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health benefits tend to replace money wage increases. the evidence indicates that increases in the cost of maintaining an existing level of fringe benefits tend to be added directly

to the cost of labor and therefore to prices.

Thus, rising

medical-care costs largely are passed on by companies to

consumers in the form of higher prices.

In addition to all of these indirect effects on inflation

from medical cost

increases, there is a final set of effects

which is very important.

Formal or informal cost-of-living

adjustments affect the wages of many workers. On average,
those workers covered by inflation-adjustment clauses
receive a wage increase of about one-half of one percent
for each one percent increase in the price level. Thus,
the massive inflation in medical costs in recent years has

been translated into higher wages, higher costs to employers,

and ultimately higher prices for a wide range of goods and

services.

Unfortunately, the data are not available to estimate

the precise impact of all of these indirect effects.

They

are significant, however.

What they mean is that the

inflationary consequences

of rapidly rising medical costs

are much greater than can be gleaned simply by looking at

the medical care component of the consumer price index.

Effects on Small Business

The effects of health-care inflation

may

hit small businesses harder than bigger firms.

The

burden of payroll taxes paid by smaller businesses tends to

be greater than for larger firms because a lower percentage

of workers in small firms have incomes above the wage base

for the social security tax.

Moreover, since health insurance

premiums generally are the same for all workers, regardless

of their income, firms with lower-wage work forces must devote

a larger percentage of their payrolls to health-care premiums if they are to provide benefits equivalent to their larger competitors.

Thus, skyrocketing medical costs have a pervasive and

far reaching effect on the overall rate of inflation in our

economy.

The Need for Hospital Cost Controls

As I noted earlier, hospital expenses have become one

of the most important contributors to health-care cost

inflation.

The cost of an average day in the hospital has

been rising twice as fast as other elements of health care.

As a result, hospital costs today account for 40 percent of

all health-care expenses, compared to only 30 percent in

1950.

The structure of the hospital industry is a major

factor underlying the escalation of hospital costs.

Nearly 60 percent of all hospital beds are located in

publicly owned hospitals. Over 35 percent of all hospital beds are in nonprofit, privately run hospitals. Fewer than

4 percent of all beds are in competitive, for-profit hospitals.

Moreover, the shift to third-party payments has affected

hospitals greatly.

Patients today pay only about 6 percent

of all hospital bills from their own pockets.

In other words,

neither patients, hospitals, nor doctors have much incentive

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patients and the rest of us bear the cost.

The mechanisms for reimbursing hospitals also have

contributed to the problem.

Whether payments are made by

individual insurance companies or by governments, hospitals generally are reimbursed according to their own costs.

As a consequence, reimbursement methods offer little incentive

to hold down costs.

Direct control over hospital costs may be the only way to bring hospital costs back into line in the immediate future. Mandatory programs run by state governments to

control hospital costs appear to have had some success.

In

1976, the latest year for which data are available, hospital

revenue increases in the six states with some form of mandatory

controls rose 15.4 percent, compared to a national rate of 17.8 percent. On the other hand, voluntary programs at the state level appear to have had little effect on costs. In

the three states with voluntary programs in effect in 1976,

hospital revenues rose by 22 percent.

The Administration originally proposed, as a remedy for the serious inflation problem in the hospital industry,

mandatory controls over hospital costs and revenues.

Proposals

in the Congress would maintain manadatory controls as a threat while giving hospitals the opportunity to bring their cost increases into line through voluntary efforts. A

mandatory program, in my view, has the better chance of

success.

But, in any event, it is clear that some form of

hospital cost-containment program is essential to bringing

down the overall rate of inflation.

Senator Nelson. Is there any evidence of the overall inflationary impact of the increasing costs of medical care?

Dr. Schultza. As I indicated, we attempted to see if we had enough data to calculate the direct and indirect effects. At this stage, I have to admit, we could not.

On the other hand, you know that there is a simple direct effect on costs when medical care costs rise 4 to 5 percent faster than the general rate of inflation. They are adding significantly to that rate of inflation, but I cannot measure it directly.

Senator Nelson. I do not know how you would measure it, but when medical costs are rising at about 15 percent; and 5 years ago they represented 5 percent of the gross national product, and now 9 percent, is there any way that an economist could extrapolate from that a rough estimate of the impact on the inflationary spíral?

Dr. Schultze. One of our problems is that we do not know with any great degree of precision, or, let me put it another way, with even less precision than we know other things, what proportion of rising fringe benefit costs to employers result in higher prices or in lower wage contracts.

You can make an assumption it is half and half, and we could presumably calculate the effect on that basis, but we really did not have any evidence.

Second, we do not know what proportion of added costs represents improved benefits as opposed to higher costs.

Again, here the evidence is all over the lot, and it is pretty difficult to make an estimate.

To be honest with you, we made one, but I would not put it in the testimony because I did not agree with it, in the sense I thought it was just too watery.

All I can say is it is significant.
Senator NELSON. I know Dr. Schultze has another appointment.
Anybody wish to comment on that?
You are free to leave.
Dr. SCHULTZE. I will stay for a little while and listen.
Senator Nelson. All right. We thank you.
Dr. SCHULTZE. Thank you.

Senator Nelson. We will now hear from Dr. Henry Aaron, Assist-
ant Secretary for Planning and Education, Department of Health,
Education, and Welfare, Washington, D.C.
STATEMENT OF DR. HENRY AARON, ASSISTANT SECRETARY FOR

PLANNING AND EDUCATION, DEPARTMENT OF HEALTH, EDU-
CATION, AND WELFARE, WASHINGTON, D.C.
Dr. Aaron. Thank you, Mr. Chairman.

Thank you for this opportunity to present my views on one of the most serious and vexing inflationary problems we face today, rising hospital costs

This session of Congress has the opportunity, as well as the responsibility, to do something about that problem by enacting legislation to contain hospital costs.

This legislation can save the American business community and the public billions of dollars in reduced health insurance premiums, in smaller out-of-pocket costs, and in lower Government expenditures.

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