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Before the Joint Economic Committee:

United States General Accounting Office:


For Release on Delivery Expected at 10:00 a.m.

Thursday, April 10, 2003:


Financial Challenges and Considerations for Reform:

Statement of David M. Walker:

Comptroller General of the United States:


Mr. Chairman and Members of the Committee:

I am pleased to be here today as you examine Medicare’s financial 

health and consider the budgetary and economic challenges presented by 

an aging society. I have been particularly attentive to the 

sustainability challenges faced by the nation’s two largest entitlement 

programs--Medicare and Social Security--for more than a decade since I 

served as a public trustee for these programs in the early 1990s. The 

recent publication of the 2003 Trustees’ annual report reminds us, once 

again, that the status quo is not an option for Medicare. If the 

program stays on its present course, in 10 years Hospital Insurance 

(HI) Trust Fund outlays will begin to exceed tax receipts, and by 2026 

the HI trust fund will be exhausted. It is important to note that trust 

fund insolvency does not mean the program will cease to exist; program 

tax revenues will continue to cover a portion of projected 

expenditures.[Footnote 1] However, Medicare is only part of the broader 

health care financing problem that confronts both public programs and 

private payers. The unrelenting growth in health care spending is 

producing a health care sector that continues to claim an increasing 

share of our gross domestic product (GDP).

Despite the grim outlook for Medicare’s financial future, fiscal 

discipline imposed on Medicare through the Balanced Budget Act of 1997 

(BBA) continues to be challenged, and interest in modernizing the 

program’s benefit package to include prescription drug coverage and 

catastrophic protection continues to grow. Such unabated pressures 

highlight the urgency for meaningful reform. As we deliberate on the 

situation, we must be mindful of several key points:

* The traditional measure of HI Trust Fund solvency is a misleading 

gauge of Medicare’s financial health. Long before the HI Trust Fund is 

projected to be insolvent, pressures on the rest of the federal budget 

will grow as HI’s projected cash inflows turn negative and grow as the 

years pass. Moreover, a focus on the financial status of HI ignores the 

increasing burden Supplemental Medical Insurance (SMI)--Medicare part 

B--will place on taxpayers and beneficiaries.

* GAO’s most recent long-term budget simulations continue to show that 

demographic trends and rising health care spending will drive 

escalating federal deficits and debt, absent meaningful entitlement 

reforms or other significant tax or spending actions. To obtain budget 

balance, massive spending cuts, tax increases, or some combination of 

the two would be necessary. Neither slowing the growth of discretionary 

spending nor allowing the tax reductions to sunset will eliminate the 

imbalance. In addition, while additional economic growth will help ease 

our burden, the potential fiscal gap is too great to grow our way out 

of the problem.

* Since the cost of a drug benefit would boost spending projections 

even further, adding drug coverage when Medicare’s financial future is 

already bleak will require difficult policy choices that will mean 

trade-offs for both beneficiaries and providers. Just as physicians 

take the Hippocratic oath to “do no harm,” policymakers should avoid 

adopting reforms that will worsen Medicare’s long-term financial 


* Our experience with Medicare--both the traditional program and its 

private health plan alternative--provides valuable lessons that can 

guide consideration of reforms. For example, we know that proposals to 

enroll beneficiaries in private health plans must be designed to 

encourage beneficiaries to join efficient plans and ensure that 

Medicare shares in any efficiency gains. We also recognize that 

improvements to traditional Medicare are essential, as this program 

will likely remain significant for some time to come.

Ultimately, we will need to look at broader health care reforms, as 

spending growth problems are not exclusive to Medicare. For both public 

and private payers, containing growth in health expenditures will be an 

abiding 21st century challenge. In today’s health care sector, there 

are few incentives for providers and consumers to be prudent in their 

ordering and use of health care services, too little transparency with 

regard to the value and costs of care, and inadequate accountability to 

ensure that health care plans and providers meet standards for 

appropriate use and quality.

These problems cannot be solved overnight. It will require committed, 

long-term resolve and sustained attention to help policymakers and the 

public understand the need to move beyond the status quo. The magnitude 

of the challenge suggests that reforms will need to be phased in over 

time to minimize any temporary disruptions that may result. However, 

incremental reforms should build upon each other and continue to bring 

us closer to our desired goals. This argues for having a systematic 

process for setting common goals and assessing the potential for any 

proposed reforms to meet these goals. At GAO, we are developing a 

framework--that is, a comprehensive set of criteria--for consideration 

by the Congress, to help policymakers evaluate proposed health care 


Now I would like to discuss overall trends in health care spending, the 

financial challenges Medicare faces, and considerations for health care 

reform efforts.

Trends in Health Care Spending Systemwide Pose Significant Challenges 

for 21st Century:

To best understand Medicare’s fiscal plight, we should also understand 

the broader health care context in which it operates. Total health care 

spending from all sources--public and private--continues to increase at 

a breathtaking pace. From 1990 through 2000, spending nearly doubled 

from about $696 billion to about $1.3 trillion (see fig. 1). From 2000 

through 2010, the rate of spending growth is expected to accelerate 

somewhat, resulting in an estimated $2.7 trillion in total annual 

health care spending by the end of the period. Increases in medical 

prices account for a little more than half of the 20-year spending 

increase, while increases in the use of services--owing to population 

growth and rise in the number of services used per person--and more 

expensive services account for the rest.

Figure 1: Total National Health Care Spending, 1990-2010:

[See PDF for image]

Note: The figure for 2010 is projected. All dollars are nominal.

[End of figure]

The rapid growth in health care spending means that an increasing share 

of the nation’s output, as measured by GDP, will be devoted to the 

production of health care services and goods. In 1970, spending on 

health care represented about 7 percent of GDP (see fig. 2). By 2010, 

health care spending’s share of GDP is expected to rise to about 17 


Figure 2: Total National Health Care Spending as a Percentage of GDP, 


[See PDF for image]

Note: The figure for 2010 is projected.

[End of figure]

At the same time that health care spending has increased, consumers 

have become more insulated from these costs. In 1962, nearly half--46 

percent--of health care spending was financed by individuals out of 

their own pockets (see fig. 3). The remaining 54 percent was financed 

by a combination of private health insurance and public programs. By 

2002, the amount of health care spending financed by individuals out of 

their own pockets was estimated to have dropped to 14 percent.

Figure 3: Sources of Health Care Financing, 1962-2002:

[See PDF for image]

Note: The figure for 2002 is estimated.

[End of figure]

Tax considerations encourage employers to offer health insurance to 

their employees, as the value of the premium is excluded from the 

calculation of employees’ taxable earnings. Moreover, the value of the 

insurance coverage does not figure into the calculation of payroll 

taxes. These tax exclusions represent a significant source of foregone 

federal revenue, currently amounting to about 1 percent of GDP.

Outlook Worsening for Medicare’s Long-Term Sustainability:

Today the Medicare program faces a long-range and fundamental financing 

problem driven by known demographic trends and projected escalation of 

health care spending beyond general inflation. The lack of an immediate 

crisis in Medicare financing affects the nature of the challenge, but 

it does not eliminate the need for change. Within the next 10 years, 

the first baby boomers will begin to retire, putting increasing 

pressure on the federal budget. From the perspectives of the program, 

the federal budget, and the economy, Medicare in its present form is 

not sustainable. Acting sooner rather than later would allow changes to 

be phased in so that the individuals who are most likely to be 

affected, namely younger and future workers, will have time to adjust 

their retirement planning while helping to avoid related “expectation 

gaps.” Since there is considerable confusion about Medicare’s current 

financing arrangements, I would like to begin by describing the nature, 

timing, and extent of the financing problem.

Demographic Trends And Expected Rise in Health Care Costs Drive 

Medicare’s Long-Term Financing Problem:

As you know, Medicare consists of two parts--HI and SMI. HI, which pays 

for inpatient hospital stays, skilled nursing care, hospice, and 

certain home health services, is financed by a payroll tax. Like Social 

Security, HI has always been largely a pay-as-you-go system. SMI, which 

pays for physician and outpatient hospital services, diagnostic tests, 

and certain other medical services, is financed by a combination of 

general revenues and beneficiary premiums. Beneficiary premiums pay for 

about one-fourth of SMI benefits, with the remainder financed by 

general revenues. These complex financing arrangements mean that 

current workers’ taxes primarily pay for current retirees’ benefits 

except for those financed by SMI premiums.[Footnote 2]

As a result, the relative numbers of workers and beneficiaries have a 

major impact on Medicare’s financing. The ratio, however, is changing. 

In the future, relatively fewer workers will be available to shoulder 

Medicare’s financial burden. In 2002 there were 4.9 working-age persons 

(18 to 64 years) per elderly person, but by 2030, this ratio is 

projected to decline to 2.8. For the HI portion of Medicare, in 2002 

there were nearly 4 covered workers per HI beneficiary. Under the 

Trustees’ intermediate 2003 estimates, the Medicare Trustees project 

that by 2030 there will be only 2.4 covered workers per HI beneficiary. 

(See fig. 4.):

Figure 4: Ratio of HI-Covered Workers to Beneficiaries:

[See PDF for image]

Note: Projections based on the intermediate assumptions of The 2003 

Annual Report of the Boards of Trustees of the Federal Hospital 

Insurance and Federal Supplementary Medical Insurance Trust Funds.

[End of figure]

The demographic challenge facing the system has several causes. People 

are retiring early and living longer. As the baby boom generation ages, 

the share of the population age 65 and over will escalate rapidly. A 

falling fertility rate is the other principal factor underlying the 

growth in the elderly’s share of the population. In the 1960s, the 

fertility rate was an average of 3 children per woman. Today it is a 

little over 2, and by 2030 it is expected to fall to 1.95--a rate that 

is below replacement. The combination of the aging of the baby boom 

generation, increased longevity, and a lower fertility rate will drive 

the elderly as a share of total population from today’s 12 percent to 

almost 20 percent in 2030.

Taken together, these trends threaten both the financial solvency and 

sustainability of this important program. Labor force growth will 

continue to decline and by 2025 is expected to be less than a third of 

what it is today. (See fig. 5.) Relatively fewer workers will be 

available to produce the goods and services that all will consume. 

Without a major increase in productivity, low labor force growth will 

lead to slower growth in the economy and slower growth of federal 

revenues. This in turn will only accentuate the overall pressure on the 

federal budget. This slowing labor force growth is not always 

recognized as part of the Medicare debate, but it is expected to affect 

the ability of the federal budget and the economy to sustain Medicare’s 

projected spending in the coming years.

Figure 5: Labor Force Growth:

[See PDF for image]

Note: GAO analysis based on the intermediate assumptions of The 2003 

Annual Report of the Board of Trustees of the Federal Old-Age and 

Survivors Insurance and the Federal Disability Insurance Trust Funds. 

Percentage change is calculated as a centered 5-year moving average.

[End of figure]

The demographic trends I have described will affect both Medicare and 

Social Security, but Medicare presents a much greater, more complex, 

and more urgent challenge. Unlike Social Security, Medicare spending 

growth rates reflect not only a burgeoning beneficiary population, but 

also the escalation of health care costs at rates well exceeding 

general rates of inflation. The growth of medical technology has 

contributed to increases in the number and quality of health care 

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

transparent. Third-party payers largely insulate covered consumers from 

the cost of health care decisions. These factors and others contribute 

to making Medicare a greater and more complex fiscal challenge than 

even Social Security.

HI’s Trust Fund Faces Cash Flow Problems Long before the HI Trust Fund 

Is Projected to Be Insolvent:

Current projections of future HI income and outlays illustrate the 

timing and severity of Medicare’s fiscal challenge. Today, the HI Trust 

Fund takes in more in taxes than it spends. Largely because of the 

known demographic trends I have described, this situation will change. 

Under the Trustees’ 2003 intermediate assumptions, program outlays are 

expected to begin to exceed program tax revenues in 2013 (see fig. 6). 

To finance these cash deficits, HI will need to draw on the special-

issue Treasury securities acquired during the years of cash surpluses. 

For HI to “redeem” its securities, the government will need to obtain 

cash through some combination of increased taxes, spending cuts, and/or 

increased borrowing from the public (or, if the unified budget is in 

surplus, less debt reduction than would otherwise have been the case). 

Neither the decline in the cash surpluses nor the cash deficits will 

affect the payment of benefits, but the negative cash flow will place 

increased pressure on the federal budget to raise the resources 

necessary to meet the program’s ongoing costs. This pressure will only 

increase when Social Security also experiences negative cash flow and 

joins HI as a net claimant on the rest of the budget.[Footnote 3]

Figure 6: Medicare’s HI Trust Fund Faces Cash Deficits as Baby Boomers 


[See PDF for image]

Note: GAO analysis based on the intermediate assumptions of The 2003 

Annual Report of the Boards of Trustees of the Federal Hospital 

Insurance and Federal Supplementary Medical Insurance Trust Funds.

[End of figure]

The gap between HI income and costs shows the severity of HI’s 

financing problem over the longer term. This gap can also be expressed 

relative to taxable payroll (the HI Trust Fund’s funding base) over a 

75-year period. This year, under the Trustees 2003 intermediate 

estimates, the 75-year actuarial deficit is projected to be 2.40 

percent of taxable payroll--a significant increase from last year’s 

projected deficit of 2.02 percent. This means that to bring the HI 

Trust Fund into balance over the 75-year period, either program outlays 

would have to be immediately reduced by 42 percent or program income 

immediately increased by 71 percent, or some combination of the two. 

These estimates of what it would take to achieve 75-year trust fund 

solvency understate the extent of the problem because the program’s 

financial imbalance gets worse in the 76th and subsequent years. Every 

year that passes we drop a positive year and add a much bigger deficit 


The projected exhaustion date of the HI Trust Fund is a commonly used 

indicator of HI’s financial condition. Under the Trustees 2003 

intermediate estimates, the HI Trust Fund is projected to exhaust its 

assets in 2026. This solvency indicator provides information about HI’s 

financial condition, but it is not an adequate measure of Medicare’s 

sustainability for several reasons. HI Trust Fund balances do not 

provide meaningful information on the government’s fiscal capacity to 

pay benefits when program cash inflows fall below program outlays. As I 

have described, the government would need to come up with cash from 

other sources to pay for benefits once outlays exceeded program tax 


In addition, the HI Trust Fund measure provides no information on SMI. 

SMI’s expenditures, which account for about 43 percent of total 

Medicare spending, are projected to grow even faster than those of HI 

in the near future. Moreover, Medicare’s complex structure and 

financing arrangements mean that a shift of expenditures from HI to SMI 

can extend the solvency of the HI Trust Fund, creating the appearance 

of an improvement in program’s financial condition. For example, the 

Balanced Budget Act of 1997 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 and beneficiary SMI premiums 

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 and the economy can 

afford the promised benefits now and in the future and at what cost to 

other claims on scarce resources. To better monitor and communicate 

changes in future total program spending, new measures of Medicare’s 

sustainability are needed. As program changes are made, a continued 

need will exist for measures of program sustainability that can 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 are 

developed, questions would need to be asked about actions to be taken 

if projections showed that program expenditures would exceed the chosen 


Absent Reform of Medicare and Other Entitlements for the Elderly, 

Budgetary Flexibility Will Disappear:

Taken together, Medicare’s HI and SMI expenditures are expected to 

increase dramatically, rising from about 12 percent of federal revenues 

in 2002 to more than one-quarter by midcentury. The budgetary challenge 

posed by the growth in Medicare becomes even more significant in 

combination with the expected growth in Medicaid and Social Security 

spending. This growth in spending on federal entitlements for retirees 

will become increasingly unsustainable over the longer term, 

compounding an ongoing decline in budgetary flexibility. Over the past 

few decades, spending on mandatory programs has consumed an ever-

increasing share of the federal budget. [Footnote 4] In 1962, prior to 

the creation of the Medicare and Medicaid programs, spending for 

mandatory programs plus net interest accounted for about 32 percent of 

total federal spending. By 2002, this share had almost doubled to 

approximately 63 percent of the budget. (See fig. 7.):

Figure 7: Federal Spending for Mandatory and Discretionary Programs, 

Fiscal Years 1962, 1982, and 2002:

[See PDF for image]

[End of figure]

In much of the past decade, reductions in defense spending helped 

accommodate the growth in these entitlement programs. Even before the 

events of September 11, 2001, however, this ceased to be a viable 

option. Indeed, spending on defense and homeland security will grow as 

we seek to combat new threats to our nation’s security.

GAO prepares long-term budget simulations that seek to illustrate the 

likely fiscal consequences of the coming demographic tidal wave and 

rising health care costs. These simulations continue to show that to 

move into the future with no changes in federal retirement and health 

programs is to envision a very different role for the federal 

government. Assuming, for example, that the tax reductions enacted in 

2001 do not sunset and discretionary spending keeps pace with the 

economy, by midcentury federal revenues may be inadequate to pay Social 

Security and interest on the federal debt. Spending for the current 

Medicare program--without any additional new benefits--is projected to 

account for more than one-quarter of all federal revenues. To obtain 

budget balance, massive spending cuts, tax increases, or some 

combination of the two would be necessary. (See fig.8). Neither slowing 

the growth of discretionary spending nor allowing the tax reductions to 

sunset eliminates the imbalance. In addition, while additional economic 

growth would help ease our burden, the projected fiscal gap is too 

great for us to grow our way out of the problem.

Figure 8: Composition of Spending as a Share of GDP Assuming 

Discretionary Spending Grows with GDP after 2003 and the 2001 Tax Cuts 

Do Not Sunset:

[See PDF for image]

Note: Assumes currently scheduled Social Security benefits are paid in 

full throughout the simulation period. Social Security and Medicare 

projections are based on the Trustees’ 2003 intermediate assumptions.

[End of figure]

Indeed, long-term budgetary flexibility is about more than Social 

Security and Medicare. While these programs dominate the long-term 

outlook, they are not the only federal programs or activities that bind 

the future. The federal government undertakes a wide range of programs, 

responsibilities, and activities that obligate it to future spending or 

create an expectation for spending. Our recent report describes the 

range and measurement of such fiscal exposures--from explicit 

liabilities such as environmental cleanup requirements to the more 

implicit obligations presented by life-cycle costs of capital 

acquisition or disaster assistance.[Footnote 5] Making government fit 

the challenges of the future will require not only dealing with the 

drivers--entitlements for the elderly--but also looking at the range of 

other federal activities. A fundamental review of what the federal 

government does and how it does it will be needed.

Medicare Is Projected to Absorb Ever-Increasing Shares of the Economy:

At the same time, it is important to look beyond the federal budget to 

the economy as a whole. Figure 9 shows the total future draw on the 

economy represented by Medicare, Medicaid, and Social Security. Under 

the 2003 Trustees’ intermediate estimates and the Congressional Budget 

Office’s (CBO) most recent long-term Medicaid estimates, spending for 

these entitlement programs combined will grow to 14 percent of GDP in 

2030 from today’s 8.4 percent. Taken together, Social Security, 

Medicare, and Medicaid represent an unsustainable burden on future 


Figure 9: Social Security, Medicare, and Medicaid Spending as a 

Percentage of GDP:

[See PDF for image]

Note: Projections based on the intermediate assumptions of the 2003 

Trustees’ Reports, CBO’s March 2003 short-term Medicaid estimates, and 

CBO’s June 2002 Medicaid long-term projections under midrange 


[End of figure]

Although real incomes are projected to continue to rise, they are 

expected to grow more slowly than has historically been the case. At 

the same time, the demographic trends and projected rates of growth in 

health care spending I have described will mean rapid growth in 

entitlement spending. Taken together, these projections raise serious 

questions about the capacity of the relatively smaller number of future 

workers to absorb the rapidly escalating costs of these programs.

As HI trust fund assets are redeemed to pay Medicare benefits and SMI 

expenditures continue to grow, the program will constitute a claim on 

real resources in the future. As a result, taking action now to 

increase the future pool of resources is important. To echo Federal 

Reserve Chairman Alan Greenspan, the crucial issue of saving in our 

economy relates to our ability to build an adequate capital stock to 

produce enough goods and services in the future to accommodate both 

retirees and workers in the future.[Footnote 6] The most direct way the 

federal government can raise national saving is by increasing 

government saving, that is, as the economy returns to a higher growth 

path, a balanced fiscal policy that recognizes our long-term challenges 

can help provide a strong foundation for economic growth and can 

enhance our future budgetary flexibility. It is my hope that we will 

think about the unprecedented challenge facing future generations in 

our aging society. Putting Medicare on a sustainable path for the 

future would help fulfill this generation’s stewardship responsibility 

to succeeding generations. It would also help to preserve some capacity 

for future generations to make their own choices for what role they 

want the federal government to play.

As with Social Security, both sustainability and solvency 

considerations drive us to address Medicare’s fiscal challenges sooner 

rather than later. HI Trust Fund exhaustion may be more than 20 years 

away, but the squeeze on the federal budget will begin as the baby boom 

generation begins to retire. This will begin as early as 2008, when the 

leading edge of the baby boom generation becomes eligible for early 

retirement.[Footnote 7] CBO’s current 10-year budget and economic 

outlook reflects this. CBO projects that economic growth will slow from 

an average of 3.2 percent a year from 2005 through 2008 to 2.7 percent 

from 2009 through 2013 reflecting slower labor force growth. At the 

same time, annual rates of growth in entitlement spending will begin to 

rise. Annual growth in Social Security outlays is projected to 

accelerate from 5.2 percent in 2007 to 6.6 percent in 2013. Annual 

growth in Medicare enrollees is expected to accelerate from 1.1 percent 

today to 2.9 percent in 2013. Acting sooner rather than later is 

essential to ease future fiscal pressures and also provide a more 

reasonable planning horizon for future retirees. We are now at a 

critical juncture. In less than a decade, the profound demographic 

shift that is a certainty will have begun.

Pressure to Address Medicare Coverage Gaps Must Be Balanced against 

Program Sustainability Concerns:

Despite a common awareness of Medicare’s current and future fiscal 

plight, pressure has been building to address recognized gaps in 

Medicare coverage, especially the lack of a prescription drug benefit 

and protection against financially devastating medical costs. Filling 

these gaps could add massive expenses to an already fiscally 

overburdened program. Under the Trustees 2003 intermediate assumptions, 

the present value of HI’s actuarial deficit is $6.2 trillion.[Footnote 

8] This difficult situation argues for tackling the greatest needs 

first and for making any benefit additions part of a larger structural 

reform effort.

The Medicare benefit package, largely designed in 1965, provides 

virtually no outpatient drug coverage. Beneficiaries may fill this 

coverage gap in various ways. All beneficiaries have the option to 

purchase supplemental policies--Medigap--when they first become 

eligible for Medicare at age 65. Those policies that include drug 

coverage tend to be expensive and provide only limited benefits. Some 

beneficiaries have access to coverage through employer-sponsored 

policies or private health plans that contract to serve Medicare 

beneficiaries. In recent years, coverage through these sources has 

become more expensive and less widely available. Beneficiaries whose 

income falls below certain thresholds may qualify for Medicaid or other 

public programs. According to one survey, in the fall of 1999, more 

than one-third of beneficiaries reported that they lacked drug coverage 

altogether.[Footnote 9]

Medicare also does not limit beneficiaries’ cost-sharing liability. The 

average beneficiary who obtained services had a total liability for 

Medicare-covered services of $1,700, consisting of $1,154 in Medicare 

copayments and deductibles in addition to the $546 in annual part B 

premiums in 1999, the most recent year for which data are available on 

the distribution of these costs. The burden can, however, be much 

higher for beneficiaries with extensive health care needs. In 1999, 

about 1 million beneficiaries were liable for more than $5,000, and 

about 260,000 were liable for more than $10,000 for covered services. 

In contrast, employer-sponsored health plans for active workers 

typically limited maximum annual out-of-pocket costs for covered 

services to less than $2,000 per year for single coverage.[Footnote 10]

Modernizing Medicare’s benefit package will require balancing competing 

concerns about program sustainability, federal obligations, and the 

hardship faced by some beneficiaries. In particular, the addition of a 

benefit that has the potential to be extremely expensive--such as 

prescription drug coverage--should be focused on meeting the needs 

deemed to be of the highest priority. This would entail targeting 

financial help to beneficiaries most in need--those with catastrophic 

drug costs or low incomes--and, to the extent possible, avoiding the 

substitution of public for private insurance coverage. As I continue to 

maintain, acting prudently means making any benefit expansions in the 

context of overall program reforms that are designed to make the 

program more sustainable over the long term instead of worsening the 

program’s financial future.

One reform to help improve Medicare’s financial future would be to 

modify Medicare’s cost-sharing rules and provide beneficiaries with 

better incentives to use care appropriately. Health insurers today 

commonly design cost-sharing requirements--in the form of deductibles, 

coinsurance, and copayments--to ensure that enrollees are aware that 

there is a cost associated with the provision of services and to use 

them prudently. Ideally, cost-sharing should encourage beneficiaries to 

evaluate the need for discretionary care but not discourage necessary 

care. Coinsurance or copayments would be required generally for 

services considered to be discretionary and potentially overused and 

would aim to steer patients to lower cost or better treatment options. 

Care must be taken, however, to avoid setting cost-sharing requirements 

so high as to create financial barriers to care.

Medicare fee-for-service cost-sharing rules diverge from these common 

insurance industry practices in important ways. For example, Medicare 

imposes a relatively high deductible of $840 for hospital admissions, 

which are rarely optional. In contrast, Medicare has not increased the 

part B deductible since 1991. For the last 12 years, the deductible has 

remained constant at $100 and has thus steadily declined as a 

proportion of beneficiaries’ real incomes. Adjusted for inflation, the 

deductible has fallen to $74.39 in 1991 dollars.

Medicare Reforms Should Realign Incentives, Improve Transparency, and 

Strengthen Accountability:

In recent years, leading proposals have been made to restructure 

Medicare that have included greater reliance on private health plans 

and reforms to the traditional fee-for-service program. The weaknesses 

identified in these two components of the current program suggest 

several lessons regarding such restructuring. Experience with 

Medicare’s private health plan alternative, called Medicare+Choice, 

suggests that details matter if competition is to produce enhanced 

benefits for enrollees and savings for the program. In addition, the 

traditional program must not be left unattended because it will be an 

important part of Medicare for years to come. The strategies needed to 

address either structural component must incorporate sufficient 

incentives to achieve efficiency, adequate transparency to reveal the 

cost of health care, and appropriate accountability mechanisms to 

ensure that the promised care and level of quality are actually 


Reforms That Include Private Plans Should Incorporate Incentives 

Sufficient to Result in Program Savings:

If the inclusion of private health plans is to produce savings for 

Medicare, private incentives and public goals must be properly aligned. 

This means designing a program that will encourage beneficiaries to 

select health plan options most likely to generate program savings. 

This is not the case in the current Medicare+Choice program. For 

example, incentives for health plan efficiency exist, but any 

efficiency gains achieved do not produce Medicare savings. Payments to 

private health plans that participate in Medicare+Choice are not set 

through a competitive process. Instead, plans receive a fixed payment 

from Medicare as prescribed by statute and in return must provide all 

Medicare-covered services with the exception of hospice. Efficient 

health plans are better able to afford to provide extra benefits, such 

as outpatient prescription drug benefits; charge a lower monthly 

premium; or both and may do so to attract beneficiaries and increase 

market share. Until recently, however, these efficiency and market 

share gains were advantageous to beneficiaries and health plans but 

generated no savings for Medicare. Even today, the opportunity for the 

program to realize savings from competition among Medicare+Choice 

health plans remains extremely limited.[Footnote 11] This experience 

has shown that savings are not automatic from simply enrolling 

beneficiaries in private health plans.

The Medicare+Choice experience offers another lesson about private 

plans and program savings. That is, as we recommended in 1998, payments 

to health plans must be adequately risk-adjusted for the expected 

health care costs of the beneficiaries they enroll. Otherwise, the 

government can inadequately compensate health plans that enroll less 

healthy beneficiaries with higher expected health care costs or will 

overpay health plans that enroll relatively healthy beneficiaries with 

low expected health care costs. Moreover, health plans will have an 

incentive to avoid enrolling less healthy beneficiaries with higher 

expected health care costs. In 2000, we reported that the failure to 

adequately adjust Medicare’s payments to private health plans for 

beneficiaries’ expected health care costs unnecessarily increased 

Medicare spending by $3.2 billion in 1998.[Footnote 12]

A third lesson is that the use of private plans to serve Medicare 

beneficiaries may not be feasible in all locations nationwide. In 

Medicare+Choice, it has been difficult and expensive to encourage 

private health plans to serve rural areas. Payment rates have been 

substantially raised in rural areas since 1997, yet by 2003 nearly 40 

percent of beneficiaries living in rural areas lack access to a private 

health plan; in contrast, 15 percent of beneficiaries in urban areas 

lack access to a plan. Finally, the Medicare+Choice experience 

underscores the importance of beneficiaries having user-friendly, 

accurate information to compare their health plan options and of 

holding private health plans appropriately accountable for the services 

they have promised to deliver.

Fixing Flaws In Traditional Medicare Essential to Alter Program’s 

Fiscal Course:

Leading Medicare reform proposals have included traditional Medicare as 

a component in their design. Traditional Medicare is likely to have a 

significant role for years to come, as any fundamental structural 

reforms would take considerable time before plan and beneficiary 

participation becomes extensive. Therefore, addressing flaws in the 

traditional program should be part of any plan to steer Medicare away 

from insolvency and improve its sustainability for future generations. 

The experience of other health insurers’ use of cost-containment 

strategies, including some incentives for beneficiaries to make value-

based choices, suggests a strategy for modernizing the program’s 

design. In the current program, the lack of insurance-type protections 

and difficulty in setting payment rates keep Medicare from achieving 

greater efficiencies and thus from improving its balance sheet.

Supplemental Coverage Reduces Beneficiary Cost Sensitivity:

Coverage through Medigap--policies that meet federally established 

standards and are sold by private insurers--helps to fill in some of 

Medicare’s gaps, but Medigap plans also have shortcomings. As required 

by law, Medigap plans must conform to 1 of 10 standard benefit 

packages, which vary in levels of coverage. Medigap offers 

beneficiaries stop-loss protections that are lacking in traditional 

Medicare, but these policies diminish important program protections by 

covering required deductibles and coinsurance. The most popular Medigap 

plans are fundamentally different from employer-sponsored health 

insurance policies for retirees in that they do not require individuals 

to pay deductibles, coinsurance, and copayments. Such cost-sharing 

requirements are intended to make beneficiaries aware of the costs 

associated with the use of services and encourage them to use these 

services prudently. In contrast, Medigap’s first-dollar coverage--the 

elimination of deductibles or coinsurance associated with the use of 

covered services--undermines this objective. Although such coverage 

reduces financial barriers to health care, it diminishes beneficiaries’ 

sensitivity to costs and likely increases beneficiaries’ use of 

services, adding to total Medicare spending.

Traditional Medicare needs the tools that other insurers use to achieve 

better value for the protection provided. Instead of working at cross-

purposes to the traditional program, Medigap should be better 

coordinated with it. Insurance-type reforms to Medicare and Medigap--

namely, the preservation of cost-sharing requirements in conjunction 

with stop-loss provisions--could help improve beneficiaries’ 

sensitivity to the cost of care while better protecting them against 

financially devastating medical costs.

Difficulties in Setting Payment Rates:

Medicare too often pays overly generous rates for certain services and 

products, preventing the program from achieving a desirable degree of 

efficiency. For example, for certain services, our work has shown 

substantially higher Medicare payments relative to providers’ costs--35 

percent higher for home health care in the first six months of 2001 and 

19 percent higher for skilled nursing facility care in 2000.[Footnote 

13] Similarly, Medicare has overpaid for various medical products. Last 

year, we reported that, in 2000, Medicare paid over $1 billion more 

than other purchasers for certain outpatient drugs that the program 

covers. Earlier findings that have since been addressed by the Congress 

following our recommendations showed Medicare paying over $500 million 

more than another public payer for home oxygen equipment. Excessive 

payments hurt not only the taxpayers but also the program’s 

beneficiaries or their supplemental insurers, as beneficiaries are 

liable for copayments equal to 20 percent of Medicare’s approved fee. 

For certain outpatient drugs, Medicare’s payments to providers were so 

high that the beneficiaries’ copayments exceeded the price at which 

providers could buy the drugs. In 2001, we recommended that, for 

covered outpatient prescription drugs, Medicare establish payment 

levels more closely related to actual market transaction costs, using 

information available to other public programs that pay at lower rates.

Over the past two decades, at the Congress’ direction, Medicare has 

implemented a series of payment reforms designed to promote the 

efficient delivery of services and control program spending. Some 

reforms required establishing set fees for individual services; others 

required paying a fixed amount for a bundle of services. The payment 

methods introduced during this time were designed to include--in 

addition to incentives for efficiencies--a means to calibrate payments 

to ensure beneficiary access and fairness to providers.

A major challenge in administering these methods--whether based on fee 

schedules or prospective payment systems using bundled payments--

involves adjusting the payments to better account for differences in 

patients’ needs and providers’ local markets to ensure that the program 

is paying appropriately and adequately. Payment rates that are too low 

can impair beneficiary access to services and products, while rates 

that are too high add unnecessary financial burdens to the program. As 

a practical matter, Medicare is often precluded from using market 

forces--that is, competition--to determine appropriate rates. In many 

cases, Medicare’s size and potential to distort market prices makes it 

necessary to use means other than competition to set a price on 

services and products.

Most of Medicare’s rate-setting methods are based on formulas that use 

historical data on providers’ costs and charges. Too often, these data 

are not recent or comprehensive enough to measure the costs incurred by 

efficient providers. At the same time, data reflecting beneficiaries’ 

access to services are also lacking. When providers contend that 

payments are not adequate, typically information is not readily 

available to provide the analytical support needed to determine whether 

these claims are valid. I have noted in the past the essential need to 

monitor the impact of program policy changes so that distinguishing 

between desirable and undesirable consequences can be done 

systematically and in a timely manner. To that end, I have also noted 

the importance of investing adequate resources in the agency that runs 

Medicare to ensure that the capacity exists to carry out these policy-

monitoring activities.

Under some circumstances, competition may be feasible and practical for 

setting more appropriate rates. Medicare has pilot tested “competitive 

bidding” in a few small markets. According to program officials, these 

test projects have shown that, for selected medical products, Medicare 

has saved money on items priced competitively. As part of these 

competitive bidding tests, steps were taken to monitor beneficiary 

access and product quality. To use competitive bidding on a broader 

scale, Medicare would require not only new authority but would need to 

make substantial administrative preparations, as competing with a 

larger number of products nationally would entail bidding in multiple 

markets and monitoring access and quality once prices had been set.

Concluding Observations:

Medicare’s financial challenge is very real. The 21st century has 

arrived and the demographic tidal wave is on the horizon. Within 5 

years, individuals in the vanguard of the baby boom generation will be 

eligible for Social Security and 3 years after that they will be 

eligible for Medicare. The future costs of serving the baby boomers are 

already becoming a factor in CBO’s short-term cost projections.

Clearly the issue before us is not whether to reform Medicare but how. 

I feel the greatest risk lies in doing nothing to improve Medicare’s 

long-term sustainability. It is my hope that we will think about the 

unprecedented challenge of facing future generations in our aging 

society. Engaging in a comprehensive effort to reform the program and 

put it on a sustainable path for the future would help fulfill this 

generation’s stewardship responsibility to succeeding generations.

Medicare reform would be done best with considerable lead time to phase 

in changes and before the changes that are needed become dramatic and 

disruptive. Given the size of Medicare’s financial challenge, it is 

only realistic to expect that reforms intended to bring down future 

costs will have to proceed incrementally. We should begin this now, 

when retirees are still a far smaller proportion of the population than 

they will be in the future. The sooner we get started, the less 

difficult the task will be.

As we contemplate the forecast for Medicare’s fiscal condition and its 

implications, we must also remember that the sources of some of its 

problems--and its solutions--are outside the program and are universal 

to all health care payers. Some tax preferences mask the full cost of 

providing health benefits and can work at cross-purposes to the goal of 

moderating health care spending. Therefore, it may be important to 

reexamine the incentives contained in current tax policy and consider 

potential reforms. Advances in medical technology are also likely to 

keep raising the price tag of providing care, regardless of the payer. 

Although technological advances unquestionably provide medical 

benefits, judging the value of those benefits--and weighing them 

against the additional costs--is more difficult. Consumers are not as 

informed about the cost of health care and its quality as they may be 

about other goods and services. Thus, while the greater use of market 

forces may help to control cost growth, it will undoubtedly be 

necessary to employ other cost control methods as well.

We must also be mindful that 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.

A major challenge policymakers face in considering health care reforms 

is the dearth of timely, accurate information with which to make 

decisions. Medicare’s size and impact on the nation’s health care 

economy means that its payment methods and rate adjustments, no matter 

how reasonable, often produce opposition. Recent experience with the 

payment reforms established in the BBA illustrates this point. In 

essence, these reforms changed Medicare’s payment methods to establish 

incentives for providers to deliver care efficiently. BBA’s changes 

were enacted in response to continuing rapid growth in Medicare 

spending that was neither sustainable nor readily linked to 

demonstrated changes in beneficiary needs. Nonetheless, affected 

provider groups conducted a swift, intense campaign to roll back the 

BBA changes. In the absence of solid, data-driven analyses, affected 

providers’ anecdotes were used to support contentions that Medicare 

payment changes were extreme and threatened their financial viability. 

This and similar reactions to mandated Medicare payment reforms 

underscore how difficult it is, without prompt and credible data, to 

defend against claims that payments changes have resulted in 

insufficient compensation that could lead to access problems.

The public sector can play an important role in educating the nation 

about the limits of public support. Currently, there is a wide gap 

between what patients and providers expect and what public programs are 

able to deliver. Moreover, there is insufficient understanding about 

the terms and conditions under which health care coverage is actually 

provided by the nation’s public and private payers. In this regard, GAO 

is preparing a health care framework that includes a set of principles 

to help policymakers in their efforts to assess various health 

financing reform options. This framework will examine health care 

issues systemwide and identify the interconnections between public 

programs that finance health care and the private insurance market. The 

framework can serve as a tool for defining policy goals and ensuring 

the use of consistent criteria for evaluating changes. By facilitating 

debate, the framework can encourage acceptance of changes necessary to 

put us on a path to fiscal sustainability. I fear that if we do not 

make such changes and adopt meaningful reforms, future generations will 

enjoy little flexibility to fund discretionary programs or make other 

valuable policy choices.

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

answer any questions you or other committee members may have.

Contacts and Acknowledgments:

For future contacts regarding this testimony, please call William J. 

Scanlon, Director, Health Care Issues, at (202) 512-7114. Other 

individuals who made key contributions include Linda Baker, James 

Cosgrove, Jessica Farb, Hannah Fein, James McTigue, Yorick F. Uzes, and 

Melissa Wolf.

[End of section]

Related GAO Products:

Major Management Challenges and Program Risks: Department of Health and 

Human Services. GAO-03-101. Washington D.C.: January 2003.

Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs and 

Uncertainties. GAO-03-213. Washington, D.C.: January 24, 2003.

Skilled Nursing Facilities: Medicare Payments Exceed Costs for Most but 

Not All Facilities. GAO-03-183. Washington, D.C.: December 31, 2002.

Medicare Home Health Care: Payments to Home Health Agencies Are 

Considerably Higher than Costs. GAO-02-663. Washington, D.C.: May 6, 


Medicare: Financial Outlook Poses Challenges for Sustaining Program and 

Adding Drug Coverage. GAO-02-643T. Washington, D.C.: April 17, 2002.

Medigap: Current Policies Contain Coverage Gaps, Undermine Cost Control 

Incentives. GAO-02-533T. Washington, D.C.: March 14, 2002.

Medicare: New Spending Estimates Underscore Need for Reform. GAO-01-

1010T. Washington, D.C.: July 25, 2001.

Medicare: Cost-Sharing Policies Problematic for Beneficiaries and 

Program. GAO-01-713T. Washington, D.C.: May 9, 2001.

Medicare: Higher Expected Spending and Call for New Benefit Underscore 

Need for Meaningful Reform. GAO-01-539T, Washington, D.C.: March 22, 


Medicare+Choice: Plan Withdrawals Indicate Difficulty of Providing 

Choice While Achieving Savings. GAO/HEHS-00-183. Washington, D.C.: 

September 7, 2000.

Medicare+Choice: Payments Exceed Cost of Fee-for-Service Benefits, 

Adding Billions to Spending. GAO/HEHS-00-161. Washington, D.C.: August 

23, 2000.


[1] Under the Trustees 2003 intermediate assumptions, revenues from the 

HI payroll tax and taxation of certain Social Security benefits are 

initially projected to cover about three-fourths of projected 

expenditures once the trust fund is exhausted. This ratio, however, is 

projected to decline rapidly.

[2] Another small source of funding derives from the tax treatment of 

Social Security benefits. Under certain circumstances, up to 85 percent 

of an individual’s or couple’s Social Security benefits are subject to 

income taxes. Under present law, the Old-Age and Survivors Insurance 

(OASI) and Disability Insurance (DI) Trust Funds are credited with the 

income taxes attributable to the taxation of the first 50 percent of 

OASDI benefit payments. The remainder of the income taxes attributable 

to the taxation of up to 85 percent of OASDI benefit payments is 

credited to the HI Trust Fund. Any other income taxes paid by retirees 

would also help finance the general revenue contribution to SMI.

[3] Under the Trustees’ intermediate 2003 projections, this will occur 

for Social Security (OASDI) in 2018.

[4] “Mandatory spending” refers to outlays for entitlement programs 

such as Food Stamps, Medicare, veterans’ pensions, payment of interest 

on the public debt, and nonentitlements such as payments to states from 

Forest Service receipts. In 2002 Social Security, Medicare, and 

Medicaid accounted for over 71 percent of mandatory spending.

[5] U.S. General Accounting Office, Fiscal Exposures: Improving the 

Budgetary Focus on Long-Term Costs and Uncertainties, GAO-03-213 

(Washington, D.C.: Jan. 24, 2003).

[6] Testimony before the Senate Committee on Banking, Housing, and 

Urban Affairs, July 24, 2001.

[7] In 2008 the first baby boomers will reach age 62 and become 

eligible for Social Security benefits; in 2011, they will reach age 65 

and become eligible for Medicare benefits.

[8] This estimate represents the present value of HI’s future 

expenditures less future tax income, taking into account the amount of 

HI trust fund assets at hand at the beginning of the projection period 

and adjusting for the ending target trust fund balance. Excluding the 

ending target trust fund balance, HI’s unfunded obligation is estimated 

to be $5.9 trillion over the 75-year period under the Trustees 2003 

intermediate assumptions. 

[9] Mary A. Laschober and others, “Trends in Medicare Supplemental 

Insurance and Prescription Drug Coverage, 1996 to 1999,” Health Affairs 

Web Exclusive (Bethesda, Md: Project Hope, Feb. 27, 2002). http:// (downloaded Mar. 19, 2003).

[10] The Kaiser Family Foundation and Health Research and Education 

Trust, Employer Health Benefits: 2000 Annual Survey (Menlo Park, Calif. 

and Chicago: 2000).

[11] Beginning in 2003, Medicare health plans may, in effect, rebate to 

beneficiaries some, or all, of Medicare’s $58.70 monthly part B 

premium. Both beneficiaries and the government benefit if health plans 

use this option to compete because, for every $1 reduction in health 

care premiums, the health plans must return $0.25 to the government. If 

a health plan rebates the entire part B premium, the government saves 

$14.68 per beneficiary per month. Currently, five Medicare+Choice 

health plans in eight counties rebate at least a portion of the part B 

premium. In 2003, Medicare began pilot testing an arrangement for 

sharing financial risk with preferred provider organizations that 

enroll program beneficiaries. As of March 2003, there were 56,677 

enrollees in these preferred provider organizations. 

[12] See U.S. General Accounting Office, Medicare+Choice: Payments 

Exceed Cost of Fee-for-Service Benefits, Adding Billions to Spending, 

GAO/HEHS-00-161 (Washington, D.C: Aug. 23, 2000). CMS has since begun 

to phase in a payment adjustment system that is designed to help 

prevent some of these excess payments.

[13] See U.S. General Accounting Office, Medicare Home Health Care: 

Payments to Home Health Agencies Are Considerably Higher than Costs, 

GAO-02-663 (Washington, D.C: May 6, 2002) and U.S. General Accounting 

Office, Skilled Nursing Facilities: Medicare Payments Exceed Costs for 

Most but Not All Facilities, GAO-03-183 (Washington, D.C: Dec. 31,