Mr. Chairman, that kind of an amendment will not operate as an open door to the Federal Treasury. As a matter of fact, the record of the State rate review programs we are describing is one of moderation of rates of increase in health care costs. We have set forth data on pages 13 to 15 in support of this point. In summary, Mr. Chairman, we believe that this proposed amendment will provide equitable treatment for all third-party payers which will avoid subsidization and will at the same time be effective in moderating increases in hospital costs. We recognize there are details of the amendment to work out and we welcome the opportunity to purchase these details with your com-mittee staff.

Mr. Chairman, on pages 15 to 17 we made comments on sections 2, 4, 6, 7, and 8. Generally our comments are very supportive of your efforts to improve these programs.

If I may direct your attention now to the middle of page 18, I would like to say a word or two about section 12 which would increase the rate of return on net equity allowed for purposes of Federal reimbursement to investor-owned hospitals to twice the average return on the social security trust fund. We support this provision on the principle that a suitable return on investment is necessary to insure that investors will continue to advance capital for investor-owned facilities. In addition, we recommend an adequate margin of revenues over expenses for not-for-profit institutions.

We are now developing the specifics for an adequate margin and will provide these to your committee in the near future. The margin is absolutely necessary to provide working capital, the equity base for future capital expenditures and the undergirding of the risk inherent in prospective payment mechanisms. The advantage of this approach to all third-party payors, including medicare and medicaid, lies in the reduction of interest charges on money which otherwise would be borrowed at high interest rates to meet these requirements and. contingencies.

Now, Mr. Chairman, I am going to summarize the comments on section 22 which we have on page 19 of our statement and I want to say that this gives us much concern. We understand the problem, but we believe it suggests the wrong solution. The section as it stands provides that hospital associated physicians would generally be paid on a feefor-service basis for personally performed patient care services. In addition, executive, educational, and administrative functions of these physicians would be paid for in amounts equivalent to salaries customarily paid to similarly competent physicians for such services. We oppose this approach because it would interfere with the management prerogatives of hospital administrators and governing boards. We understand that your committee has identified instances where payments to hospital associated physicians are out of line with payments to other physicians. We have tried to determine a way to deal with the problem, but have not yet been able to find a solution. We know, for example, that percentage arrangements generally provide fair compensation but we do not know how to compare these arrangements with salary arrangements, with fee for service arrangements, or with lease arrangements.

We suspect that it is not the form of the contract, Mr. Chairman, but the contracting parties that can assure fairness to physician, institution, patient, and a third-party payor. Our statement suggests, Mr. Chairman, that we need more information to determine the extent of the problem and the effectiveness of alternative solutions. Since we have no solution to offer, we can only pledge our cooperation in exploring the problem further with this committee, its staff, and other organizations. I assure you we will make available all of the information that we have, and that we have tried to summarize in the last few months.

Mr. Chairman, on page 20 we have touched on section 40, the procedures for determining reasonable costs and reasonable charges. Section 40 would vest within the Secretary of HEW authority to determine in advance the reasonableness of all hospital contracts greater than $10,000 annually and we have indicated our concerns with that section, Mr. Chairman.

Senator TALMADGE. Mr. McMahon, I hate to call time on you but your 10 minutes have expired.

First I want to thank you and the American Hospital Association. for your cooperation and helpfulness in drafting this proposed legislation. It seems to me that a major deficiency in the State rate regulation is that it compares the reasonableness of the hospital costs only with other hospitals in the same State. Our sample review of routine hospital costs in Maryland which you cited as an example to the effective State review indicates that in fact those routine costs are often higher than those in reasonably comparable hospitals and in the State of Pennsylvania. In Maryland, for example, what other hospital is comparable to the Johns Hopkins Hospital?

Mr. MCMAHON. There is no other hospital. As a matter of fact, I am not sure that there is one in Pennsylvania, Mr. Chairman. You would have to go some distance from Baltimore to find a comparable hospital. But let me say that the reason that we have long espoused the principle of regulation by the State is the same reason we thought that it was appropriate for planning to take place there. The rates established, Mr. Chairman, for any hospital are largely a reflection of the services provided by that hospital and we believe a regulatory process closer to the people served will assure, for example, that the people of the State of Maryland who are referred to Johns Hopkins Hospital for treatment are going to be in a better position to determine to what extent those rates should rise which in effect means to what extent should the services rise. Therefore, a comparability from State to State, while it has its advantages, also has the difficulties, Mr. Chairman, of not giving the people of a specific State the opportunity to determine the level of rates and thus the level of service. Senator TALMADGE. Yesterday we heard from Governors, State legislatures and counties as to the extreme difficulties they were having in meeting hospital and medical costs. All urged that the States be given greater discretion in determining appropriate reimbursement. It seems to me it might make sense to let a State determine reimbursement for medicare and medicaid where that reimbursement is on the same basis as for other patients or even just a majority of the patients. The only restriction would be a requirement in the Controller General

and the Secretary of HEW which certifies that this would not cost the Federal Government more than it would otherwise have paid under present law. Does that sound fair to you?

Mr. MCMAHON. Mr. Chairman, I would suggest a couple of modifications to that suggestion. First, when you made reference to the fact that medicare and medicaid might pay where all or a majority of the patients are covered by a rate review program, we have set out in our testimony-I think it is at page 15-some comments by Mr. Elmer Smith, an associate commissioner of Social Security, and Dr. Alice Rivlin that suggests that these rate review programs ought to cover all third parties.

Now as far as the second part of your question goes, the difficulty with having anybody certify that the payment being made would be no more than what would be paid under existing medicare and medicaid is that, Mr. Chairman, once you put into place a State rate review program, clearly it is going to have its impact on the reduction of cost. One that takes place there no one can say that medicare or medicaid is not in a position to be paying less than what would be the case if that kind of process were not in place.

Therefore, we think the basic thing the committee should recognize is that once a State rate review program is put in place, then the mechanics of cost reduction or cost effectiveness, the attention of the hospital on the reduction of cost is already underway. Therefore, it would seem to us that at that time medicare and medicaid have been thoroughly protected because the decision is being made just as you heard from the Governors and the counties. The decision has been made to reduce the rate of increase in costs and medicare and medicaid will have the benefit of those activities.

Senator TALMADGE. Senator Dole.

Senator DOLE. Mr. McMahon, what measures has the Association taken to improve the surplus bed problem in rural hospitals, where we have much of the facility remaining empty while overhead continues to mount. And with reference to that, do you think we might be able to utilize some of those beds for long-term care patients?

Mr. MCMAHON. Senator, we have given our attention to that in a number of ways. We think, and my statement indicates, two things that the committee is looking at that make good sense, one of which is the opportunity to utilize some of those beds for long-term care.

In addition, we have given specific attention over on the next to the last page of the statement to S. 3661 introduced by Senator Laxalt and others. The provision that we understand the subcommittee is looking at, sometimes called the swing bed proposal, would encourage rural hospitals particularly to utilize unused beds for long-term care. In addition, we are looking at other ways to provide for the conversion of facilities not only to long-term care but to other kinds of activities. and working on ways to advise hospitals of what help is available for that kind of conversion. It is really a use of the existing facilities in some alternative way that we think will provide a very useful approach to the problem.

Clearly in time, Senator Dole, and the reason why we are reluctant particularly in the rural areas to encourage closure is that population shifts are taking place and as the population grows across the country

we may come to a time in the not very distant future where we are going to find an increase in utilization not on a per patient basis but because of the addition of the total number of citizens in those areas. Senator DOLE. With reference to your statement on the bottom of page 5 and the top of page 6 concerning Senator Long's amendment to restore the $1.4 billion cost in medicare and medicaid mandated by the Budget Committee in the First Concurrent Resolution, I might just note that I supported that effort so I am sympathetic with your concerns. But just what impact would the $700 million reduction ultimately decided on in conference have on your member hospitals?

Mr. MCMAHON. Senator Dole, our problem with it was that we have no idea because since the basic law as found in Public Law 89-97 it is a commitment by the Federal Government to pay for the reasonable cost of covered services, we don't know how the mechanics would be put into place. We assume before the Congress could live with such a reduction they would have to identify, in ways other than a limitation on costs, a way that costs might be reduced or that services might be reduced because there is not

Senator DOLE. That would get into the program structure itself, however, which the Budget Committee does not do. We simply deal with functional categories, and in that regard the pressures to cut costs are going to remain. I just wonder, then, if you might have any recommendations in that area?

Mr. MCMAHON. No, sir, we do not. We would be glad to work with the committee toward this end. We don't know how costs can be cut for covered services. The planning bill over time will have its effect. The Professional Standards Review Organizations will have its effect but it may very well be that at some point the Congress will have to grapple with the benefit structure itself.

Dr. GEHRIG. We do believe, as was indicated earlier, and as Senator Talmadge indicated there is a need to avoid any short-term meat ax approach that doesn't pay for services provided. We really think that the thrust of the Talmadge bill is forward looking. While it does not promise you a short-term 1977 savings, it moves to the matter of costcontrol in a judgmental way which protects the ability of providers to render the services that are offered, so we really are looking down the road.

Senator DOLE. I agree that the bill may help contain costs, but I am not sure how far it can go in reducing them. Maybe containment is the real question, but as a member of the Budget Committee I can almost promise you we will toss out some resolution cutting Federal health programs $500 million or $1 billion, then leave it up to the authorizing committee to determine how that is going to be done while we run for cover. [Laughter.]

Senator TALMADGE. Mr. McMahon, I am somewhat surprised at your position with respect to payments to hospital associated physicians. say that because my staff and I had many conversations and communications with the State Hospital Association executives and individual hospital administrators. They recognized the need and were generally supportive of the position. In view of this discrepancy I would be interested to know if you have polled your hospital membership with respect to this issue.

Mr. MCMAHON. I have not polled each of the 7,000 member institutions, Mr. Chairman, but we certainly have had broad discussions about the problem. There is no question about the fact that there is a widespread recognition that the problem exists. On the other hand, I have been able to find no specific solution. While there are some who have, I know, taken the position that section 22 as it stands would offer a useful approach, nevertheless the vast majority of the hospital people that I have talked to recognized the difficulty.

They recognized the difficulties, Mr. Chairman, because many of them have learned to live with percentage arrangements and live with them appropriately. They look at the percentage, adjust the percentage from year to year, and make sure that the percentage as it changes with respect to volume brings out an appropriate compensation that is in line with the services and compensation of other physicians on the medical staff, and often involve the medical staff in the discussion. They say, do not take away from us a useful approach to compensation which we have learned to live with and put us into another kind of mandatory compensation arrangement because there is no way that we can be sure that that itself will contain costs.

As I said in my oral statement, Mr. Chairman, we don't know how we can look at the different kinds of arrangements. We know that there are appropriate compensation arrangements under all kinds of formula arrangements and we know that there are problems under all kinds. That is the reason that in this informal kind of polling that has gone on that the only thing I can suggest to the subcommittee at this point is our willingness to continue the discussion so that we can seek an appropriate kind of solution that will work across the board.

Senator TALMADGE. Do you consider a poll worthwhile?

Mr. MCMAHON. No, sir. In any poll you run into the difficulties of a simplistic solution. That is the reason in my approach rather than saying, "Would you prefer this to this?" I have said, "Here is the problem." First the problem exists and with some exceptions there was a recognition, though we have not seen the specifics of it, that is likely that there is a real problem in some isolated cases with these kinds of arrangements. But when we go from there, Mr. Chairman, I run into the problem that different people have learned to live with different arrangements and obviously they have a favorable attitude toward the arrangement they have learned to live with and in opposition to

others.

So I think, Mr. Chairman, this is far too complex a matter to subject to simple polling techniques but I have offered in the statement and in the written testimony our full cooperation including bringing some of the people in from whatever part of the country, under whatever kind of arrangement seems appropriate to the discussion of this problem because we think it is a very complex one.

Senator TALMADGE. In general is there bona fide economic competition by radiologists and pathologists competing for the monopoly situations which hospitals give them? Is this situation of such a broad and competitive nature that hospitals negotiate from a position of strength in contracting with radiologists and pathologists?

Mr. MCMAHON. Mr. Chairman, as attorneys we understand the words "bona fide," yet there is a good-faith approach to this. The diffi