Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform (Testimony, 03/10/99, GAO/T-AIMD/HEHS-99-113). The President proposes to use about two-thirds of the projected budget surpluses over the next 15 years to reduce publicly held debt. At the same time, he also proposes to transfer a like amount to the Social Security and Medicare trust funds in the form of nonmarketable Treasury securities, which is projected to extend the life of Medicare's Hospital Insurance (HI) trust fund from 2008 to 2020. His proposal would trade debt held by the public for debt held by the Social Security and Medicare trust funds. These new Treasury securities would constitute a new unearned claim on general funds for the HI program--a marked break with the payroll tax-based financing structure of the program. This change could undermine the remaining fiscal discipline associated with the self-financing trust fund concept and could induce a false complacency about the financial health of the HI program. Without change, however, Medicare is projected to more than double its share of the economy by 2050, and Social Security, health, and interest will take nearly all the revenues the federal government takes in. Real and substantive Medicare reform, not simple financing shifts among funds within the budget, is essential. Acting now would allow changes to benefits and health care delivery systems to be phased in gradually so that stakeholders and participants would have time to adjust their saving or retirement goals. --------------------------- Indexing Terms ----------------------------- REPORTNUM: T-AIMD/HEHS-99-113 TITLE: Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform DATE: 03/10/99 SUBJECT: Economic analysis Future budget projections Fiscal policies Health care programs Presidential proposals Deficit reduction US Treasury securities Budget surplus Balanced budgets Debt held by public IDENTIFIER: Medicare Hospital Insurance Program Medicare Program Social Security Program Medicare Choice Program Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform (Testimony, 03/10/99, GAO/T-AIMD/HEHS-99-113). The President proposes to use about two-thirds of the projected budget surpluses over the next 15 years to reduce publicly held debt. At the same time, he also proposes to transfer a like amount to the Social Security and Medicare trust funds in the form of nonmarketable Treasury securities, which is projected to extend the life of Medicare's Hospital Insurance (HI) trust fund from 2008 to 2020. His proposal would trade debt held by the public for debt held by the Social Security and Medicare trust funds. These new Treasury securities would constitute a new unearned claim on general funds for the HI program--a marked break with the payroll tax-based financing structure of the program. This change could undermine the remaining fiscal discipline associated with the self-financing trust fund concept and could induce a false complacency about the financial health of the HI program. Without change, however, Medicare is projected to more than double its share of the economy by 2050, and Social Security, health, and interest will take nearly all the revenues the federal government takes in. Real and substantive Medicare reform, not simple financing shifts among funds within the budget, is essential. Acting now would allow changes to benefits and health care delivery systems to be phased in gradually so that stakeholders and participants would have time to adjust their saving or retirement goals. --------------------------- Indexing Terms ----------------------------- REPORTNUM: T-AIMD/HEHS-99-113 TITLE: Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform DATE: 03/10/99 SUBJECT: Economic analysis Future budget projections Fiscal policies Health care programs Presidential proposals Deficit reduction US Treasury securities Budget surplus Balanced budgets Debt held by public IDENTIFIER: Medicare Hospital Insurance Program Medicare Program Social Security Program Medicare Choice Program Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform (Testimony, 03/10/99, GAO/T-AIMD/HEHS-99-113). The President proposes to use about two-thirds of the projected budget surpluses over the next 15 years to reduce publicly held debt. At the same time, he also proposes to transfer a like amount to the Social Security and Medicare trust funds in the form of nonmarketable Treasury securities, which is projected to extend the life of Medicare's Hospital Insurance (HI) trust fund from 2008 to 2020. His proposal would trade debt held by the public for debt held by the Social Security and Medicare trust funds. These new Treasury securities would constitute a new unearned claim on general funds for the HI program--a marked break with the payroll tax-based financing structure of the program. This change could undermine the remaining fiscal discipline associated with the self-financing trust fund concept and could induce a false complacency about the financial health of the HI program. Without change, however, Medicare is projected to more than double its share of the economy by 2050, and Social Security, health, and interest will take nearly all the revenues the federal government takes in. Real and substantive Medicare reform, not simple financing shifts among funds within the budget, is essential. Acting now would allow changes to benefits and health care delivery systems to be phased in gradually so that stakeholders and participants would have time to adjust their saving or retirement goals. --------------------------- Indexing Terms ----------------------------- REPORTNUM: T-AIMD/HEHS-99-113 TITLE: Medicare and Budget Surpluses: GAO's Perspective on the President's Proposal and the Need for Reform DATE: 03/10/99 SUBJECT: Economic analysis Future budget projections Fiscal policies Health care programs Presidential proposals Deficit reduction US Treasury securities Budget surplus Balanced budgets Debt held by public IDENTIFIER: Medicare Hospital Insurance Program Medicare Program Social Security Program Medicare Choice Program ****************************************************************** ** This file contains an ASCII representation of the text of a ** ** GAO report. 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For further details, please ** ** send an e-mail message to: ** ** ** **** ** ** ** with the message 'info' in the body. ** ****************************************************************** A399113t.book GAO United States General Accounting Office Testimony Before the Committee on Finance, U.S. Senate For Release on Delivery Expected at 10 a.m. Wednesday, March 10, 1999 MEDICARE AND BUDGET SURPLUSES GAO's Perspective on the President's Proposal and the Need for Reform Statement of David M. Walker Comptroller General of the United States GAO/T-AIMD/HEHS-99-113 Page 1 GAO/T-AIMD/HEHS-99-113 Mr. Chairman and Members of the Committee: It is a pleasure to be here today to discuss the President's recent proposal for addressing Medicare and use of the projected budget surpluses over the next 15 years. As you know, I testified last month on the implications of the President's surplus proposals for Social Security. Today, I will briefly reprise our views on the overall fiscal consequences of the proposal, discuss what it does and does not do for the Medicare program, and examine the importance of and difficulty in making fundamental changes to this complex program. Regarding the President's proposal: It would significantly reduce debt held by the public from current levels, thereby also reducing net interest costs, raising national savings, and contributing to future economic growth. This element of the President's proposal would have positive short- and long- term effects on the economy. It provides a grant (or in the President's word, a gift) of a new set of Treasury securities for the Medicare Hospital Insurance (HI) program which would extend the life of the HI trust fund from 2008 to 2020. It is important to note, however, that these new Treasury securities would constitute a new unearned claim on general funds for the HI program--a marked break with the payroll tax-based financing structure of the program. This would be a significant change that could serve to undermine the remaining fiscal discipline associated with the self- financing trust fund concept. It has no effect on the current and projected cash-flow deficits that have faced the HI program since 1992deficits that taxpayers will continue to finance through higher taxes, lower spending elsewhere or lower paydowns of publicly held debt than the baseline. Importantly, the President's proposal would not provide any new cash to pay for medical services. It does not include any meaningful program reform that would slow spending growth in the HI program. In fact, the transfer of these new Treasury securities to the HI program could very well serve to reduce a sense of urgency for reform. At the same time, it could strengthen pressure to expand Medicare benefits in a program that is fundamentally unsustainable in its present form. The current Medicare program is both economically and fiscally unsustainable. This is not a new message--the Medicare Trustees noted in Page 2 GAO/T-AIMD/HEHS-99-113 the early 1990s that the program is unsustainable in its present form. They also noted the need for dramatic and fundamental reform of the program to assure its solvency. With regard to Medicare: The program's continued growth threatens to crowd out other spending and economic activity of value to our society. Even if we save the entire surplus, Medicare is projected to more than double its share of the economy by 2050. Meaningful reform of this program is urgently needed and such reform will require hard choices. The program changes enacted in 1997 illustrate how difficult even incremental reform is to adopt. Major change requires reshaping the nation's perspective on health care consumption and drawing distinctions between what the nation needs, wants, and can afford both at the national and individual level. To be effective and sustainable, reforms must begin soon and be comprehensive in nature. However, the history of entitlement reforms tell us that, to be enduring, such reforms must be introduced gradually after widespread public education in order to garner sufficient support from the system's multiple stakeholders. Context: Long-term Outlook Is Important It is important to look at the President's proposal in the context of the fiscal situation in which we find ourselves. After nearly 30 years of unified budget deficits, we look ahead to projections for surpluses as far as the eye can see. At the same time, we know that we face a demographic tsunami in the future that poses significant challenges for Social Security, Medicare, and our economy as a whole. In this context, it is noteworthy that the President has proposed a longer term framework for resource allocation than has been customary in federal budgeting. Although all projections are uncertainand they get more uncertain the farther out they gowe have long held that a long-term perspective is important in formulating fiscal policy for the nation. Each generation is in part the custodian for the economy it hands the next and the nation's long- term economic future depends in large part on today's budget decisions. This perspective is particularly important because our model and that of the Congressional Budget Office (CBO) continue to show that absent a change in policy, the changing demographics to which I referred above will lead to renewed deficits. This longer term problem provides the critical backdrop for making decisions about today's temporary budget surpluses. Page 3 GAO/T-AIMD/HEHS-99-113 Surpluses are the result of a good economy and difficult policy decisions. They also provide a unique opportunity to put our country on a more sustainable path for the long term, both for the nation's fiscal policy and selected entitlement programs. Current decisions can help in several important respects: (1) current fiscal policy decisions can help expand the future capacity of our economy by increasing national savings and investment, (2) engaging in substantive reforms of retirement and health programs can reduce future claims, (3) by acting now, we have the opportunity of phasing in changes to Social Security and Medicare programs over a sufficient period of time to enable our citizens to adjust, and (4) failure to achieve needed reforms in the Social Security and Medicare programs will drive future spending to levels that will eventually squeeze out most or all discretionary spending, including national defense spending. If we let the achievement of a temporary budget surplus lull us into complacency about the budget, then in the middle of the 21st century we could face daunting demographic challenges without having built the economic capacity or program and policy reforms to handle them. The Proposal Before turning to Medicare specifically, it is important to describe the President's overall proposal for using the surpluses over the next 15 years. The proposal's effects on Medicare are part of a broader initiative to save a major share of the surplus to reduce the debt held by the public and thereby enhance future economic capacity for the nation. The President proposes to use a significant portion of the total projected unified budget surpluses over the next 15 years to reduce debt held by the public. He also proposes to take some related steps to address the financing problems facing both the Medicare and Social Security programs. His approach to this, however, is extremely complex and confusing. Specifically, the President proposes to allocate about two-thirds of the projected surplus over the next 15 years to reduce publicly held debt. This portion of his proposal would increase our future economic capacity. At the same time, the President proposes to transfer a like amount to the Social Security and Medicare trust funds in the form of nonmarketable Treasury securities. In effect, the President's proposal would trade debt held by the public for debt held by the Social Security and Medicare trust funds. The administration has defended this approach as a way of assuring both a reduction in debt held by the public and as securing a first claim for both Social Security and Medicare on what they call the debt-reduction dividend to pay future benefits for those two programs. The HI program Page 4 GAO/T-AIMD/HEHS-99-113 would receive nearly $700 billion in additional Treasury securities - representing nearly 15 percent of total surpluses over the 15 years. 1 This transfer is projected to extend the life of the HI trust fund from 2008 to 2020. The President's proposal has raised important questions about how the federal government can promote long-term economic security by using today's surplus resources to save for the future. In the federal unified budget, the only way to save for the future is to run a unified budget surplus or purchase a financial asset. When there is a cash surplus it is used to reduce debt held by the public. Therefore, to the extent that there is an actual cash surplus, debt held by the public falls. This is exactly what happened in fiscal year 1998 when the debt held by the public was reduced by $51 billion. In the federal budget, trust funds are not vehicles to park real savings for the future. They are simply budget accounts used to record receipts and expenditures earmarked for specific purposes. A private trust fund can set aside money for the future by increasing its assets. State governments similarly can park surplus resources in real pension funds and other trust funds that are routinely invested in assets (e.g., readily marketable securities) outside the government. However, under current law, when a trust fund like HI ran a surplus of payroll tax revenues over benefit payments, the excess was invested in Treasury securities and used to meet current cash needs of the government. These securities are an asset to the trust fund, but they are a claim on the Treasury. When a trust fund runs a cash deficit, like HI has been doing since 1992, it redeems these securities to pay benefit costs exceeding current payroll tax receipts. 2 Medicare will be able to do this until 2008 under current law when its trust fund securities will be exhausted. However, in order to redeem these securities, the government as a whole must come up with the cash by either increasing taxes, reducing spending, or raising borrowing from the public above the baseline. Increasing the balances of Treasury securities owned by HI trust funds alone would increase the formal claim that the trust funds have on future general revenues since the trust fund's securities constitute a legal claim 1 With the additional interest these new securities would earn, total assets held by the HI trust fund would go up by over $1 trillion. 2 This may mean either using interest or the principal itself to cover the difference. Page 5 GAO/T-AIMD/HEHS-99-113 against the Treasury. However, increasing the HI trust fund balances alone, without underlying reform, does nothing to make the program more sustainable. From a macro perspective, the critical question is not how much a trust fund has in assets, but whether the government as a whole has the economic capacity to finance the trust funds claims to pay benefits now and in the future. From a micro perspective, trust funds can provide a vital signaling function for policymakers about underlying fiscal imbalances in covered programs. However, extending a trust fund's paper solvency without reforms to make the underlying program more sustainable can, in effect, obscure the warning signals that trust fund balances provide. Government Financing The President's proposals would enhance the nation's future economic capacity by significantly reducing debt held by the public from the current level of 44 percent of gross domestic product (GDP) to 7 percent over the 15-year period. The President notes that this would be the lowest level since 1917. Nearly two-thirds of the projected unified budget surplus would be used to reduce debt held by the public. Because the surplus is also to be used for other governmental activities, the amount of debt reduction achieved would be less than the baseline (i.e., a situation in which none of the surplus was used), but nonetheless the outcome would confer significant short- and long-term benefits on the budget and the economy. Our previous work on the long-term effects of federal fiscal policy has shown the substantial benefits of debt reduction. 3 One of these is lowering the burden of interest payments in the budget. Today, net interest represents the third-largest program in the budget, after Social Security and Defense. Interest payments, of course, are a function of both the amount of debt on which interest is charged and the interest rate . At any given interest rate, reducing publicly held debt reduces net interest payments within the budget. For example, CBO estimates that the difference between spending the surplus and saving the surplus is $123 billion in annual interest payments for debt held by the public by 2009--or almost $500 billion cumulatively between now and then. Compared to spending the entire surplus, the President's proposal would also substantially reduce projected interest payments . Lower interest payments lead to larger surpluses; these in turn lead to lower debt which 3 Budget Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, October 22, 1997). Page 6 GAO/T-AIMD/HEHS-99-113 leads to lower interest payments and so on: The miracle of compound interest produces a virtuous circle. The result would be to provide increased budgetary flexibility for future decisionmakers who will be faced with enormous and growing spending pressures from the aging population. For the economy, lowering debt levels increases national saving and frees up resources for private investment. This in turn leads to increased productivity and stronger economic growth over the long term. Over the last several years, we and CBO have both simulated the long-term economic results from various fiscal policy paths. These projections consistently show that reducing debt held by the public increases national income over the next 50 years, thereby making it easier for the nation to meet future needs and commitments. Our latest simulations done for the Senate Budget Committee, as shown in figure 1, illustrate that any path saving all or a significant share of the surplus in the near term would produce demonstrable gains in per capita GDP over the long run. 4 This higher GDP in turn would increase the nation's economic capacity to handle all its commitments in the future. 4 The on-budget balance path assumes that any surplus in the non- Social Security part of the budget is spent on either a tax cut or spending increases or some combination but assumes the current law path for the Social Security trust fund (SSTF). Thus, the surplus in the Social Security trust fund remains untouched until it disappears in 2013 after which the unified budget runs a deficit equal to the SSTF deficit. The save the surplus path assumes no changes in current policies and that budget surpluses through 2024 are used to reduce debt held by the public. The no surplus path assumes that permanent increases in discretionary spending and tax cuts deplete the surpluses but keep the budget in balance through 2009. Thereafter, deficits reemerge as spending pressures grow. Page 7 GAO/T-AIMD/HEHS-99-113 Figure 1: GDP Per Capita Under Alternate Fiscal Policy Simulations Source: GAO Analysis. While reducing debt held by the public appears to be a centerpiece of the President's proposaland has significant benefitsas I noted above, the transfer of a portion of the unified surpluses to the HI trust fund is a separate issue. The transfer is not technically necessary: Whenever revenue exceeds outlays and the cash needs of the Treasury, debt held by the public falls. 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000 65,000 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050 On- budget balance Save the surplus No surplus 1998 level Per capita 1998 dollars Page 8 GAO/T-AIMD/HEHS-99-113 The President's proposal appears to be premised on the belief that the only the way to sustain surpluses is to tie them to Social Security and Medicare. He has merged two separate questions: (1) How much of the surplus should be devoted to reducing debt held by the public? and (2) How should the nation finance these two programs in the future? The President has proposed to save the surplus by, in effect, hiding it in the Social Security and HI trust funds. The additional nonmarketable Treasury securities transferred to the Social Security and Medicare trust funds are recorded as a subtraction from the unified budget surplusa new budgetary concept. Accordingly, the surplus disappears under this novel scoring approach since these transfers approximate the surplus the President is proposing to save by reducing publicly held debt. 5 Let me turn now to the question of how the President's proposal would affect Medicare financing. Impact on Medicare Financing The mechanics of the proposed transfer of surpluses to the Medicare program are, like the transfers to Social Security, complex and difficult to follow. In form they are similar, but the effects on Medicare would be somewhat different. Unlike Social Security, Medicare's HI program has been experiencing a cash flow deficit since 1992current payroll taxes and other revenues have been insufficient to cover benefit payments and program expenses. Accordingly, Medicare has been drawing on its special Treasury securities, along with interest on those accumulated balances, acquired during the years when the program generated a cash surplus. In effect, these general fund payments can be viewed as repaying the loan of cash that the trust fund provided the rest of government when the Medicare program was in surplus. In fiscal year 1999, the HI program will run a cash deficit of $8 billion. As noted earlier, in order to redeem these securities, the government must either raise taxes, cut spending, or increase borrowing from the public. In essence, Medicare has already crossed the point where it is a net claimant on the Treasurya threshold that Social Security is not currently expected to reach until 2013. Stated differently, the bleeding of the HI trust fund has already started based on the program's annual cash flow deficits. 5 The President also proposes to use about 13 percent of these surpluses to purchase stocks for Social Security. Page 9 GAO/T-AIMD/HEHS-99-113 The current financing flows for the HI program are depicted in figure 2 below. As the figure shows, to help pay benefits in fiscal year 1999, the HI trust fund receives an $8 billion general fund payment for interest it earned on its treasury securities from its past cash surpluses. The HI fund also receives $5 billion for a portion of the income taxes paid on Social Security benefits. Figure 2: Medicare Flows Under Current Law *Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security Benefits. Source: GAO Analysis. Under the President's proposal, the above scenario would continue. However, as shown in figure 3, at the point where total tax receipts are allocated to pay for government activities, a new financing step would be added to transfer a portion of the projected unified budget surpluses to the Medicare HI trust fund. The Treasury would do this by issuing a new set of securities for the HI trust fund. Unlike the current securities owed the trust fund, these new securities are not supported by payroll tax surpluses in the program; rather, they represent what amounts to a grant or gift. However, it is important to remember that these new securities equal a Benefits Claims for interest earned on past surpluses Cash for benefit payments and additional special treasuries Payroll Taxes* Unified surplus would pay down the debt held by the public Hospital Insurance Trust Fund General Fund Discretionary Spending Other Mandatory Spending Other Taxes Unified Budget Page 10 GAO/T-AIMD/HEHS-99-113 portion of the excess cash that would be used to reduce the debt held by the public. The administration argues that the new securities are, in effect, supported by the enhanced economic resources gained by reducing publicly held debt. Nonetheless, we should remember that under the current law baselinei.e., with no changes in tax or spending policythis would happen without crediting additional securities to either the Social Security or Medicare trust funds. Figure 3: Medicare Flows Under President's Proposal *Since 1994, the HI trust fund has also received a share of income taxes paid on Social Security Benefits. Source: GAO Analysis. The financial consequences of this transfer are depicted in figure 4 below. This graph first shows that by providing the additional Treasury securities, the solvency of the Hospital Insurance trust fund would be extended from 2008 to 2020. However, the figure also shows that the President's proposal does nothing to alter the imbalance between the program's tax receipts and benefit payments. It has been in cash deficit since 1992 and remains in a cash deficit even with the new Treasury securities. Thus, the President Payroll Taxes* Unified surplus would pay down the debt held by the public Hospital Insurance Trust Fund General Fund Discretionary Spending Other Mandatory Spending Other Taxes Benefits Unified Budget Transfer for Trust Fund New Special Treasuries Claims for interest earned on past surpluses Cash for benefit payments and additional special treasuries Page 11 GAO/T-AIMD/HEHS-99-113 proposes to provide additional claims on the Treasury, not additional cash to pay benefits. Figure 4: Medicare Hospital Insurance Trust Fund Financial Outlook Under President's Proposal Source: GAO Analysis. Notwithstanding the fact that no real cash is exchanged, the transfer of additional securities to Medicare is a discretionary act with major economic consequences for the future financing of the HI program. As with Social Security, this proposal represents a fundamental shift in the way the HI program is financed. It moves it away from payroll financing toward a formal commitment of future general fund resources for the program for the future. The general fund obligation would begin far earlier than for Social Security. Specifically, the HI trust fund would begin drawing on the general fund to redeem these new securities in 2008well before the full reduction in publicly held debt and associated benefits to the general fund will have been realized under the President's plan. In addition, -400 -300 -200 -100 0 100 200 300 400 500 600 Cash Surplus/Deficit Trust Fund Balance Trust Fund Balance with Transfer Cash Deficit 1992 Page 12 GAO/T-AIMD/HEHS-99-113 this is 24 years before the Social Security Trust Fund would begin drawing on the additional Treasury securities that the President is proposing to grant to that program. The transfer would constitute an explicit general fund subsidy for the HI programa subsidy whose magnitude is unprecedented for this program. This is true because the newly transferred securities would be in addition to any buildup of historical payroll tax surpluses. Securities held by the trust fund have always represented the value of the loan of its surpluses to the Treasury--annual cash flows in excess of benefits and expenses, plus interest. Under the President's proposal, the value of securities held by the HI trust fund would exceed that supported by earlier payroll tax surpluses and constitute a new and unearned claim on the general fund for the future. In effect, the proposal would shift the financing of the HI Trust Fund to look more like that for the Part B Supplemental Medical Insurance (SMI) Trust Fund. The SMI portion of Medicare obtains 75 percent of its revenues from a general fund subsidy, with the remainder supported by beneficiaries' premiums. This is a major change in the underlying theoretical design of the HI program. Whether you believe it is a major change actually depends on what you assume about the likely future use of general revenues under the current circumstances. For example, current projections are that the HI Fund will exhaust its securities to pay the full promised benefits in 2008. If you believe that this shortfall wouldwhen the time camebe made up with general fund moneys, then the shift embedded in the President's proposal merely makes that explicit. If, however, you believe that there would be changes in the benefit or tax structure of the fund instead, then the President's proposal represents a very big change. In this case, less of the long-term shortfall would be addressed through future changes in the HI program itself and more would financed through higher taxes or spending cuts elsewhere in the federal budget as a whole. Thus, the question of bringing significant general revenues into the financing of the HI program is a question that deserves full and open debate. The debate should not be overshadowed by the accounting complexity and budgetary confusion of the President's proposal. In our view, the proposal carries some significant risks that should be carefully considered by the Congress. One risk is that the transfers to both the Medicare and Social Security trust funds would be made regardless of whether the expected budget surpluses are actually realized. The amounts to be transferred apparently would be written into law as either a fixed Page 13 GAO/T-AIMD/HEHS-99-113 dollar amount or as a percent of taxable payroll rather than as a percent of the actual unified surplus in any given year. These transfers would have a claim on the general fund even if the actual surplus fell below the amount specified for the transfers. However, it is important to emphasize that any proposal to allocate surpluses is vulnerable to the risk that those projected surpluses may not materialize. Proposals making permanent changes to use the surplus over a long period are especially vulnerable to this risk. The history of budget forecasts should remind us not to be complacent about the certainty of these large projected surpluses. In its most recent outlook book, CBO compared the actual deficits or surpluses for 1988-1998 with the first projection it produced 5 years before the start of each fiscal year. Excluding the estimated impact of legislation, CBO says its errors averaged about 13 percent of actual outlays. Such a shift in 2004 would mean a surplus $250 billion higher or lower; in 2009, the swing would be about $300 billion. Accordingly, we should consider carefully any permanent commitments that depend on the realization of a long-term forecast. The Compelling Need for Fundamental Program Reform A more significant risk of the President's proposal is that by appearing to extend financial stability for Medicare, it could very well undercut the incentives to engage in meaningful and fundamental reform of the HI programreform that is vital to making the HI program sustainable over the long term. Unlike Social Security, the HI program is already in a negative cash flow positionpayroll taxes support 89 percent of spending now and will cover less than one half 75 years from now. Even in the short term, the HI program's annual outlays grow by several times the rate of general inflation. Although its growth has slowed in recent years, it remains one of the most volatile and uncontrollable programs in the federal budget. According to CBO, the growth of Medicareboth HI and SMI-- will increase its share of the economy by nearly a full percentage point over the next 10 years, from 2.5 percent to 3.3 percent of GDP in 2009. By contrast, the share devoted to Social Security is projected to remain relatively flat during this period rising from 4.4 percent of GDP in 1999 to 4.7 percent in 2009. Over the long term, the program's growth rates are more daunting. Absent any changes, the combined Medicare program (i.e., HI and SMI) is projected to more than double its share of the economy by 2050from 2.7 percent now to 6.8 percent based on the Medicare Trustees' most recent best estimated assumptions. When coupled with Medicaid, federal health Page 14 GAO/T-AIMD/HEHS-99-113 care costs will grow to nearly 10 percent of GDP by 2050, as depicted in figure 5. The progressive absorption of a greater share of the nation's resources for health is, like Social Security, a reflection of the rising share of elderly in the population. However, health care growth rates also reflect the escalating cost growth of health care at rates well exceeding general rates of inflation. Increases in the number and quality of health services fueled by the explosive growth of medical technology has spurred much of this extraordinary cost growth in health care. Consequently, Medicare represents a much greater and more complex fiscal challenge than even Social Security over the longer term. Figure 5: Medicare and Medicaid as a Share of GDP Source: GAO's save the surplus long- term simulation based on HCFA's 1998 intermediate projections for Medicare spending and CBO's May 1998 projections for Medicaid spending. The President's proposal to strengthen the HI program is more perceived than real. Specifically, while the HI trust fund will appear to have more 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10. 0 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050 Medicare Part A Medicare Part B Medicaid Percentage of GDP Page 15 GAO/T-AIMD/HEHS-99-113 resources as a result of the President's proposal, in reality nothing about the program has really changed. The proposal does not represent program reform but rather a supplemental means to finance the current program. Stated differently, the reform proposed has more form than substance. What is most alarming is that the President's proposal could induce a sense of false complacency about the financial health of the HI program. The impending insolvency of the HI program sends important signals to policymakers that the program needs to be made more affordable through benefit changes, revenue increases, or both. The 2008 date has become an important cue to policymakers that could provide the impetus needed to make the hard choices necessary to promote the solvency and sustainability of the HI program for the long term. Extending the life of the HI trust fund without substantive program reform could be a recipe for delay and denial that could increase the ultimate fiscal and social cost of HI program reform. At a minimum, the President's proposal is likely to create a public misperception that something meaningful is being done to reform the Medicare program. Changes to the HI program should be made sooner rather than later. The longer meaningful action is delayed, the more severe such actions will have to be in the future. Since Medicare is the fastest growing sector of the federal budget, early action to reduce its costs will have compounding fiscal benefits. Even if the rate of growth is not changed, reducing the base level of spending can produce outyear dividends for the program's finances. Moreover, acting now would allow changes to benefits and health care delivery systems to be phased in gradually so that stakeholders and participants can adjust their saving or retirement goals accordingly. When viewed together with Social Security, the programs' financial burden on the future economy takes on daunting proportions. As figure 6 shows, the cost of these two programs would nearly double as a share of the payroll tax base over the long term. Assuming no other changes, these programs would constitute an unimaginable drain on the earnings of our future workers, even without including the financing challenges of the SMI program. Page 16 GAO/T-AIMD/HEHS-99-113 Figure 6: Social Security and Medicare's HI Program as a Percentage of Taxable Payroll Note: Taxable payrolls of the two trust funds are different. For analytic purposes, they have been combined by the Social Security Trustees. Source: 1998 Social Security Trustees' Report. There is another reason to take early action to reform both Social Security and Medicare costs. Reducing the future costs of these programs is vital to reclaiming our nation's future capacity to address other important needs in the public sector. To move into the future without changes in the Social Security, Medicare, and Medicaid programs is to envision a very different role for the federal government. Assuming no financing or benefit changes, our long-term model (and that of CBO) shows a world in 2050 in which Social Security, Medicare, and Medicaid absorb a much greater share of the federal budget. (See figure 7.) Budgetary flexibility declines drastically and there is increasingly less room for programs for national defense, the 30 Percent 10 12 14 16 18 20 22 24 26 28 *** End of document. ***