The Congressional Budget Office predicts that medicare outlays will rise an average of 13.2 percent annually over the next decade. Revenues, on the other hand, are expected to rise only 6.8 percent. That structural funding gap spells disaster for America's elderly. The increase in medicare costs is due almost entirely to inflation in health care-more expensive procedures, new technology, higher prices for physicians and hospitals fees. It is not caused by the aging of America's population.

The increase in the number of elderly is not a problem for medicare. While increased costs are expected to average 13.2 percent, CBO points out that only 2.2 percentage points are due to the aging of the population.

The problem is inflation and there are no easy answers.

The reason we are here today is to listen to experts from the administration, from the public sector, and from State government. We in Congress will need to enact legislation and I strongly feel that any reforms we enact should only be considered after hearings like this, at which interested parties have the opportunity to register their views.

I also feel that any legislation to reform medicare must be based on three fundamental principles: One, it should address the real problem-inflation; two, it must protect health benefits for the elderly; and three, it should be bipartisan.

There have been a number of proposals already made to deal with the financing shortage in medicare. People have recommended increasing revenues, through use of general revenues, increasing the payroll tax, or providing new, earmarked sources of revenue to the hospital trust fund.

Others have suggested we reduce costs through benefit reductions, increased copayments by beneficiaries, and voluntary participation through a voucher system.

I think one thing is clear from the CBO report: Any attempt to reduce the shortfall solely through benefit cutbacks is unaccepta

ble.

With more than 15 percent of the aged now living in poverty and millions more surviving just above the poverty level, cuts in medicare will spell greater suffering for millions of Americans.

I also do not think we can simply increase the payroll tax to close the funding gap. Financing this enormous amount by the payroll tax alone would require an increase in the contributions of both employers and employees from 1.3 percent to 2.5 percent.

That would mean additional tax increases for FICA. And right now, with the measure passed by Congress last week, FICA taxes are already scheduled to increase 5 out of the next 7 years.

Congress must face the problem head on. We have got to hold down hospital costs. And only by concentrating on the source of health care inflation can we hope to preserve the scope of current medicare coverage.

One of the sections of the 1983 Social Security Amendments which I supported was title VI, the prospective payment system for medicare. That system is estimated to save about $12 billion over the next 3 years. In fact, it is based on a system very similar to the diagnostic related group system which we have been using successfully in New Jersey.

I have pointed out the three principles I feel should underlie any reform of medicare. I think there is a fourth principle that we ought to keep in mind. In reviewing the system, we ought to keep all of our options open.

I believe it is possible to fund a portion of medicare through general revenues. But we certainly cannot expect the U.S. Treasury to write a blank check covering medicare's deficit. The budget could not tolerate such a shock, and it would provide absolutely no incentive to hold down costs.

However, I believe it is an avenue that we, Congress, the administration, and the Advisory Council on Social Security which is now studying medicare, have simply got to consider.

We have made a pact with our Nation's elderly. I believe we ought to live up to it. If the financing problem continues to be severe, we ought to tell new people coming onto the system that they will have a different package of benefits, so that they will know well ahead of time exactly what medicare will do for them when they retire.

I am grateful to our witnesses for coming here this morning to provide their expertise to the committee. I want to assure all of you that your remarks will be extremely helpful to us as Congress reviews medicare.

I also want to mention that we are faced with a time problem. This is an official hearing of the House Select Committee on Aging, and while we would like very much to have everyone testify, there have been numerous individuals who have come here this morning and asked for an opportunity to speak. Because of Congressman Smith's schedule and my own, and that of the committee staff, at this point in time, it will be virtually impossible to put on additional witnesses. But if time permits, we will be pleased to do it. It does not look possible, however, because after the witness list was already publicized, we received many, many requests for additional people asking to testify. And since we refused all of those people, to open it up now would be unfair to them and to everyone else who welcomed this opportunity.

However, there will be additional hearings in Washington, and possibly even in the State of New Jersey. At that time, if anyone who wants to testify writes to us in advance, we will be pleased to do everything possible to get you on the agenda.

But without objection, what I would like to do, is put into the record the statements of everyone who came here and had a prepared statement. And I will read the list of statements that we will add to the record.

The statement of the Senior Citizens of Manville, Inc.
The statement of the Medical Society of New Jersey.

The statement of Richmond Towers Residence Association.
The New Jersey Association of Health Care Facilities.

The New Jersey State Nurses Association.

The Health Security Action Council.

The New Jersey Federation of Senior Citizens.
The Union County Division on Aging.

Here to Help, Inc.

National American Association of Retired Persons.

I would also like to make a few additional announcements that I think are important.

Any group or individual who is not on this scheduled list, who has come here and does not have a statement, and would like to submit that statement, you are encouraged to do so. And all you have to do is put your views on medicare in writing and send them to the Aging Committee. Without objection, I will leave the official hearing record open for 30 days, so that additional statements may be submitted and included in the record.

Those interested may submit their remarks to the House Select Committee on Aging, 606 House Annex One, Washington, D.C., 20515.

I have also been asked by the Administrator of Princeton Borough to inform you that a local ordnance in Princeton prohibits smoking during public meetings. If anyone wants to smoke, we request that you step outside.

I am also pleased to acknowledge the presence of Mr. Thomas Burke, the Executive Director of the Advisory Council on Social Security, a panel within the Department of Health and Human Services which is studying Medicare this year. He will be reporting on today's proceedings to the Advisory Council back in Washington. Mr. Burke, would you kindly stand up and let everybody see who you are, in case they want to speak to you later.

Now, I would like to recognize my distinguished colleague, Representative Chris Smith, who is the newest member of the Select Committee on Aging. I think I should add one final comment. Many Members of Congress want to get on the Aging Committee. A lot of people are interested in these issues. But I have not met anyone who was so interested in aging issues and worked so hard to get on this committee as Congressman Smith. I think it shows the tremendous commitment that my colleague here today has to the problems of our Nation's elderly. Mr. Smith.

STATEMENT OF REPRESENTATIVE CHRISTOPHER H. SMITH Mr. SMITH. Thank you, Mr. Chairman. First of all, I want to commend you for scheduling and calling this hearing. As you know, the medicare financing problem and the potential short term solvency problem are very real. We know that the trustees themselves, the Congressional Budget Office, the Library of Congress and the Congressional Research Service, have all concluded that we do have a solvency problem that must be faced and addressed. And I know that the Administrator will soon be sharing some of her thoughts on that.

I think, as most people in this room know, medicare does provide basic health protection for our senior citizens, age 65 and older, as well as for some 3 million disabled persons. And it is crucial that we not only face, but adequately address this situation, so that you do not see an elimination or a reduction of benefits.

I also think this opportunity to evaluate medicare gives us the chance to perhaps provide some services that I think have long been neglected, like catastrophic health insurance. Perhaps an elimination of the spell of illness concept and some other situations need some reform. I know there are some proposals on the table.

There are some bills in the Congress, the administration approaches to this. I think this hearing will give us the opportunity to elicit some response from you, the public, as well as some of the providers, and the beneficiaries, so that we can make some informed decisions.

I just want to also say that as a new member of the Select Committee on Aging, I have found that this committee provides the Congress with a great deal of information, particularly from its field hearings, regarding what needs to be done. What the people out in the field, out in the various townships and cities across the United States really want done for their various programs, be it social security or medicare.

So I am proud to join this committee, and also commend the chairman for holding this hearing.

Mr. RINALDO. Thank you very much, Congressman Smith.

We are fortunate to have at this hearing, Dr. Carolyne Davis, the Administrator of the Health Care Financing Administration, the agency which oversees the medicare program.

Dr. Davis has come up from Washington, and she will now testify and present the administration's proposals for health care reform. Dr. Davis.

STATEMENT OF CAROLYNE K. DAVIS, PH. D., ADMINISTRATOR, HEALTH CARE FINANCING ADMINISTRATION

Dr. DAVIS. Thank you, Mr. Chairman. I am very pleased to be here today. With me, on my left, is Mr. Bill Toby, who is the Regional Administrator of Region 2, which as you know encompasses New York, New Jersey, Puerto Rico, and the Virgin Islands for the Health Care Financing Administration.

I would like to talk to you about the longterm financing of the medicare Hospital Insurance Trust Fund and some of our key reform proposals.

If I may, Mr. Chairman, I would like to stand up because I would like to be able to get nearer to the charts.

Mr. RINALDO. Sure. I believe copies of your testimony have been distributed, so if you want to summarize at any point, feel free to do so.

Dr. DAVIS. Well, as you indicated very clearly, the first step I think that has been taken by Congress-and I would like to thank both of you for participating in that effort was the passage of the prospective payment system, which we believe will make a significant difference in the way hospitals are paid. Under the retrospective cost system of payment, there was no incentive to manage the care better.

We believe that the payment of hospitals through a prospectively determined rate is a better method. Clearly, we have learned much from our 7 or 8 years of work here in New Jersey with the New Jersey State people, the hospital association, and others on that particular developmental system. Although our system will differ somewhat from the New Jersey system, clearly it is based upon the information we have learned here. It will be a fixed payment system. The rates will be established for some 467 different diag

noses.

I think it is important to realize that although there are 467 disagnosis related groups, only 167 of the diagnosis related groups account for 90 percent of the medicare expenditures. And so, that other margin, the other 10 percent has a great number of occasions for review.

One of the most important things we learned in New Jersey was the fact that the total operating expenses in the New Jersey hospitals increased less than the national increase. We think that is an important concern.

One of the areas we looked at in terms of the development of the prospective payment system was how to assure predictability for the Government and also for the hospital. And we wanted to establish the Federal Government as a prudent buyer of services, rather than to pay, if you will, whatever amount the individual hospitals felt was appropriate.

Lastly, we wanted to create a system of rewards and penalties, and the system would do just that. We have provided an incentive to hospital management for flexibility, for innovation, and for more efficient use of hospital resources.

And also, most importantly, we are going to continue to assure the beneficiary will have access to appropriate care.

Let me move now to the impact of the passage of the prospective payment system.

If you look at this chart, (see chart A, p. 7) you can clearly see that if we had not passed the provisions in H.R. 1900, alternative II-B, the Hospital Insurance trust fund would have been going broke in 1986. Passage of H.R. 1900 delayed the termination date of the trust fund to the point where it now is expected that it will be bankrupt in 1989 or 1990. It would be 1989 if there is no payback of the $12 billion that was borrowed from the Social Security Trust Fund. However, Social Security has indicated to us that they do intend to start paying us back. And if you add that back in, then we will be fiscally balanced until 1990, which gives us a few more years to work on the problems.

The basic solvency issue, however, is one that we need to continue to work on. We need to continue to think about it in relationship to reimbursement reform, such as the prospective payment system, as well as looking at alternatives to high cost hospital care. If one looks at the 25-year projection period from 1982 through 2007 on the next chart (see chart B, p. 8), the average cost of the program, if expressed as a percent of payroll, will be 5.14 percent. During that same 25-year period, the average current law tax rate is running 2.87 percent. So in order to have the program in balance, we would have to reduce payments by 44 percent, or we would have to increase the Hospital Insurance payroll tax by 80 percent, in order to keep the program solvent over the next 25 years.