would also preserve some capacity

to make their own choices by strengthening both the budget and the

economy they inherit. While not ignoring today’s needs and demands, we

should remember that surpluses can be used as an occasion to promote

the transition to a more sustainable future for our children and

grandchildren. While reducing debt is important, debt reduction alone will

be insufficient to secure our economic future. We need to view this period

of projected prosperity as an opportunity to address the structural

imbalances in Medicare, Social Security, and other entitlement programs

before the approaching demographic tidal wave makes the imbalances

more dramatic and meaningful reform less feasible.

The bottom line is that surpluses represent both an opportunity and an

obligation. We have an opportunity to use our unprecedented economic

wealth and fiscal good fortune to address today’s needs but an obligation

to do so in a way that improves the prospects for future generations. This

generation has a stewardship responsibility to future generations to

reduce the debt burden they will inherit, to provide a strong foundation for

future economic growth, and to ensure that future commitments are both

adequate and affordable. Prudence requires making the tough choices

today while the economy is healthy and the workforce is relatively large.

National saving pays future dividends over the long term but only if

meaningful reform begins soon. Entitlement reform is best done with

considerable lead time to phase in changes and before the changes that

are needed become dramatic and disruptive. The prudent use of the

Concluding

Observations
Page 23 GAO/T-AIMD-00-126

nation’s current and projected budget surpluses combined with

meaningful Medicare and Social Security program reforms can help

achieve both of these goals.

Mr. Chairman and Members of the Committee, this concludes my prepared

statement. I will be happy to answer any questions you may have.

(935360)
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