Prescription Drugs: Increasing Medicare Beneficiary Access and Related Implications
Released: 2000-02-16T00:00:00

Letter

Rising Drug Spending Elevates Beneficiary Access Concerns and the Importance of Cost-Control Efforts

benefit package, largely designed in 1965, provides virtually no coverage. In 1996, almost one third of beneficiaries had employer- sponsored health coverage, as retirees, that included drug benefits. More than 10 percent of beneficiaries received coverage through Medicaid or other public programs. To protect against drug costs, the remainder of Medicare beneficiaries can choose to enroll in a Medicare+Choice plan with drug coverage if one is available in their area or purchase a Medigap policy. 3 The availability, breadth, and price of such coverage is changing as the costs of expanded prescription drug use drives employers, insurers, and managed care plans to adopt new approaches to control the expenditures for this benefit. These approaches, in turn, are reshaping the drug market.

Rise in Prescription Drug Spending

Over the past 5 years, prescription drug expenditures have grown substantially, both in total and as a share of all health care outlays. Prescription drug spending grew an average of 12.4 percent per year from 1993 to 1998, compared with a 5 percent average annual growth rate for health care expenditures overall. (See table 1.) As a result, prescription drugs account for a larger share of total health care spending—rising from 5.6 percent to 7.9 percent in 1998.

As an alternative to traditional Medicare fee-for-service, beneficiaries in Medicare+Choice plans (formerly Medicare risk health maintenance organizations) obtain all their services through a managed care organization and Medicare makes a monthly capitation payment to the plan on their behalf.

Prescription Drugs: Increasing Medicare Beneficiary Access and Related Implications Prescription drug expenditures (in billions)

Annual growth in prescription drug expenditures (percent)

Annual growth in all health care expenditures (percent)

Total drug expenditures have been driven up by both greater utilization of drugs and the substitution of higher-priced new drugs for lower-priced existing drugs. Private insurance coverage for prescription drugs has likely contributed to the rise in spending, because insured consumers are shielded from the direct costs of prescription drugs. In the decade between 1988 and 1998, the share of prescription drug expenditures paid by private health insurers rose from almost a third to more than half. (See fig. 1.) The development of new, more expensive drug therapies— including new drugs that replace old drugs and new drugs that treat disease more effectively—also contributed to the drug spending growth by boosting the volume of drugs used as well as the average price for drugs used. The average number of new drugs entering the market each year rose from 24 at the beginning of the 1990s to 33 now. Similarly, biotechnology advances and a growing knowledge of the human immune system are significantly shaping the discovery, design, and production of drugs. Advertising pitched to consumers has also likely upped the use of prescription drugs. A recent study found that the 10 drugs most heavily advertised directly to consumers in 1998 accounted for about 22 percent of the total increase in drug spending between 1993 and 1998.Between March 1998 and March 1999, industry spending on advertising grew 16 percent to $1.5 billion. All of these factors suggest the need for effective cost control mechanisms to be in place under any option to increase access to prescription drugs.

Current Medicare Beneficiary Drug Coverage

Medicare beneficiaries spent $2,000 or more.A recent report had projected that by 1999 an estimated 20 percent of Medicare beneficiaries would have total drug costs of $1,500 or more—a substantial sum for people lacking some form of insurance to subsidize their purchases or for those facing coverage limits.

In 1996, almost a third of Medicare beneficiaries lacked drug coverage altogether. (See fig. 2.) The remaining two-thirds had at least some drug coverage—most commonly through employer-sponsored health plans. The proportion of beneficiaries who had drug coverage rose between 1995 and 1996, owing to increases in those with Medicare HMOs, individually purchased supplemental coverage, and employer-sponsored coverage. However, recent evidence indicates that this trend of expanding drug coverage is unlikely to continue.

Medicare+Choice plans have found drug coverage to be an attractive benefit that beneficiaries seek out when choosing to enroll in managed care organizations. However, owing to rising drug expenditures and their effect on plan costs, the drug benefits the plans offer are becoming less generous. Many plans restructured drug benefits in 2000, increasing enrollees’ out-of-pocket costs and limiting their total drug coverage.

Beneficiaries may purchase Medigap policies that provide drug coverage, although this tends to be expensive, involves significant cost-sharing, and includes annual limits. Standard Medigap drug policies include a $250 deductible, a 50 percent coinsurance requirement, and a $1,250 or $3,000 annual limit. Furthermore, Medigap premiums have been increasing in recent years. In 1999, the annual premium for one type of Medigap policy with a $1,250 annual limit on drug coverage, ranged from approximately $1,000 to $6,000.

All beneficiaries who have full Medicaid benefitsreceive drug coverage that is subject to few limits and low cost-sharing requirements. For beneficiaries whose incomes are slightly higher than Medicaid standards, 14 states currently offer pharmacy assistance programs that provided drug coverage to approximately 750,000 beneficiaries in 1997. The three largest state programs accounted for 77 percent of all state pharmacy assistance program beneficiaries. Most state pharmacy assistance programs, like Medicaid, have few coverage limitations.

The burden of prescription drug costs falls most heavily on the Medicare beneficiaries who lack drug coverage or who have substantial health care needs. Drug coverage is less prevalent among beneficiaries with lower incomes. In 1995, 38 percent of beneficiaries with income below $20,000 were without drug coverage, compared to 30 percent of beneficiaries with higher incomes. Additionally, the 1995 data show that drug coverage is slightly higher among those with poorer self-reported health status. At the same time, however, beneficiaries without drug coverage and in poor health had drug expenditures that were $400 lower than the expenditures of beneficiaries with drug coverage and in poor health. This might indicate access problems for this segment of the population. employer-sponsored benefits, Medigap policies, and most recently, Medicare+Choice plans. Although reasonable cost sharing serves to make the consumer a more prudent purchaser, copayments, deductibles, and annual coverage limits can reduce the value of drug coverage to the beneficiary. Harder to measure is the effect on beneficiaries of drug benefit restrictions brought about through formularies designed to limit or influence the choice of drugs.

Cost-Control Approaches Are Reshaping the Pharmaceutical Market

During this period of rising prescription drug expenditures, third-party payers have pursued various approaches to control spending. These efforts have initiated a transformation of the pharmaceutical market. Whereas insured individuals formerly purchased drugs at retail prices at pharmacies and then sought reimbursement, now third-party payers influence which drug is purchased, how much is paid for it, and where it is purchased.

A common technique to manage pharmacy care and control costs is to use a formulary. A formulary is a list of prescription drugs, grouped by therapeutic class, that a health plan or insurer prefers and may encourage doctors to prescribe. Decisions about which drugs to include in a formulary are based on the drugs’ medical value and price. The inclusion of a drug in a formulary and its cost can affect how frequently it is prescribed and purchased and, therefore, can affect its market share.

Formularies can be open, incentive-based, or closed. Open formularies are often referred to as “voluntary” because enrollees are not penalized if their physicians prescribe nonformulary drugs. Incentive-based formularies generally offer enrollees lower copayments for the preferred formulary or generic drugs. Incentive-based or managed formularies are becoming more popular because they combine flexibility and greater cost-control features than open formularies. A closed formulary limits insurance coverage to the formulary drugs and requires enrollees to pay the full cost of nonformulary drugs prescribed by their physicians.

Another way in which the market has been transformed is through the use of pharmacy benefit managers (PBM) by health plans and insurers to administer and manage prescription drug benefits. PBMs offer a range of services, including prescription claims processing, mail-service pharmacy, formulary development and management, pharmacy network development, generic substitution incentives, and drug utilization review. PBMs also negotiate discounts and rebates on prescription drugs with manufacturers.

Expanding Access to Prescription Drugs Involves Difficult Design Decisions

Expanding access to more affordable prescription drugs could involve either subsidizing prescription drug coverage or allowing beneficiaries access to discounted pharmaceutical prices. The design of a drug coverage option, that is, the scope of the benefit, the covered population, and the mechanisms used to contain costs, as well as its implementation will determine the effect of the option on beneficiaries, Medicare or federal spending, and the pharmaceutical market. A new benefit would need to be crafted to balance competing concerns about the sustainability of Medicare, federal obligations, and the hardship faced by some beneficiaries. Similarly, the effect of granting some beneficiaries access to discounted prices will hinge on details such as the price of the drugs after the discount, how discounts are determined and secured, and which beneficiaries are eligible.

The relative merits of any approach should be carefully assessed. We suggest that the following five criteria be considered in evaluating any option. (1) Affordability: an option should be evaluated in terms of its effect on public outlays for the long term. (2) Equity: an option should provide equitable access across groups of beneficiaries and be fair to affected providers. (3) Adequacy: an option should provide appropriate beneficiary incentives for prudent utilization, support standard treatment options for beneficiaries, and not impede effective and clinically meaningful innovations. (4) Feasibility: an option should incorporate such administrative essentials as implementation and cost and quality monitoring techniques. (5) Acceptance: an option should account for the need to educate the beneficiary and provider communities about its costs and the realities of trade-offs required by significant policy changes.

Adding a Medicare Benefit

drug costs, which is yet to be designed. Under the Breaux-Frist approach, competing health plans could design their own copayment structure, with requirements on the benefit’s actuarial value but no provision to limit beneficiary catastrophic drug costs.

Benefit cost-control provisions for the traditional Medicare program may present some of the thorniest drug benefit design decisions. Recent experience provides two general approaches. One would involve the Medicare program obtaining price discounts from manufacturers. Such an arrangement could be modeled after Medicaid’s drug rebate program. While the discounts in aggregate would likely be substantial, this approach lacks the flexibility to achieve the greatest control over spending. It could not effectively influence or steer utilization because it does not include incentives that would encourage beneficiaries to make cost-conscious decisions. The second approach would draw from private sector experience in negotiating price discounts from manufacturers in exchange for shifting market share. Some plans and insurers employ PBMs to manage their drug benefits, including claims processing, negotiating with manufacturers, establishing lists of drug products that are preferred because of efficacy or price, and developing beneficiary incentive approaches to control spending and use. Applying these techniques to the entire Medicare program, however, would be difficult because of its size, the need for transparency in its actions, and the imperative for equity for its beneficiaries.

Medicaid Programs Rely on Rebates and Have Limited Utilization Controls

As the largest government payer for prescription drugs, Medicaid drug expenditures account for about 17 percent of the domestic pharmaceutical market. Before the enactment of the Medicaid drug rebate program under the Omnibus Budget Reconciliation Act of 1990 (OBRA), state Medicaid programs paid close to retail prices for outpatient drugs. Other large purchasers, such as HMOs and hospitals, negotiated discounts with manufacturers and paid considerably less.

The rebate program required drug manufacturers to rebate to state Medicaid programs a percentage off of the average price wholesalers pay manufacturers. The rebates were based on a percentage reduction that reflects the lowest or “best” prices the manufacturer charged other purchasers and the volume of purchases by Medicaid recipients. In return for the rebates, state Medicaid programs must cover all drugs manufactured by pharmaceutical companies that entered into rebate agreements with HCFA.

After the rebate program’s enactment, a number of market changes affected other purchasers of prescription drugs and the amount of the rebates that Medicaid programs received. Drug manufacturers substantially reduced the price discounts they offered to many large private purchasers, such as HMOs. Therefore, the market quickly adjusted by increasing drug prices to compensate for rebates obtained by the Medicaid program.

Although the states have received billions of dollars in rebates from drug manufacturers since OBRA’s enactment, state Medicaid directors have expressed concerns about the rebate program. The principal concern involves OBRA’s requirement to provide access to all the drugs of every manufacturer that offers rebates, which limits the utilization controls Medicaid programs can use at a time when prescription drug expenditures are rapidly increasing. Although the programs can require recipients to obtain prior authorization for particular drugs and can impose monthly limits on the number of covered prescriptions, they cannot take advantage of other techniques, such as incentive-based formularies, to steer recipients to less expensive drugs. The few cost-control strategies available to state Medicaid programs can add to the administrative burden on state Medicaid programs.

Other Payers Employ Various Techniques to Control Expenditures

Other payers, such as private and federal employer health plans and Medicare+Choice plans, have taken a different approach to managing their prescription drug benefits. They typically use beneficiary copayments to control prescription drug use, and they use formularies to both control use and obtain better prices by concentrating purchases on selected drugs. In many cases, these plans and insurers retain a PBM’s services to manage their pharmacy benefit and control spending.

Beneficiary cost-sharing plays a central role in attempting to influence drug utilization. Copayments are frequently structured to influence both the choice of drugs and the purchasing arrangements. While formulary restrictions can channel purchases to preferred drugs, closed formularies, which provide reimbursement only for preferred drugs, have generated substantial dissatisfaction among consumers. As a result, many plans link their cost-sharing requirements and formulary lists. The fastest growing trend today is the use of a formulary that covers all drugs but that includes beneficiary cost-sharing that varies for different drugs—typically a smaller copayment for generic drugs, a larger one for preferred drugs, and an even larger one for all other drugs. Reduced copayments have also been used to encourage enrollees using maintenance drugs for chronic conditions to obtain them from particular suppliers, like a mail-order pharmacy.

Plans and insurers have turned to PBMs for assistance in establishing formularies, negotiating prices with manufacturers and pharmacies, processing beneficiaries’ claims, and reviewing drug utilization. Because PBMs manage drug benefits for multiple purchasers, they often may have more leverage than individual plans in negotiating prices through their greater purchasing power.

Traditional fee-for-service Medicare has generally established reimbursement rates for services like those provided by physicians and hospitals and then processed and paid claims with few utilization controls. Adopting some of the techniques used by private plans and insurers might help better control costs. However, how to adapt those techniques to the characteristics and size of the Medicare program raises questions.

Negotiated or competitively determined prices would be superior to administered prices only if Medicare could employ some of the utilization controls that come from having a formulary and differential beneficiary cost-sharing. In this manner, Medicare would be able to negotiate significantly discounted prices by promising to deliver a larger market share for a manufacturer’s product. Manufacturers would have no incentive to offer a deep discount if all drugs in a therapeutic class were covered on the same terms. Without a promised share of the Medicare market, these manufacturers might reap greater returns from charging higher prices and by concentrating marketing efforts on physicians and consumers to influence prescribing patterns.

Implementing a formulary and other utilization controls could prove difficult for Medicare. Developing a formulary involves determining which drugs are therapeutically equivalent so that several from each class can be included. Plans and PBMs currently make those determinations privately—something that would not be possible for Medicare, which must have transparent policies that are determined openly. Given the stakes involved in selecting drugs, one can imagine the intensive efforts to offer input to and scrutinize the selection process. operated in each area, beneficiaries could choose one to administer their drug benefit. This raises questions about how to inform beneficiaries of the differences in each PBM’s policies and whether and how to risk-adjust payments to PBMs for differences in the health status of the beneficiaries using them.

Extending Federal Price Discounts to Beneficiaries

Another option before the Congress would allow Medicare beneficiaries to purchase prescription drugs at the lowest price paid by the federal government. Because of their large purchasing power, federal agencies, such as, the Departments of Veterans Affairs (VA) and Defense (DOD), have access to prescription drug prices that often are considerably lower than retail prices. Extending these discounts to Medicare beneficiaries, or some groups of beneficiaries, could have a measurable effect on lowering their out-of-pocket spending, although whether this would adequately increase access or raise prices paid by other purchasers that negotiate drug discounts is unknown.

Typically, federal agencies obtain prescription drugs at prices listed in the federal supply schedule (FSS) for pharmaceuticals.FSS prices represent a significant discount off the prices drug manufacturers charge wholesalers.Under the Veterans Health Care Act of 1992, drug manufacturers must make their brand-named drugs available to federal agencies at the FSS price in order to participate in the Medicaid program. The act requires that the FSS price for VA, DOD, the Public Health Service, and the Coast Guard be at least 24 percent below the price that the manufacturers charge wholesalers. competitive basis for specific drugs considered therapeutically interchangeable. These contracts enable VA to obtain larger discounts from manufacturers by channeling greater volume to certain pharmaceutical products.

Providing Medicare beneficiaries access to the lowest federal prices could result in important out-of-pocket savings to those without coverage who are paying close to retail prices. However, concerns exist that extending federal discounts to Medicare beneficiaries could lead to price increases to federal agencies and other purchasers since the discount is based on prices determined by manufacturers. Federal efforts to lower Medicaid drug prices demonstrate the potential for this to occur. While it is not possible to predict how federal drug prices would change if Medicare beneficiaries are given access to them, the larger the market that seeks to take advantage of these prices, the greater the economic incentive would be for drug manufacturers to raise federal prices to limit the impact of giving lower prices to more purchasers.

Expanding Benefits Needs to be Considered in Light of Larger Medicare Fiscal Concerns

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 hand, Medicare’s benefit package contains gaps in desired coverage, most notably the lack of outpatient prescription drug coverage, compared with private employer coverage. Any option to modernize the benefits runs the risk of exacerbating the fiscal imbalance of the programs. That is why we believe that expansions should be made in the context of overall program reforms that are designed to make the program more sustainable over the long term. Any discussions about expanding beneficiary access to prescription drugs should carefully consider targeting financial help to those most in need and minimizing the substitution of public funds for private funds. Employers that offer drug coverage through a retiree health plan may choose to adapt their health coverage if a Medicare drug benefit is available. A key characteristic of America’s voluntary, employer-based system of health insurance is an employer’s freedom to modify the conditions of coverage or to terminate benefits.

Medicare’s Financial Condition

device. It allows the government to track the extent to which earmarked payroll taxes cover Medicare’s HI outlays. In serving the tracking purpose, the 1999 Trustees’ annual report showed that Medicare’s HI component has been, on a cash basis, in the red since 1992, and in fiscal year 1998, earmarked payroll taxes covered only 89 percent of HI spending. In the Trustees’ report, issued in March 1999, projected continued cash deficits for the HI trust fund. (See fig. 3.)

F u n d B a la n c e When the program has a 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 generates a cash surplus. In essence, for Medicare to “redeem” its securities, the government must raise taxes, cut spending for other programs, or reduce the projected surplus. Outlays for Medicare services covered under Supplementary Medical Insurance (SMI)–physician and outpatient hospital services, diagnostic tests, and certain other medical services and supplies–are already funded largely through general revenues.

Although the Office of Management and Budget (OMB) has recently reported a $12 billion cash surplus for the HI program in fiscal year 1999 due to lower than expected program outlays, the long-term financial outlook for Medicare is expected to deteriorate. Medicare’s rolls are expanding and are projected to increase rapidly with the retirement of the baby boomers. Today’s elderly make up about 13 percent of the total population; by 2030, they will comprise 20 percent as the baby boom generation ages and the ratio of workers to retirees declines from 3.4 to 1 today to roughly 2 to 1.

Without meaningful reform, the long-term financial outlook for Medicare is bleak. Together, Medicare’s HI and SMI expenditures are expected to increase dramatically, rising from about 12 percent in 1999 to about a quarter of all federal revenues by mid-century. 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 4.

The progressive absorption of a greater share of the nation’s resources for health care, like Social Security, is in part a reflection of the rising share of elderly population, but Medicare 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.

When viewed from the perspective of the entire budget and the economy, the growth in Medicare 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 absorb more than three-quarters of total federal revenue. (See fig. 5.) Budgetary flexibility would be drastically constrained and little room would be left for programs for national defense, the young, infrastructure, and law enforcement.

Prescription Drugs: Increasing Medicare Beneficiary Access and Related Implications *The “eliminate non-Social Security surpluses” simulation can only be run through 2066 due to the elimination of the capital stock.

Revenue as a share of GDP during the simulation period is lower than the 1999 level due to unspecified permanent policy actions that reduce revenue and increase spending to eliminate the non-Social Security surpluses.

Medicare expenditure projections follow the Trustees’ 1999 intermediate assumptions. The projections reflect the current benefit and financing structure. term. Assuming no other changes, these programs would constitute an unimaginable drain on the earnings of our future workers. actuarial balance to the HI trust fund. This analysis, moreover, does not incorporate the financing challenges associated with the SMI and Medicaid programs.

Early action to address the structural imbalances in Medicare is critical. First, ample time is required to phase in the reforms needed to put this program on a more sustainable footing before the baby boomers retire. Second, timely action to bring costs down pays large fiscal dividends for the program and the budget. The high projected growth of Medicare in the coming years means that the earlier the reform begins, the greater the savings will be as a result of the effects of compounding.

The actions necessary to bring about a more sustainable program will no doubt call for some hard choices. Some suggest that the size of the imbalances between Medicare’s outlays and payroll tax revenues for the HI program may well justify the need for additional resources. One possible source could be general revenues. Although this may eventually prove necessary, such additional financing should be considered as part of a broader initiative to ensure the program’s long-range financial integrity and sustainability.

What concerns us most is that devoting general funds to the HI trust fund may be used to extend HI’s solvency without addressing the hard choices needed to make the whole Medicare program more sustainable in economic or budgetary terms. Increasing the HI trust fund balance alone, without underlying program reform, does nothing to make the Medicare program more sustainable—that is, it does not reduce the program’s projected share of GDP or the federal budget. From a macroeconomic 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 all Medicare’s promised benefits—both now and in the future. We must keep in mind the unprecedented challenge facing future generations in our aging society. Relieving them of some of the financial burden of today’s commitments would help preserve some budgetary flexibility for future generations to make their own choices. portion of Medicare, which is projected to grow even faster than HI in coming decades, assuming no additional SMI benefits.

The issue of the extent to which general funds are an appropriate financing mechanism for the Medicare program would remain important under financing arrangements that differed from those in place in the current HI and SMI structures. For example, under approaches that would combine the two trust funds, a continued need would exist for measures of program sustainability that would signal potential future fiscal imbalance. Such measures might include the percentage of program funding provided by general revenues, the percentage of total federal revenues or gross domestic product devoted to Medicare, or program spending per enrollee. As such measures were developed, questions would need to be asked about the appropriate level of general revenue funding. Regardless of the measure chosen, the real question would be what actions should be taken when and if the chosen cap is reached.

Long-Term Fiscal Policy Choices

Beyond reforming the Medicare program itself, maintaining an overall sustainable fiscal policy and strong economy is vital to enhancing our nation’s future capacity to afford paying benefits in the face of an aging society. Decisions on how we use today’s surpluses can have wide-ranging impacts on our ability to afford tomorrow’s commitments.

As we know, there have been a variety of proposals to use the surpluses for purposes other than debt reduction. Although these proposals have various pros and cons, we need to be mindful of the risk associated with using projected surpluses to finance permanent future claims on the budget, whether they are on the spending or the tax side. Commitments often prove to be permanent, while projected surpluses can be fleeting. For instance, current projections assume full compliance with tight discretionary spending caps. Moreover, relatively small changes in economic assumptions can lead to very large changes in the fiscal outlook, especially when carried out over a decade. In its January 2000 report,CBO compared the actual deficits or surpluses for 1986 through 1999 with the first projection it had produced 5 years before the start of each fiscal year. Excluding the estimated impact of legislation, CBO stated that its errors in projecting the federal surplus or deficit averaged about 2.4 percent of GDP in the fifth year beyond the current year. For example, such a shift in 2005 would mean a potential swing of about $285 billion in the projected surplus for that year.

Although most would not argue for devoting 100 percent of the surplus to debt reduction over the next 10 years, saving a good portion of our surpluses would yield fiscal and economic dividends as the nation faces the challenges of financing an aging society. Our work on the long-term budget outlook illustrates the benefits of maintaining surpluses for debt reduction. Reducing the publicly held debt reduces interest costs, freeing up budgetary resources for other programmatic priorities. For the economy, running surpluses and reducing debt increase national saving and free up resources for private investment. These results, in turn, lead to stronger economic growth and higher incomes over the long term.

Over the last several years, our simulations illustrate the long-term economic consequences flowing from different fiscal policy paths.Our models consistently show that saving all or a major share of projected budget surpluses ultimately leads to demonstrable gains in GDP per capita. Over a 50-year period, GDP per capita is estimated to more than double from present levels by saving all or most of projected surpluses, while incomes would eventually fall if we failed to sustain any of the surplus. Although rising productivity and living standards are always important, they are especially critical for the 21st century, for they will increase the economic capacity of the projected smaller workforce to finance future government programs along with the obligations and commitments for the baby boomers’ retirement.

Concluding Observations

Updating the Medicare benefit package may be a necessary part of any realistic reform program to address the legitimate expectations of an aging society for health care, both now and in the future. Expanding access to prescription drugs could ease the significant financial burden some Medicare beneficiaries face because of outpatient drug costs. Such changes, however, need to be considered as part of a broader initiative to address Medicare’s current fiscal imbalance and promote the program’s longer-term sustainability. Balancing these competing concerns may require the best from government-run programs and private sector efforts to modernize Medicare for the future. Further, the Congress should consider adequate fiscal incentives to control costs and a targeting strategy in connection with any proposal to provide new benefits such as prescription drugs. expectation and the future projected growth of the program, some additional revenue sources may in fact be a necessary component of Medicare reform. However, it is essential that we not take our eye off the ball. The most critical issue facing Medicare is the need to ensure the program’s long range financial integrity and sustainability. The 1999 annual reports of the Medicare Trustees project that program costs will continue to grow faster than the rest of the economy. Care must be taken to ensure that any potential expansion of the program be balanced with other programmatic reforms so that we do not worsen Medicare’s existing financial imbalances.

Current budget 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 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, this concludes my prepared statement. I will be happy to answer any questions you or other Subcommittee Members may have.

GAO Contacts and Acknowledgments

For future contacts regarding this testimony, please call Paul L. Posner, Director, Budget Issues, at (202) 512-9573 or William J. Scanlon, Director, Health Financing and Public Health Issues at (202) 512-7114. Other individuals who made key contributions include Linda F. Baker, Laura A. Dummit, John C. Hansen, Tricia A. Spellman, and James R. McTigue. (201033/935352)