ence in dealing with some 13,000 physicians in Massachusetts, I really do not think that you can make that distinction. You certainly cannot as to individuals.

Mr. ROSTENKOWSKI. Well, if, as you have stated, Dr. Somers, there are abuses and we have some testimony in other committees that will back that up, that there is unnecessary hospitalization, there is unnecessary surgery, what do we do about it? What can we do about it? Mr. SOMERS. I think you obviously cannot do much without the cooperation of the profession itself. I think incentives have to be created for a good deal more self-policing by the profession over the behavior of its members. I would advise that for their own sake as well, because it is obviously better for them that it be done by them than to have it imposed by the Government.

Theoretically, hospitals are supposed to do that. You have in every hospital utilization review committees, and various other committees of the medical staff which are supposed to sort of determine whether the members of that staff are behaving in a proper way. But there are counterpressures.

Hospitals are in trouble unless the beds are reasonably filled. During certain periods of the recession, for example, as utilization ran down and the average occupancy rate in hospitals got to the low seventies, you found the administrators informing the utilization review committees that this hospital simply cannot survive financially with empty beds, which is true.

There are places where you found on bulletin boards figures showing we have an occupancy rate of 60 percent or whatever, and we ran a deficit of so much and if it continues indefinitely, we have to close this hospital. That is a message.

A great many forces are at work here. That is one of the reasons, of course, that I am a great believer in cutting down on the number of hospital beds in this country, and I have a lot of company on that. It is not too bad to have a waiting list. Nothing terrible happens if elective surgery is delayed.

Primarily, we ought to be able to depend on hospitals, but with these countervailing pressures, with the reluctance of the medical societies. to be effective disciplinarians of the profession, I expect Government may have to mandate that they do so.

Mr. ROSTENKOWSKI. Mr. Stark?

Mr. STARK. I think that other

Mr. ROSTENKOWSKI. I would like for you to keep it to a minimum. I would like to recognize Mrs. Keys.

Mr. STARK. All right.

The medical care system I characterize as being functionally open ended. In other words, the financial gains are greater rather than less when the cost of care is greater.

Hospitals are usually paid if they overrun on their proposed budgets. Once it is known that insurance is in the picture, neither the providers nor consumers are going to worry very much about the costs of their medical care.

I would urge very strongly, regardless of what kind of a system we finally come up with, that we build into incentives, not only for the providers but for the consumers.

Mr. ROSTENKOWSKI. Dr. England?

Dr. ENGLAND. The question of unnecessary surgery of course relates to unnecessary to whom?

There are a multitude of human ills which can be treated surgically, but if not treated do not result in death or catastrophe. An unsightly wart is not something that will kill anybody, but to that person, having it removed is necessary.

The matter of keeping beds filled is an interesting one, with waiting lists and all. It is true there is some pressure I understand on the part of some hospital administrators to keep the beds filled.

In our particular locality, we have not experienced that problem. But I do know that the areawide health planning council, which is something that was structured from legislation here, has a rule that a hospital that is consistently below 70 percent shall be closed. So they are really between a rock and a hard place in that community. But again, it is not because of what is happening with the medical profession particularly, it is because of the legislative response to a supposed problem.

Mr. ROSTENKOWSKI. Mrs. Keys will inquire.

Mrs. KEYS. Thank you. It looks like I have the last word so I intend to squeeze the last drop of expert opinion from you gentlemen before 2 o'clock.

One area that is especially important to me has not been touched on much.

Mr. Stark, you stated that you did not see as any primary objective of national health insurance modifying or changing the present health care system. Yet all of you in your testimony, I believe, in one way or another have recognized that the prepaid health care of the health insurance system that we have now has certainly militated toward

overuse.

Second, it seems to me that the present system has militated toward undereffective use of facilities in the area of preventive care. Our health insurance system now, it seems to me, really does not emphasize attempts to get into the very necessary area of preventive care, and it seems to me this is very important in terms of cost control, in addition to being important in terms of accepting our responsibility for delivering important health care.

I would like any comments you have on this as to whether you feel that moving our insurance system so that we can deliver, encourage, and give equitable access for preventive care is important, for one thing for cost control; and if you feel we can do that or if you feel maybe my statement is wrong, maybe you would state your disagree

ment.

Mr. STARK. No; I might disagree with you in saying that the prepaid system has created more health care delivery problems. I would think this would be an incentive to provide less unnecessary care than might otherwise be the case.

The incentive is that the opportunity to keep one out of the hospital is certainly going to reduce the cost of that care to the benefit of the provider.

The fact that preventive medicine, whatever that term means, could be practiced more effectively with the added incentive of keeping the person out of the hospital; the factor of health maintenance, education in proper health care, all of these things I think stand a better chance actually of being provided under a prepaid insurance program than otherwise.

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hospital costs and wages have risen there more rapidly than wages in the general economy. Nevertheless, this does not begin to account for the rise in hospital costs. From 1955 to 1973 labor costs rose 350 percent. But as a fraction of the total hospital bill labor costs actually decreased from 62 percent of total costs in 1955 to 56 percent in 1974. In other words, nonlabor costs have risen faster than labor costs.

Moreover, about a fifth of the increase in labor costs reflects a rise in the number of personnel per patient today. Only a third of the increase in total costs can be attributed to wage increases per se. Moreover, since hospital wages rose 188 percent while wages in the economy rose about 130 percent during this period, the excess rise in hospital wages—the difference between the 188 percent and 130 percent increase can only account for a small part of the total increase in hospital costs, probably on the order of 14 percent.

The third explanation is that hospital cost inflation is due to a low rate of technical progress. I think this is clearly and obviously false. Hospitals have been the scene of extremely rapid technical change. But the character of these changes has been different from that in other industries. It has not been cost-reducing. Technological progress in hospitals does not involve making the old product more cheaply, but making a new range of products that are more expensive.

Why have hospitals moved toward increasingly expensive ways of doing things rather than providing old products more cheaply? Although some of this reflects the path of basic scientific progress, it is our method of financing health services that primarily determines the pattern of technical change.

The final traditional explanation is that hospital costs have risen because supply has not kept up with demand. I have already pointed to the reasons for increasing demand, higher incomes, greater education, and especially a rise in insurance. Usually economic analysis of ordinary markets shows that prices rise because supply does not increase as rapidly as demand. But in the case of hospitals, I think the opposite is true.

It is precisely because supply has kept pace with demand that hospital costs have gone up. Hospitals have responded to the increased demand and willingness to pay for sophisticated services by providing those services and costs have gone up accordingly. The increase in demand has induced a rapid increase in the supply of a more expensive type of hospital care.

This brings me back to my original contention that the rise in hospital costs reflects a change in product induced largely by the growth in insurance. But this explanation of the rise in hospital costs raises an awkward question. Implicit in every discussion of hospital cost inflation is the assumption that the rise in cost has been excessive and should not be allowed to continue at the same rate in the future. But if this rise reflects a change in product rather than an increase in inefficiency or a low rate of technological progress, why is it really a problem?

The answer in brief is that the current type of costly medical care does not really correspond to what consumers or their physicians would regard as being appropriate if their choices were not distorted by insurance. The effect of prepaying health care through insurance, both private and public, is to encourage hospitals to provide a more expensive product than the consumers actually wish to purchase.

Although the consumer pays for the expensive care through higher insurance premiums, at the time of illness the patient's demand for service reflects the net cost of the care. Because this net out-of-pocket cost appears so modest, the patient is willing to buy more expensive care than he would if he were not insured. In this way our current method of financing hospital care denies patients the opportunity to choose effectively between higher cost and lower cost hospital care.

If insurance is responsible for such an inappropriate expansion in the demand for expensive care, why has insurance grown so rapidly? In part the growth of insurance reflects a family's rational demand for protection against unexpected illness. It is unfortunate, but inevitable, that this process is self-reinforcing. The high cost of care induces the patient to buy more complete insurance and the growth of insurance induces the hospital to produce more expensive care.

But this demand for protection cannot explain the comprehensive first dollar insurance that now exists. Current insurance is often inadequate in protecting the family against the substantial bills that can cause real hardship. Why then have American families bought such complete coverage for relatively small bills? Why have they been willing to pay for insurance that often provides little real protection, but induces them to buy more expensive and sophisticated care than they really want?

As you know, most insurance is now group insurance and, more specifically, insurance bought for employee groups. The decisions on the scope of coverage on co-insurance rates and deductibles are generally made in collective bargaining agreements by expert representatives of labor and management.

Why should such experts forego higher wages in order to obtain excessive, shallow insurance? The answer, I believe, lies in the tax treatment of premiums. Federal policies encourage insurance by a tax deduction and exclusion that now costs the Treasury more than $4 billion a year.

As you all know, individuals can deduct about half of the premiums they pay for health insurance. More important, employee payments for insurance are excluded from the taxable income of the employee as well as the employer. These premiums are not subject to social security taxes or State income taxes.

Even for a relatively low-income family the inducement to buy insurance can be quite substantial. Because of the income and payroll taxes, a married man with two children earning $8,000 a year will take home an additional $70 for each $100 the employer adds to his income. If the employer buys health insurance instead, the full $100 can be applied against the premium and there is no tax to be paid.

In this case the dollar buys nearly 50 percent more health care services if it is paid through an insurance premium than if paid in wages and left to the individual to buy the care directly. For workers in higher tax brackets, the incentive is stronger. In the aggregate the Government tax subsidy exceeds the total profits and administrative costs of the insurance industry by a substantial margin.

I believe the subsidy is strong enough to induce employees and unions to opt for higher insurance instead of higher wages. The primary effect of this insurance is to distort the pattern of care and exacerbate the rising cost of hospital care. This tax subsidy costs the Government

several billion dollars a year. Its benefits are regressive; the benefits are greatest for high-income employees in high-wage industries.

In short, the current tax treatment of insurance premiums, particularly the exclusion of employer payments from taxable incomes, is a costly, regressive and inefficient aspect of our tax system.

Let me summarize my remarks about cost inflation. I have emphasized three basic points:

First, the current tax treatment of health insurance premiums substantially increases the demand for shallow insurance and for the comprehensive coverage of small medical bills. This is coverage that individuals would not otherwise want.

Second, such excessive insurance coverage distorts the demand for health care, encouraging expensive procedures that cost more than the patients and the doctors think they are really worth.

Third, the growth of insurance has thus induced hospitals to change the nature of their product. It is this change in the product or the quality or the style or care that has been responsible for the rapid increase in health costs during the last 20 years.

These points have important implications for national health insurance. Whatever form of insurance you propose, you must face squarely the problem of controlling the evolution of the quality and style of medical care.

It is crucial to recognize the nature of this problem. The long-run problem is not to reduce or to limit the growth of medical spending, but to achieve the correct rate of growth of that spending. This must ultimately come down to balancing additional spending on medical care against the alternative uses to which households might put those resources. And this requires comparing the expected gains from additional medical care gains that are psychological as well as physical— with the satisfaction that households would enjoy from the alternative spending on food, housing, or recreation.

It is clear that controlling the quality of medical care is not a technical issue that can be solved by bureaucrats. Nor can it be assigned to the process of physician peer review. Although peer review can try to assure the application of accepted standards of care, it cannot be used to establish what those standards should be.

Deciding on the correct quality and style of medical care requires involving the individual household in the decision of how much they want to spend for medical care and how much they want to spend for other things.

Although this direct involvement of households is not possible in determining our Nation's spending on defense or on medical research, it is possible for personal health care services. The form of national health insurance should assure that individual consumers play this crucial role in guiding the growth and form of their health services.

It is important that you develop an approach to national health insurance that is appropriate to the advanced technology of today's medical care and the ever-increasing affluence of the American people. Too much of the current debate relies on the ideas about the delivery of medical care that have been inherited from a period with quite different technological and economic conditions.

The challenge to public policy is to find new methods of organization and financing that protect families from the risk of financial