Medicare, the federal health insurance program for the elderly and some people with disabilities, is divided into three basic programs. Part A, Hospital Insurance, pays for inpatient care in hospitals and skilled nursing facilities. It also pays for some home health care and hospice services. Part B, Supplementary Medical Insurance, pays for physicians' services, hospital out-patient services, some home health care, and other services. Part D, the prescription drug benefit added in 2006, is used to reduce what participants pay for medicine. (Medicare's Part C specifies the rules under which private health care plans can assume responsibility and be paid for providing benefits covered under Parts A, B, and D.)

Total Medicare spending has grown at an average annual rate of about 9 percent in recent years. The Congressional Budget Office estimates that net outlays will total $370 billion in 2007, including discretionary outlays of about $5 billion for Medicare's administrative costs. Roughly $60 billion will be offset by premium payments (mostly from participants in Parts B and D), by payments from states, and by recovery of improper payments to providers. In the next few years, Medicare enrollment—and its cost—will expand substantially as the first members of the baby-boom generation become eligible because of age or disability.

Under current law, the age at which workers become eligible for full Social Security retirement benefits—the normal retirement age (NRA)—is gradually increasing until it reaches 67 for people who were born in 1960 or later. (Workers can receive a reduced retirement benefit as early as age 62, however.) The eligibility age for Medicare will remain at 65, although people can qualify for coverage earlier if they are disabled or have end-stage renal disease. Because the two programs affect the same population, some people have argued that the eligibility age for Medicare should be identical to Social Security's NRA.

This option comprises two alternatives for raising the eligibility age for Medicare. Each alternative assumes that the eligibility age would not be increased until 2017, so people who are currently nearing retirement would not be affected. The first alternative would increase the eligibility age by two months every year beginning in 2017 until it reached 67 in 2028, where it would stay indefinitely. Although the increases under that alternative are consistent with increases currently scheduled for Social Security's NRA, the Medicare eligibility age would remain below Social Security's NRA until 2028 (because the NRA increases under Social Security started sooner). The second alternative would increase the eligibility age by two months every year beginning in 2017 until it reached 70 in 2046, at which point it would stabilize. That alternative is analogous to the option for raising Social Security's NRA (see Option 650-5), but it would be phased in more slowly and would not raise the eligibility age above 70.

In 2050, Medicare spending would fall by about 3 percent under the first alternative and by about 10 percent under the second. Because those estimates are not within the Congressional Budget Office's 10-year budget window, no year-by-year table is shown. Spending would fall by less than enrollment because younger beneficiaries are healthier and less costly than average.

The reduced spending for Medicare would be partially offset by higher spending under Medicaid and the Federal Employees Health Benefits program—both of which would pick up part of the health care costs of those beneficiaries whose eligibility for Medicare had been delayed. Spending under the military's Tricare For Life program would decline, however, because eligibility for that program is limited to people who are enrolled in Medicare.

The primary rationale for this option is that it would restrain the growth of Medicare spending, which would ease long-term budgetary pressures. Life expectancy has risen since the Medicare program began in 1965, and the life expectancy of 65-year-olds is expected to continue increasing. Therefore, on average, people will spend a longer time covered by Medicare, which will boost the program's costs. In addition, raising the eligibility age would reinforce incentives created by increases in Social Security's NRA for people to delay retirement. Disability among the elderly has declined over time, and jobs are generally less physically demanding, suggesting that a larger fraction of the population may be capable of working past age 65. Many who do so could have access to employment-based insurance.

An argument against this option is that many workers retire before age 65. For those early retirees, raising the eligibility age for Medicare would lengthen the time they might be at risk of having no health insurance. Furthermore, raising the eligibility age for Medicare would shift costs that are now paid by that program to individuals and to employers that offer health insurance to their retirees. Those higher costs might lead more employers to reduce or eliminate health coverage for their retirees. Also, raising the eligibility age for Medicare would strengthen the incentive for people to apply for Social Security disability benefits, reducing the net savings to the federal government.

The Medicare Advantage program is the vehicle through which private health plans can participate in Medicare. Plans that want to participate in the program submit bids reflecting the per capita payment for which they are willing to provide Medicare's covered benefits. The government compares those bids with benchmarks that are determined in advance through statutory rules. Plans are paid their bids (up to the benchmark) plus 75 percent of the amount by which the benchmark exceeds their bid. Plans must return that 75 percent to beneficiaries as additional benefits or rebates on their Medicare premium. Plans whose bids are above the benchmark are required to charge enrollees the full difference between the bid and benchmark as an add-on to their regular Medicare premium. (Private plans submit separate bids to provide Medicare's prescription drug benefit; this option pertains to their bids for all other Medicare benefits.)

Benchmarks are established for each county and are required to be at least as high as local per capita spending in Medicare's fee-for-service (FFS) program. (The county-level benchmarks are also used to establish benchmarks for the program for regional preferred provider organizations; see Option 570-4.) In many counties, the benchmark is higher than per capita FFS spending, in some cases substantially. Benchmarks were derived from a payment mechanism for private plans that was established in the Balanced Budget Act of 1997 and modified through subsequent legislation. Those rules resulted in rates in many counties that are higher than local per capita spending in the FFS program.

This option would set the benchmark in each county equal to local per capita Medicare fee-for-service spending. That change would reduce Medicare spending by about $8.1 billion in 2008 and $64.8 billion over five years.

An argument in favor of this option is that the Medicare program should be neutral as to whether beneficiaries decide to enroll in private plans or remain in the fee-for-service sector. (Most beneficiaries—about 82 percent—are enrolled in the FFS program.) The current payment system gives an advantage to private plans because they can operate in areas where their bids exceed FFS spending levels and, if their bids are less than the benchmark, provide additional benefits to attract enrollees. Under that system, Medicare pays more for enrollees in some private plans than it would have paid if they had remained in the FFS sector. Setting the benchmark equal to per capita FFS spending in each county would encourage private plans to operate only in areas where they could provide Medicare services at a lower cost than the FFS sector, without encouraging them to operate in areas where they could not.

An argument against this option is that, in many geographic areas, it would reduce the revenue that private plans receive from Medicare, which could lead many plans to limit the benefits they offer, raise their premiums, or withdraw from the program. Another argument is that private plans should not be expected to provide Medicare services in all markets at a cost that is less than per capita FFS spending because Medicare may be able to use its market power to set FFS payment rates at levels below those that are determined through private-market forces. Below-market payments to health care providers may result in a less-efficient allocation of resources than would be achieved if more beneficiaries were enrolled in private plans that paid providers at rates determined in the market.

Hospitals with teaching programs receive additional payments from Medicare for costs associated with graduate medical education (GME). One component of those additional payments covers the direct costs of GME (such as residents' compensation). Two other components are indirect medical education (IME) adjustments to Medicare's payments for hospitals' operating costs and for their capital-related costs; they are designed to account for the fact that teaching hospitals tend to have greater expenses than other hospitals for various reasons. (For instance, teaching hospitals typically offer more technically sophisticated services and treat patients with more complex conditions than other hospitals do.) Medicare makes those three types of medical education payments to hospitals for the inpatient stays of all Medicare beneficiaries, including those who are enrolled in private health plans that participate in the Medicare Advantage program.

About 18 percent of Medicare beneficiaries are enrolled in Medicare Advantage plans, which assume responsibility and financial risk for providing Medicare benefits. The government's maximum payment, or benchmark, for an enrollee in such a plan is set for each county and updated annually. Benchmarks were derived from a setof payment rates for private plans that were in effect in 2004; under that system, the rate for each county was the greatest of four amounts: a minimum or "floor" rate; a blend of a local rate and the national average rate; a minimum increase from the previous year's rate; and local per capita spending in Medicare's fee-for-service (FFS) program. Beginning in 2005, the benchmark (or rate) in each county is equal to the previous year's benchmark (or rate) updated by the national growth in per capita Medicare spending or by 2 percent, whichever is greater. The government is required to reestimate local per capita FFS spending at least once every three years, and when it does so, the benchmark in each county is the greater of that new estimate of local FFS spending or the previous year's benchmark updated in the usual manner.

The estimates of local per capita FFS spending in 2004 and the revised estimates generated in later years include payments for IME even though the Medicare program makes IME payments directly to teaching hospitals for the inpatient stays of Medicare Advantage enrollees. As a result, the Medicare program is paying twice for IME for those enrollees—first, as an allowance for IME payments in the benchmark and, second, as a payment to teaching hospitals.

This option would remove payments for IME from the benchmarks for private plans, leaving the payment to teaching hospitals as the only compensation for IME. Making that change would reduce Medicare outlays by $700 million in 2008 and by $5.2 billion through 2012.

A rationale for this option is that it would reduce Medicare expenditures. According to proponents, there is no basis for making double payments for IME for Medicare Advantage enrollees.

A potential drawback of this option is that eliminating the double payment for IME would reduce the revenue that private health plans earn from Medicare, which could lead some plans to limit the benefits they offer, raise their premiums, or withdraw from the program. Plan withdrawals could reduce the number of Medicare beneficiaries with access to private health plans and the additional benefits they provide.

The Medicare Modernization Act of 2003 (MMA) established incentives for preferred provider organizations (PPOs) to participate in Medicare and serve broad regions of the country. One of those incentives is a stabilization fund that the Medicare program may use to increase the maximum payment amounts (or benchmarks) for regional PPOs to encourage them to enter into and remain in the Medicare Advantage program. Regional PPOs, like other types of Medicare Advantage plans, submit bids reflecting the per capita payment for which they are willing to provide Medicare's covered benefits. The plans are paid their bids (up to the benchmark) plus 75 percent of the amount by which the benchmark exceeds their bid. Plans must return that 75 percent to beneficiaries as additional benefits or as rebates on their Part B or Part D premiums. Plans whose bids are above the benchmark are required to charge enrollees the full difference between the two amounts as an additional premium for the Medicare benefit package.

The benchmarks for regional PPOs are a weighted average of two components: a statutory component and a bid component. The statutory component is the weighted average of the county-level benchmarks in the region, with each county weighted by the number of Medicare beneficiaries who live there. (The county-level benchmarks are determined each year by statutory rules. They are required by law to be at least as high as per capita fee-for-service spending in the county; in many counties, they are higher than such spending.) The bid component is a weighted average of the bids of the PPOs in the region, with each PPO weighted by its enrollment. To determine the regional benchmark, the statutory component is weighted by the number of Medicare beneficiaries nationally who are enrolled in the fee-for-service program, and the bid component is weighted by the number who are enrolled in private plans. (In contrast, for all other types of Medicare Advantage plans, the benchmark is the weighted average of the county-level benchmarks in the plan's service area, with each county weighted by the number of the plan's enrollees who live there. The plans' bids do not affect their benchmarks.)

The MMA established the stabilization fund for the regional PPO program and mandated that $10 billion be available to the fund from 2007 through 2013. The Tax Relief and Health Care Act of 2006 reduced the amount of money that will be available to the fund to $3.5 billion and limited the period during which it can be used to 2012 and 2013. The fund will also receive a portion (12.5 percent) of the difference between the bids of regional PPOs and their benchmarks when those bids are below the benchmarks. The Medicare program can use the stabilization fund to increase the benchmarks in regions that were not served by regional PPOs in the previous year and, under certain conditions, to increase the benchmarks in regions in which PPOs inform the government that they intend to leave the program. The stabilization fund can also be used to increase the benchmarks for organizations that participate in every region.

This option would eliminate the stabilization fund for the regional PPO program. Because no money will be available to the fund until 2012, this option would have no effect on Medicare spending until that year. It would reduce Medicare spending by $1.6 billion in 2012 and by $3.5 billion over 10 years.

An argument in favor of this option is that the stabilization fund could give regional PPOs an advantage relative to other plans that participate in Medicare Advantage. In addition, the evidence suggests that increased benchmarks may not be necessary to encourage regional PPOs to participate in Medicare—such plans participated in 21 of the 26 regions in 2006, with no payment from the fund.

An argument against this option is that it could decrease the number of regional PPOs that participate in Medicare and reduce the number of regions that are served by such plans. Without the increased benchmarks, PPOs may not be willing to participate in some regions, particularly those that are largely rural. (Health plans typically find it more costly to develop provider networks in rural areas because of the lack of competition among providers there.) Consequently, elimination of the stabilization fund could reduce the number and types of private plans that are available to Medicare beneficiaries; as a result, the additional benefits and premium rebates that many plans offer might be reduced or eliminated for beneficiaries in some areas.

Medicare pays hospitals for the inpatient stays of its beneficiaries through a prospective payment system. Under that system, hospitals with teaching programs receive additional amounts for costs associated with graduate medical education (GME). One component of the education-related payment is called direct GME, which covers a portion of a hospital's costs for residents' compensation and institutional overhead. Payments are made on the basis of a hospital's 1984 cost per resident (indexed for changes in consumer prices) and Medicare's share of inpatient days. Direct GME payments for physician residents, received by about one-fifth of U.S. hospitals, totaled $2.3 billion in 2006. (Option 570-6 covers Medicare's indirect payments for medical education.)

Under this option, hospitals' direct GME payments would be set at 120 percent of the national average salary paid to residents in 1987 and updated annually for changes in consumer prices since 1987. In effect, this option would reduce payments for teaching and overhead while continuing payments for residents' compensation. It would also maintain the current practice of reducing payments for residents who have exceeded their initial period of residency. (Such a resident is treated as one-half of a full-time-equivalent resident.) The savings from this option would total $900 million in 2008 and $5.9 billion over five years.

An argument in favor of this option is that market incentives appear sufficient to entice people to enter medicine, so a reduction in the federal subsidy for medical education may be warranted. In addition, because hospitals benefit from the services that residents provide, they should shoulder more of the costs of residents' training. Although residents would bear more of the cost of their education if hospitals responded by cutting residents' salaries or benefits, the training ultimately enables them to earn higher future incomes.

An argument against this option is that reducing the federal subsidy for graduate medical education could lead some hospitals to cut the resources they devote to medical training, possibly compromising the quality of their education programs.

Under Medicare's prospective payment system for in-patient medical services, hospitals with teaching programs receive additional funds for costs related to graduate medical education (GME). One part of the additional payment to teaching hospitals covers the costs of indirect medical education (IME), or those costs that are not attributable either to residents' compensation or to other direct costs of running a teaching program. Examples of IME expenses are the added demands placed on staff as a result of teaching activities and the greater number of tests and procedures ordered by residents. IME payments also compensate for the higher proportion of severely ill patients treated at teaching hospitals. (Option 570-5 discusses direct GME payments.)

The IME adjustment provides teaching hospitals with about 5.5 percent more in payments for inpatient services for every increase of 0.1 in the ratio of full-time residents to the number of beds. (The adjustment for 2007 is 5.35 percent.) This option would lower the IME adjustment to 2.2 percent—an amount that the Medicare Payment Advisory Commission has estimated would more accurately reflect indirect costs—saving $3.9 billion in 2008 and $21.6 billion through 2012.

An argument in favor of this option is that it would bring payments into line with actual teaching costs, thus reducing the federal subsidy without unduly affecting teaching activity. It also would remove an incentive for hospitals to have a higher number of residents than is necessary.

Possible drawbacks of this option are that a lower teaching adjustment could prompt teaching programs to train fewer residents or devote less time and resources to beneficial educational activities. Also, because some teaching hospitals use a portion of the additional payments they receive to fund charitable care, reducing those payments could limit the number of low-income patients they were able to serve or decrease the quality of care they were able to provide.

Under the prospective payment system for inpatient hospital services, Medicare pays hospitals an amount for each discharged patient that is intended to compensate hospitals for capital-related costs such as depreciation, interest, rent, and other expenses related to property. Hospitals with teaching programs receive additional capital-related payments that are made on the basis of "teaching intensity," which is measured as the ratio of residents to the average daily number of hospitalized patients. An increase of 0.1 in that ratio raises a hospital's capital-related payment by 2.8 percent.

This option would eliminate those extra payments to teaching hospitals, saving the Medicare program $400 million in 2008 and $2.3 billion over five years.

One argument in favor of this option is that paying teaching hospitals more than nonteaching hospitals for treating otherwise similar patients may promote inefficient practices at teaching hospitals. In addition, Medicare's payment adjustments for teaching intensity may distort the market for residency training by artificially increasing the value (or decreasing the cost) of residents to hospitals. According to that argument, if residents' training raised the costs of patient care for a hospital, the hospital should bear those costs in order to encourage an efficient amount of training. Finally, although residents would bear more of the cost of their education if hospitals responded by cutting their salaries or benefits, their training would still enable them to eventually earn a high income.

A possible drawback of this option is that it could prompt teaching programs to train fewer residents or to devote less time and resources to beneficial educational activities. Also, because some teaching hospitals use a portion of their additional payments to fund charity care, reducing those payments could limit the number of low-income patients they were able to serve or decrease the quality of care they were able to provide.

Hospitals that serve a disproportionately large number of low-income patients can receive higher payment rates under Medicare than other hospitals do. The Medicare disproportionate share hospital (DSH) adjustment was introduced in 1986 to account for what were assumed to be the higher costs of treating Medicare patients in such hospitals. The DSH adjustment has also come to be seen as a way to protect low-income patients' access to care by providing financial support to hospitals that serve a large share of people from low-income populations.

Between 1992 and 1997, annual outlays for Medicare DSH payments rose from $2.2 billion to $4.5 billion. Restrictions established by the Balanced Budget Act of 1997 caused those outlays to decline for a few years, but they resumed growing in 2000. In 2003, the Medicare Modernization Act further boosted DSH payments to rural and small urban hospitals by adjusting the payment formulas. As a result, Medicare DSH payments totaled $9.5 billion in 2006.

This option would convert DSH payments into a block grant to the states. In 2008, each state's grant would be 10 percent less than the estimated sum of Medicare DSH payments made to hospitals in that state in 2006. In subsequent years, the block grant would be indexed to the change in the consumer price index for all urban consumers minus 1 percentage point. In return for the lower Medicare DSH payments, states would be granted increased flexibility in how they used their DSH funds. Those changes would decrease Medicare outlays by $1.2 billion in 2008 and by $11.2 billion over five years. (The estimated savings include the lower payment updates that plans participating in the Medicare Advantage program would receive.)

An argument in favor of this option is that the added flexibility provided to states under this option could result in DSH funds being targeted more appropriately and equitably to facilities and providers that serve low-income populations. For example, rather than going solely to hospitals, such funds might also be used to support outpatient clinics that treat low-income patients.

An argument against this option is that the net reduction in federal payments to hospitals, unless made up for by states with their own funds, would result in some hospitals' receiving less public funding than they do now. That drop in funding could limit the number of low-income patients they were able to serve or decrease the quality of care they were able to provide.

Medicare compensates hospitals for their operating costs tied to providing inpatient services to Medicare beneficiaries under a prospective payment system (PPS). Payments are determined on a per-case basis, according to preset rates that vary with a patient's diagnosis and the characteristics of the hospital. Medicare adjusts those payment rates each year using an update factor that is determined in part by the projected rise in the hospital market-basket index (MBI), which reflects increases in hospitals' costs per case or their unit costs.

Under current law, hospitals that submit quality performance data each year to the Department of Health and Human Services will receive the full MBI update for that year. Hospitals must report on a set of measures approved by the Hospital Quality Alliance (HQA). The current set of measures—which is continuously being expanded by the HQA—reflects recommended treatments for three serious medical conditions (heart attack, heart failure, and pneumonia) and guidelines for patient safety (such as the prevention of surgical infection). Hospitals that do not submit the required information will receive the MBI update factor minus 2 percentage points. That reduction will apply only for the year in which the hospital does not submit the required information and will not be taken into account in subsequent years. (The Congressional Budget Office expects that nearly all hospitals will submit the required data and receive the full update.)

This option would reduce the Medicare PPS update factor set under current law by 1 percentage point. That lower rate would take effect in 2008 and continue through at least 2017. Savings from this option would total $1 billion in 2008 and $17.8 billion over five years.

Supporters of this option reason that granting the full MBI update factor will overcompensate hospitals for their average growth in operating costs. To the extent that the MBI is intended to approximate how much providers' costs would rise if the quantity, quality, and mix of inputs they use to provide care remained constant, the MBI would generally overstate cost inflation because of productivity improvements (such as the tendency of providers to adopt cost-saving technological advances in response to the fixed payments established under the PPS).

Critics of this option contend that Medicare's payments for inpatient services should not be reduced without carefully evaluating the adequacy of payments for other hospital services (such as outpatient care). The overall Medicare margin (which includes both inpatient and outpatient care) has decreased continuously since 2000 (falling to -3 percent in 2004), and further reductions in the update factor could cause considerable hardship for hospitals.

In 1992, Medicare changed its method of paying hospitals for capital expenses associated with providing in-patient services; specifically, it switched from a cost-based reimbursement system to a prospective payment system. Under the revised system, hospitals receive a predetermined amount to cover capital-related costs for every Medicare patient treated at their facility. (Those costs include depreciation, insurance, interest, taxes, and similar expenses for the maintenance of buildings and the purchase and upkeep of equipment.) The prospective payment system for capital-related costs applies to hospitals that are also reimbursed by Medicare for inpatient operating costs under that system. A hospital's payment rate is adjusted to reflect its case mix of patients and other characteristics, such as whether the hospital is new and where it is located.

Analyses by the Centers for Medicare and Medicaid Services (CMS), which administers the Medicare program, suggest that the rates for capital payments set in 1992 were too high. Those rates were based on 1989 data projected to 1992; but in actuality, capital costs grew more slowly than expected during those years. Moreover, the level of capital costs per case that was used to set rates in 1989 was probably higher than would be optimal because of incentives created under cost-based reimbursement before 1992. Factors such as changes in capital prices, the mix of patients treated at a given hospital, and the "intensity" (technological complexity) of hospital services contributed to the inflated estimates for the initial capital rates set in 1992, which the Medicare Payment Advisory Commission and CMS calculated were between 15 percent and 28 percent, with an average of about 22 percent. In response, as part of the Balanced Budget Act of 1997, lawmakers reduced by 17.8 percent the federal rate for capital payments made to hospitals for patient discharges occurring between 1998 and 2002. (A small part of that reduction, 2.1 percentage points, was restored effective October 1, 2002.)

This option would further reduce the prospective payment rate for hospitals' capital-related costs by 5 percentage points. That change would lower Medicare outlays by $400 million in 2008 and $2.4 billion through 2012.

A rationale for this option is that it would reduce the overestimate that might remain in Medicare's capital payment rates. Moreover, since Medicare's payments for capital-related costs represent a small share—about 5 percent—of hospitals' total revenues, most hospitals would probably be able to adjust to the reductions by lowering their capital costs or by partially covering those expenses through other sources of revenue.

An argument against this option is that hospitals in poor financial condition could have difficulty absorbing the reductions. As a result, the quality of the care that they offered could decline, and they might provide fewer services to people without health insurance.

In 2006, Medicare paid about $13 billion for home health care services (which include skilled nursing care, physical and speech therapy, and home health aide services for beneficiaries deemed to be homebound). Medicare spending on home health services grew rapidly in the late 1980s and early 1990s, when home health agencies were reimbursed separately for each home health visit, but it fell sharply after a new payment system was implemented under the Balanced Budget Act of 1997. Since 2000, however, Medicare spending on home health care has again been increasing rapidly.

Home health agencies currently receive a single payment from Medicare for providing all covered services to an individual beneficiary for a 60-day period (known as a home health episode). The Centers for Medicare and Medicaid Services sets the payment rates for different types of episodes prospectively, meaning that payment rates are set in advance to reflect the expected costs of each episode and are not determined by the costs that home health agencies actually incur. In calendar year 2007, the base payment rate per home health episode is $2,339. Under current law, that rate is updated from year to year, partly on the basis of annual changes in the prices of inputs (such as wages for home health aides).

The Medicare Payment Advisory Commission, or MedPAC, has calculated that among freestanding home health agencies, the aggregate Medicare margin—the excess of Medicare payments over providers' costs expressed as a percentage of payments—was high in 2004, at about 16 percent. (MedPAC did not report the aggregate Medicare margin for hospital-based agencies in 2004.) MedPAC projects that the aggregate Medicare margin will remain at a high level (15 percent) in 2006, even though the Deficit Reduction Act of 2005 eliminated the 2006 update for home health agencies. The continuing high margins appear to be the result of reductions in home health agencies' costs in response to the incentives created by the new prospective payment system.

This option would freeze the base payment for each home health episode under Medicare at its calendar year 2007 level ($2,339) through 2012, with the goal of gradually narrowing the gap between payments and costs. That change would reduce federal outlays by $300 million in 2008 and by $8.5 billion over five years.

A rationale for this option is that margins for home health care are likely to remain high under current law. MedPAC estimates that home health agencies' costs per episode have grown by less than 1 percent a year in recent years, and if that trend continues, home health agencies would still receive more than adequate margins under this option.

A drawback of this option is that it could reduce access to home health services for Medicare beneficiaries. Home health agencies that had substantially higher costs than average and that were not able to reduce their operating expenses sufficiently would cease participating in the program. As a result, some beneficiaries might have difficulty obtaining home health services. Also, although MedPAC has not thus far identified problems with the quality of care provided under the new payment system, lower payment rates could lead some home health agencies to reduce the level or quality of the services they provide.

Medicare's coverage of post-acute care is generally limited to patients who require skilled nursing care or rehabilitation. Post-acute care is offered by four types of providers: skilled nursing facilities, home health agencies, long-term care hospitals, and inpatient rehabilitation facilities. In 2004, Medicare outlays for post-acute care accounted for over 12 percent of total Medicare spending. In each of the four post-acute care settings, providers are paid by Medicare under prospective payment systems in which payment rates reflect "base" payment rates. The payment for a specific case equals the base payment rate adjusted to reflect local practice costs, the clinical characteristics of the patient, and other factors.

Annual increases in Medicare's base payment rates are referred to as "update factors." Under current law, update factors generally are determined by increases in the prices of various "inputs," such as labor and equipment, that medical providers use to produce medical services. Those increases in input prices are measured by market-basket indexes, which combine various price increases into a single number for each type of provider.

This option would change the update factors for each type of post-acute care provider to equal the market basket index minus 1 percentage point for each year beginning in 2008. This option would reduce Medicare outlays by $350 million in 2008 and by $8.1 billion over five years.

An argument in favor of this option is that Medicare's payment rates for post-acute care have been found, in general, to be more than adequate relative to providers' costs. The Medicare Payment Advisory Commission (MedPAC) came to that conclusion in its March 2006 report to the Congress. MedPAC recommended that the Congress eliminate the update to payment rates for all types of post-acute care providers for 2007 and stated that doing so would be unlikely to harm beneficiaries' access to post-acute care. A second argument for this option is that it could provide a stronger incentive for post-acute care providers to increase their efficiency and reduce their operating costs.

An argument against this option is that the reduced federal payments that would result might increase the incentive of post-acute care providers to avoid admitting to their facilities patients with complex conditions who require costly care. Reducing update factors, therefore, might lead to certain patients having difficulty obtaining post-acute care. To the extent that patients faced limited access to post-acute care, they might either remain longer in a short-stay hospital, return home without receiving post-acute care, or be discharged to receive long-term care not covered by Medicare. By reducing the revenue of providers, this option might also limit their ability to provide high-quality care.