Testimony 

Before the Subcommittee on Health, 

Committee on Energy and Commerce, 

House of Representatives 

United States General Accounting Office 

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Wednesday, May 5, 2004 MEDICARE PHYSICIAN 

PAYMENTS 

Information on Spending 

Trends and Targets 

Statement of A. Bruce Steinwald 

Director, Health Care—Economic 

 and Payment Issues 

GAO-04-751T 
www.gao.gov/cgi-bin/getrpt?GAO-04-751T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact A. Bruce 

Steinwald at (202) 512-7101. 

Highlights of GAO-04-751T, a testimony 

before the Subcommittee on Health, 

Committee on Energy and Commerce, 

House of Representatives 

May 5, 2004

MEDICARE PHYSICIAN PAYMENTS

Information on Spending Trends and 

Targets 

Medicare spending on physician services grew rapidly through the 1980s, at 

an average annual rate of 13.4 percent, even though physician fee increases 

were subject to some limits. The spending growth was driven by increases 

in the number of services provided to each beneficiary—referred to as 

volume—and an increase in the average complexity and costliness of those 

services—referred to as intensity. Recognizing that expenditure growth of 

this magnitude was not sustainable, the Congress attempted to impose fiscal 

discipline by establishing a system of spending targets for Medicare 

physician services along with a fee schedule beginning in 1992. Following 

the introduction of spending targets, volume and intensity growth slowed 

substantially during the 1990s. In recent years, under the SGR system, 

volume and intensity growth has increased, but not by the rates experienced 

during the 1980s before spending targets were in place. 

SGR, the current system of spending targets, evolved from the target system 

that went into effect in 1992. Under the SGR system, physician fees are 

adjusted up or down, depending on whether actual spending has fallen 

below or has exceeded the target. Fees increase at least as fast as the costs 

of providing physician services as long as volume and intensity growth 

remains below a specified rate—currently, a little more than 2 percent a 

year. If volume and intensity grows faster than the specified rate, SGR 

lowers fee increases or causes fees to fall. Physicians raised concerns about 

SGR when fees dropped significantly in 2002, a decline that was, in part, a 

correction for fees that had been set too high in prior years because of errors 

in forecast estimates and other data. Congressional action averted fee 

reductions, and projected fee reductions, for 2003 through 2005. However, 

beginning in 2006, fees are projected to resume falling for several years, 

partly to recoup the excess spending accumulated from averted cuts in 

previous years and partly because real per beneficiary spending on physician 

services is projected to grow faster than allowed under SGR. A dilemma for 

policymakers posed by projected fee reductions is that while SGR’s 

automatic responses work as intended from a budgetary perspective, the 

consequences for physicians and their patients are uncertain. 

The Sustainable Growth Rate 

(SGR) system, implemented in 1998 

and subsequently revised, is used 

to update Medicare’s physician fees 

and moderate the growth in 

Medicare spending for physician 

services. SGR, and a predecessor 

system implemented in 1992, were 

designed to reduce physician fee 

updates if spending growth 

exceeded a specified target. 

Although spending growth slowed 

substantially under both systems, 

concerns about SGR arose when 

the system caused fees to decline 

by 5.4 percent in 2002. 

GAO was asked to discuss (1) 

Medicare physician spending 

trends both before and after the 

implementation of spending targets 

and (2) the evolution and 

mechanics of the SGR system. This 

statement is largely based on 

GAO’s previous work on Medicare 

spending trends and the SGR 

system. 
Page 1 GAO-04-751T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today as you discuss the Sustainable Growth Rate 

(SGR) system that Medicare uses to update physician fees and moderate 

the growth in spending for physician services. As you know, the current 

SGR system evolved from the Medicare Volume Performance Standard 

(MVPS) system, which, along with a fee schedule for physician services, 

was established in 1992. MVPS, and later SGR, were designed to reduce 

physician fee updates if spending growth exceeded a specified target. 

Under both systems, spending growth slowed substantially. However, 

concerns about SGR arose when the system and other factors caused fees 

to decline by 5.4 percent in 2002. In February of that year, we testified 

before this Subcommittee and discussed the reasons for the fee decline 

and potential SGR modifications.1

 Subsequent administrative and 

legislative actions modified or overrode the SGR system and resulted in 

fee increases for 2003, 2004, and 2005. Absent additional legislative action, 

fees are expected to fall by approximately 5 percent each year beginning 

in 2006 and continuing through 2012. These projected declines have raised 

concerns about the appropriateness of the SGR system for updating 

physician fees and physicians’ continued participation in the Medicare 

program. 

My comments today are intended to describe the current situation 

pertaining to physician fees and how we arrived at this juncture. 

Specifically, I will discuss (1) Medicare physician spending trends both 

before and after the implementation of spending targets and (2) the 

evolution and mechanics of the SGR system, explaining how it is designed 

to help control spending growth. My testimony is based on our previous 

work on Medicare spending trends and the SGR system—updated to 

include recent information on spending, fees, and projections—and was 

prepared during April 2004 according to generally accepted government 

auditing standards. In our February 2002 testimony, we discussed the need 

to maintain fiscal discipline to help ensure the long-term sustainability of 

the Medicare program for future generations. The Medicare Prescription 

Drug, Improvement, and Modernization Act of 2003 (MMA) requires us to 

study the appropriateness of the factors used in SGR and consider 

alternatives to the system.2

 Our work on that study is currently underway. 

 1

U. S. General Accounting Office, Medicare Physician Payments: Spending Targets 

Encourage Fiscal Discipline, Modifications Could Stabilize Fees, GAO-02-441T

(Washington, D.C.: Feb. 14, 2002). 

2

See Pub. L. No. 108-173, §953, 117 Stat. 2066, 2427-28. 
Page 2 GAO-04-751T 

We look forward to working with the Subcommittee and others in 

Congress as policymakers seek to ensure appropriate physician payments. 

In summary, Medicare spending on physician services grew rapidly 

through the 1980s, at an average annual rate of 13.4 percent, even though 

physician fee increases were subject to some limits. The spending growth 

was driven by increases in the number of services provided to each 

beneficiary—referred to as volume—and an increase in the average 

complexity and costliness of those services—referred to as intensity. 

Recognizing that expenditure growth of this magnitude was not 

sustainable, the Congress attempted to impose fiscal discipline by 

requiring the establishment of spending targets for Medicare physician 

services along with a fee schedule beginning in 1992. Following the 

introduction of spending targets, volume and intensity growth slowed 

substantially during the 1990s. In recent years, under the SGR system, 

volume and intensity growth has increased, but not by the rates 

experienced during the 1980s before spending targets were in place. 

SGR, the current system of spending targets, evolved from the target 

system that went into effect in 1992. Under the SGR system, physician fee 

updates are adjusted up or down, depending on whether actual spending 

has fallen below or has exceeded the target. Over time, fees tend to 

increase at least as fast as the costs of providing physician services as long 

as volume and intensity growth remains below a specified rate—currently, 

a little more than 2 percent a year. If volume and intensity grows faster 

than the specified rate, SGR lowers fee increases or causes fees to fall. 

Physicians raised concerns about SGR when fees dropped significantly in 

2002, a decline that was, in part, a correction for fees that had been set too 

high in prior years because of errors in forecast estimates and other data. 

Congressional action averted fee reductions, and projected fee reductions, 

for 2003 through 2005. However, beginning in 2006, fees are projected to 

resume falling for several years, partly to recoup the excess spending 

accumulated from averted cuts in previous years and partly because real 

per beneficiary spending on physician services is projected to grow faster 

than allowed under SGR. The dilemma for policymakers posed by 

projected fee reductions is that while SGR’s automatic responses work as 

intended from a budgetary perspective, the consequences for physicians 

and their patients are uncertain. 
Page 3 GAO-04-751T 

The Omnibus Budget Reconciliation Act of 1989 (OBRA 1989) reformed 

the way Medicare pays for physician services in the traditional fee-forservice (FFS) program.3

 OBRA 1989 required the establishment of a 

physician fee schedule and a system of spending growth targets, known as 

MVPS, that became effective in 1992. In 1998, the SGR system of spending 

targets replaced MVPS. Both spending target systems were designed to 

moderate growth in the volume and intensity of services provided to 

beneficiaries. 

Prior to the establishment of the fee schedule, Medicare payment rates for 

physician services were based on historical charges for these services.4

The establishment of a fee schedule was an attempt to break the link 

between physicians’ charges and Medicare payments. The fee schedule 

was not designed to reduce spending levels overall but to redistribute 

payments for services based on the relative resources used by physicians 

to provide different types of care. Under the fee schedule, Medicare pays 

for more than 7,000 physician services. 5

 To arrive at Medicare’s fee, the 

service’s relative value is multiplied by a dollar conversion factor. 

Currently, under SGR, the Centers for Medicare & Medicaid Services 

(CMS), the agency that administers Medicare, uses the dollar conversion 

factor to calculate Medicare fees and updates the conversion factor each 

calendar year to account for the change in the cost of providing physician 

services (as measured by the Medicare Economic Index (MEI)), adjusted 

for the extent to which actual spending aligns with spending targets. Fee 

updates represent the aggregate of increases and decreases across all 

services; the fees for specific services may rise or fall each year. 

 3

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

4

Medicare paid physicians on the basis of “reasonable charge,” defined as the lowest of the 

physician’s actual charge, the customary charge (the amount the physician usually charged 

for the service), or the prevailing charge (based on comparable physicians’ customary 

charges). 

5

The fee for each service is determined using a resource-based relative value scale—that is, 

the resources required for that service relative to the resources required to provide all 

other physician services adjusted for the differences in the costs of providing services 

across geographic areas. 

Background 
Page 4 GAO-04-751T 

In 1980, Medicare spending for physician services totaled $7.5 billion.6 (See 

fig. 1.) By 2003, Medicare spending on these services totaled $47.9 billion. 

During much of this period, increases in both the volume and intensity of 

services physicians provided to each beneficiary were an important factor 

in spending growth. 

Figure 1: Medicare Spending for Physician Services, 1975-2005 

Notes: Amounts represent Medicare spending for aged and disabled beneficiaries in the traditional 

FFS program, net of beneficiary cost sharing. Spending for end stage renal disease (ESRD) patients 

is not included. Amounts for 1975-1990 are for the years ending June 30 and amounts for 1995-2005 

represent calendar years. The estimate for 2005 is based on Trustees’ projections under intermediate 

assumptions. 

 6

This includes spending, net of beneficiary cost-sharing, for aged and disabled beneficiaries 

in the traditional FFS program. 

Medicare Spending 

for Physician Services 

Grew Rapidly in 

1980s, Slowed After 

Implementation of 

Spending Targets 

Dollars in billions

54.2

26.4

15.7

7.5

3.2

31.2

36.9

0

10

20

30

40

50

60

1975 1980 1985 1990 1995 2000 2005 est.

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

Medical Insurance (SMI) Trust Funds.
Page 5 GAO-04-751T 

Before the physician fee schedule was implemented, Medicare payments 

for physician services were largely based on historical charges. 

Experience in the 1980s repeated the experience of the prior decade: the 

Congress froze fees or limited fee increases, but spending continued to 

rise. From 1980 through 1991, for example, Medicare spending per 

beneficiary for physician services grew at an average annual rate of about 

11.6 percent. (See fig. 2.) 

Figure 2: Average Annual Change in Medicare Spending for Physician Services per 

Beneficiary, 1980-2003 

Notes: Amounts for 1980-1991 are for the years ending June 30 and represent weighted average 

Medicare spending for aged and disabled beneficiaries in the traditional FFS program, net of 

beneficiary cost sharing. Spending for ESRD patients is not included. Amounts for 1992-1997 and 

1998-2003 are for calendar years and represent total allowed charges—Medicare spending, including 

beneficiary cost sharing—for aged and disabled beneficiaries in the traditional FFS program. 

Total Medicare spending for physician services depends on the fee paid for 

each service, the number of beneficiaries served, the number of services 

provided to each beneficiary (volume), and the mix of those services—that 

is, the combination of more and less expensive services (intensity). Of 

these factors, physicians directly influence only the volume and intensity 

of services provided to beneficiaries. 

In 1980s, Spending for 

Physician Services Grew 

Rapidly 

11.6

4.4

6.0

0

2

4

6

8

10

12

14

1980-1991 1992-1997 1998-2003

Percentage

Sources: GAO analysis of data from CMS and the Boards of Trustees of the Federal HI and SMI Trust Funds.
Page 6 GAO-04-751T 

Much of the spending growth resulted from increases in the volume and 

intensity of services. For example, from 1986 until 1992, physician 

payment rates grew by less than 2 percent annually, while the volume and 

intensity of services rose, on average, by almost 8 percent per year. In 

1986, the Congressional Budget Office stated that “[b]oth the price and the 

volume of services must be controlled to constrain costs....”7

 In 1989, 

citing the need for spending targets to limit spending growth for physician 

services, the Secretary of Health and Human Services (HHS) testified that 

“Medicare physician spending has increased at compound annual rates of 

16 percent over the past 10 years. And in spite of our best efforts to control 

volume and rein in expenditures, Medicare physician spending is currently 

out of control.... An expenditure target...sets an acceptable level of 

growth in the volume and intensity of physician services.”8

Annual spending growth during the 1990s was far lower than in the 

preceding 10 years. Beginning in 1992, the Congress introduced spending 

targets for physician services to help constrain the rise in Medicare 

spending for physician services. Unlike prior attempts to control spending, 

spending target systems sought to limit the growth in the volume and 

intensity of services each year. 

From 1992 until 1999, the growth in the volume and intensity of physician 

services per Medicare beneficiary moderated. (See fig. 3.) During this time 

period, the average annual increase in Medicare spending due to changes 

in volume and intensity of services per beneficiary was about 1 percent, in 

contrast with the average annual growth of about 7 percent in the period 

from 1985 through 1991. 

 7

Congressional Budget Office, Physician Reimbursement Under Medicare: Options for 

Change (Washington, D.C.: Apr. 1986). 

8

Testimony before the Subcommittee on Medicare and Long-term Care, Committee on 

Finance, U.S. Senate, 101st Congress, 1st Session (June 16, 1989). 

In 1990s, Growth in 

Spending on Physician 

Services Slowed Under 

Spending Target Systems 
Page 7 GAO-04-751T 

Figure 3: Growth in Volume and Intensity of Medicare Physician Services per Beneficiary, 1975-2003 

Notes: Data are for aged and disabled beneficiaries in the traditional FFS program only. Data for 

ESRD patients are not included. From 1975 through 1992, volume and intensity of services changes 

are based on Medicare outlays for all physician services. From 1993 through 2003, volume and 

intensity of services changes are based on Medicare outlays for physician services covered by the 

fee schedule. 

The moderation of volume and intensity growth slowed the rate of 

increase in spending on physician services. This spending grew from $25.6 

billion in 1992 to $36.9 billion in 2000an average annual rate of 4.7 

percent. In contrast, from 1985 through 1991, total spending increased at 

an average annual rate of about 10.8 percent. 

Beginning in 2000, the growth in volume and intensity of services per 

Medicare beneficiary began to rise, although the average annual rate of 

growth remained substantially below that experienced before spending 

targets were introduced. From 2000 to 2003, volume and intensity rose at 

an average annual rate of 5 percent. CMS actuaries project an average 

annual growth in volume and intensity of 3 percent from 2004 through 

2013. Total spending on physician services is projected to grow by an 

average of 8 percent a year from 2000 through 2005. 

In 2000s, Spending Growth 

for Physician Services 

Rose but Remained Lower 

than Rates in the 1980s 

Percentage

4.5

8.3

3.7

7.6

9.7

3.9

6.5

9.0

9.4

1.7

3.4

1.5 1.2

3.5

4.3

6.1

4.5

-0.7 -0.2 0.2

1.5

-1

0

1

2

3

4

5

6

7

8

9

10

1975 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Fee schedule and 

spending targets

introduced 

Sources: GAO analysis of data from CMS and the Boards of Trustees of the Federal HI and SMI Trust Funds.
Page 8 GAO-04-751T 

A target for spending on physician services serves as a budgetary control 

by automatically lowering fee updates in response to excess volume and 

intensity growth. Under Medicare’s SGR spending target system and its 

MVPS predecessor, physician fees are adjusted annually to help bring 

actual spending in line with spending targets. Projected increases in 

volume and intensity, beyond what the current SGR targets allow, are 

expected to contribute to annual fee reductions for several years as the 

system tries to align spending with targets. 

The SGR system evolved from the MVPS system of spending targets, which 

was introduced with the physician fee schedule in 1992. The goal of MVPS 

was to provide an incentive for physicians to reduce volume and intensity 

growth and thus slow the high annual rate of increase in expenditures.9

Under MVPS, if a year’s actual spending growth exceeded the target, 

future payment rates would be reduced, relative to what they would have 

been if actual spending had equaled the target, to offset the excess 

spending. If a year’s actual spending growth fell short of the target, future 

payment rates would be increased. 

Concerns about the MVPS spending target prompted the Congress to 

create SGR’s system of spending targets.10 In its 1996 report to Congress, 

the Physician Payment Review Commission noted that, under MVPS, 

physician fees would fall over time unless there were continual declines in 

the volume and intensity of services provided.11 In response to the system’s 

perceived shortcomings, the Congress took action in 1997 to replace it 

with the SGR system. 

 9

At that time, the Secretary of HHS defined “physician services” to include “services and 

supplies incident to physicians’ services,” such as laboratory tests and Medicare-covered 

outpatient prescription drugs. This definition remains today. 

10The MVPS spending target was based, in part, on a 5-year historical trend in volume and 

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

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

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

11Physician Payment Review Commission, 1996 Annual Report to Congress (Washington, 

D.C.: Physician Payment Review Commission, 1996). 

Under SGR and Prior 

System, Physician Fee 

Updates Are 

Mechanism To Bring 

Actual Spending in 

Line with Spending 

Targets 

SGR System Evolved from 

Spending Target System 

Introduced with Physician 

Fee Schedule in 1992 
Page 9 GAO-04-751T 

The SGR system was created in the Balanced Budget Act of 1997 (BBA)12

and revised by the Medicare, Medicaid, and SCHIP Balanced Budget 

Refinement Act of 1999 (BBRA)13 and, most recently, by MMA.14 Similar to 

MVPS, SGR sets spending targets for physician services and updates fees 

to bring spending in line with those targets. Under the SGR system, if 

spending exceeds the target, future fee updates are reduced. If spending 

falls short of the target, future fee updates are increased. By adjusting fees 

when prior-year spending has deviated from the target, SGR attempts to 

moderate the growth in total Medicare outlays for physician services. 

Specifically, the SGR formula establishes expenditure targets as follows: 

from a base year—199615—the targets are updated each year16 to account 

for four factors: (1) changes in the number of Medicare beneficiaries in 

traditional fee-for-service; (2) growth in the costs of providing physician 

services, laboratory tests, and Medicare-covered outpatient prescription 

drugs; (3) growth in the overall economy, as measured by changes in real 

per capita gross domestic product (GDP); and (4) changes in expenditures 

that result from changes in laws or regulations. Spending and targets are 

estimated from data available in the fall, when CMS sets physician fees for 

the next calendar year. Because SGR spending targets are cumulative, the 

target set for a specific year is affected by the targets set in all prior years. 

BBRA required CMS, in calculating each year’s SGR spending target and 

fee update, to revise the targets set for the two previous years using the 

most recent available data.17

SGR differs from MVPS in two key ways. The first relates to volume and 

intensity growth limits. MVPS relied, in part, on historical trends in volume 

and intensity growth to set new targets each year, whereas SGR ties 

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

capita. Under SGR, real spending per beneficiary—that is, spending 

 12See Pub. L. No. 105-33, §4503, 111 Stat. 251, 433-34. 

13See Pub. L. No. 106-113, App. F, §211(b), 113 Stat. 1501A-321, 348-49. 

14See Section 601(b), 117 Stat. 2301. 

15The base year is set equal to the 12-month period ending March 31, 1997. 

16SGR changed from a fiscal year basis to a calendar year basis in 2000. 

17The first year of fee updates to be based on revised targets was 2001. In setting the target 

for that year, CMS revised only the 2000 SGR target. According to CMS, the agency was not 

authorized to revise the 1998 or 1999 SGR targets. 

SGR System Differs From 

Prior System in Important 

Ways 
Page 10 GAO-04-751T 

adjusted for the underlying cost of providing physician services—is 

allowed to grow at the same rate that the national economy grows over 

time on a per-capita basis—currently projected to be about 2 percent 

annually. If volume and intensity grow faster, the annual increase in 

physician fees will be less than the estimated increase in the cost of 

providing services. Conversely, if volume and intensity grow more slowly 

than 2 percent annually, the SGR system permits physicians to benefit 

from fee increases that exceed the increased cost of providing services. To 

reduce the effect of business cycles on physician fees, economic growth is 

measured as the 10-year moving average change in real per capita GDP. 

This measure is projected to range from 2.1 percent to 2.5 percent during 

the 2005 through 2014 period. 

A second difference is that MVPS compared target and actual expenditures 

in a single year, whereas SGR compares targets and actual expenditures 

cumulatively from a base year. The cumulative nature of SGR’s spending 

targets increases the potential volatility of physician fee updates because 

the system requires that excess spending in any year be recouped in future 

years. Conceptually, this means that if spending has exceeded the SGR 

targets, fee updates in future years must be lowered sufficiently to offset 

the excess spending. Conversely, the system also requires that if spending 

has fallen short of the targets, fees must be increased to boost future 

spending. 

SGR limits how much fees can be adjusted when spending has missed the 

target. SGR’s performance adjustment may decrease fees by as much as 7 

percentage points below the percentage change in MEI when spending has 

exceeded the target and may increase fees by as much as 3 percentage 

points above the percentage change in MEI when spending has fallen short 

of the target. SGR adjustments to the fees are determined by how much 

the cumulative amount of spending on physician services since 1996 

differs from the cumulative spending target since that base year. 
Page 11 GAO-04-751T 

Since the introduction of the fee schedule in 1992 through 2001, physicians 

generally experienced real increases in their fees—that is, fees increased 

more than the increase in the cost of providing physician services, as 

measured by MEI. Specifically, during that period, fees increased by 39.7 

percent, whereas MEI increased by 25.9 percent. In 2002, however, SGR 

reduced fees by 4.8 percent,18 despite an estimated 2.6 percent increase in 

the costs of providing physician services. (See fig. 4.) 

 18CMS reduced 2002 fees by an additional 0.64 percent to offset an increase in spending 

projected to occur as a result of changes in the calculations used to determine the amount 

of resources associated with physician services. As a result of both the SGR reduction and 

this additional offset, 2002 fees declined by 5.4 percent. 

Legislative Action 

Temporarily Avoided Fee 

Declines; Fees Projected 

to Decline Beginning in 

2006 
Page 12 GAO-04-751T 

Figure 4. Percentage Change in MEI, Fee Schedule Update, and Medicare Physician Services Spending Per Beneficiary, 1998-

2005 

Note: Spending per beneficiary represents Medicare spending for aged and disabled beneficiaries in 

the traditional FFS program, net of beneficiary cost sharing. Spending for end stage renal disease 

(ESRD) patients is not included. 

SGR reduced fees in 2002 because estimated spending for physician 

services—cumulative since 1996—exceeded the target by approximately 

$8.9 billion, or 13 percent of projected 2002 spending. In part, the fee 

reduction occurred because CMS revised upward its estimates of previous 

years’ actual spending. Specifically, CMS found that its previous estimates 

had omitted a portion of actual spending for 1998, 1999, and 2000. In 

addition, in 2002 CMS lowered the 2 previous years’ spending targets 

based on revised GDP data from the Department of Commerce. Based on 

the new higher spending estimates and lower targets, CMS determined 

2.2 2.3 2.4 2.0

2.6

3.0 2.9 2.7 2.3 2.3

5.5

4.8

-4.8

1.7 1.5 1.5

4.9

4.0

9.9 10.1

1.9

6.3

7.1

4.7

-6

-4

-2

0

2

4

6

8

10

12

1998 1999 2000 2001 2002 2003 2004 2005

MEI

Physician fee update

Spending per beneficiary

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

Percentage
Page 13 GAO-04-751T 

that fees had been too high in 2000 and 2001. In setting the 2002 physician 

fees, the SGR system reduced fees to recoup previous excess spending. 

The update would have been about negative 9 percent if the SGR system 

had not limited its decrease to 7 percentage points below MEI. Because 

the previous overpayments were not fully recouped in 2002, and because 

of volume and intensity increases, by 2003, physicians were facing several 

more years of fee reductions to bring cumulative Medicare spending on 

physician services in line with cumulative targets. 

However, CMS had determined that its authority to revise previous 

spending targets was limited. In 2002 CMS noted that the 1998 and 1999 

spending targets had been based on estimated growth rates for beneficiary 

fee-for-service enrollment and real per capita GDP that actual experience 

had shown to be too low. If the estimates could have been revised, the 

targets for those and subsequent years would have been increased. 

However, at the time that CMS acknowledged these errors, the agency 

concluded that it was not allowed to revise these estimates.19 Without such 

revisions, the cumulative spending targets remained lower than if errors 

had not been made. 

In late 2002, the estimate of SGR called for a negative 4.4 percent fee 

update in 2003. With the passage of the Consolidated Appropriations 

Resolution of 2003,20 CMS determined that it was authorized to correct the 

1998 and 1999 spending targets. Because SGR targets are cumulative 

measures, these corrections resulted in an average 1.4 percent increase in 

physician fees for services for 2003.21

In 2003, MMA averted additional fee reductions projected for 2004 and 

2005 by specifying an update to physician fees of no less than 1.5 percent 

for 2004 and 2005.22 The MMA increases replaced SGR fee reductions of 4.5 

percent in 2004 and an estimated 3.6 percent in 2005. Because MMA did 

 19BBRA required CMS to use actual, after-the-fact data to revise the estimates used to set 

the spending targets, beginning with the estimated spending target in 2000. 

20See Pub. L. No. 108-7, Div. N, Title IV, §402, 117 Stat. 11, 548. 

21The law allowed for a recalculation of prior years’ spending targets, which resulted in a 

1.7 increase in fees applied to spending on physician services provided on or after March 1, 

2003. Over 12 months, the increase averaged 1.4 percent. CBO estimated that this provision 

would increase the baseline for Medicare spending by $800 million in 2003 and $53.4 billion 

over the 2003-2013 period. 

22See Section 601(a), 117 Stat. 2300. 
Page 14 GAO-04-751T 

not make corresponding revisions to SGR’s spending targets, SGR will 

reduce fees beginning in 2006, to offset the additional spending caused by 

MMA’s fee increases. In addition, recent growth in volume and intensity, 

which has been larger than SGR targets allow, will further compound the 

problem of excess spending that needs to be recouped. 

The 2004 Medicare Trustees Report announced that the projected 

physician update would be about negative 5 percent for 7 consecutive 

years beginning in 2006; the result is a cumulative reduction in physician 

fees of more than 31 percent from 2005 to 2012, while physicians’ costs of 

providing services, as measured by MEI, are projected to rise by 19 

percent.23

To a large extent, the physician fee cuts projected by Medicare’s Trustees 

are required under SGR’s system of cumulative spending targets to make 

up for excess spending in earlier years. MMA added to the excess spending 

by specifying minimum fee updates for 2004 and 2005 without resetting the 

spending targets for those years. As a result, physician fee cuts were 

postponed, not avoided. 

In considering the projected fee cuts, however, it is important to recall that 

Congress originally established Medicare spending targets for physician 

services in response to runaway spending in the 1980s. The recent increase 

in volume and intensity growth suggests that Medicare faces a 

fundamental physician spending growth problem even if the SGR slate of 

missed spending targets were somehow wiped clean. Currently, projected 

Medicare spending for physician services exceeds what policymakers have 

specified—through the parameters of the SGR system—is the appropriate 

amount to spend. Because of expected increases in the volume and 

intensity of services provided by physicians, real spending per beneficiary 

is projected to grow by more than 3 percent per year. SGR, designed to 

promote fiscal discipline, allows such spending to grow by just over 2 

percent per year. If the growth in real spending per beneficiary is not 

lowered through other means, SGR will mechanically reduce fee updates 

in an attempt to impose fiscal discipline and moderate total spending 

increases. Although this mechanical response may be desirable from a 

 23Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical 

Insurance Trust Funds, 2004 Annual Report of the Boards of Trustees of the Federal 

Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds 

(Washington, D.C.: Mar. 23, 2004). 

Concluding 

Observations 
Page 15 GAO-04-751T 

budgetary perspective, any consequences for physicians and their patients 

are uncertain. 

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

answer questions you or other Subcommittee Members may have. 

For further information regarding this testimony, please contact A. Bruce 

Steinwald at (202) 512-7101. James Cosgrove, Jessica Farb, Hannah Fein, 

and Jennifer Podulka contributed to this statement. 

Contact and 

Acknowledgments 

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