In my testimony, Mr. Chairman, I would like to document the seriousness of hospital cost inflation and to show how the cost containment legislation you are sponsoring can help the American economy and the Federal budget.

Health expenditures will reach an estimated $183 billion this fiscal year, up $20 billion from last year.

Health expenditures have increased nearly 250 percent in the last decade.

Health care now absorbs about 8.8 percent of our gross national product. Unless a viable hospital cost containment plan is enacted by Congress, health care expenditures will consume nearly 10 percent of the Nation's gross national product by 1983.

The most inflationary part of the Nation's health care costs is hospital costs. Hospital expenditures will comprise 40 percent of total health care expenditures in 1978-$73 billion.

Over the last 10 years, total hospital expenses have quadrupled, rising more than 15 percent a year. That is almost 2.4 times the rate of increase in the consumer price index, more than 31⁄2 times the rate of increase for clothing prices, and more than twice the rate of increase for food prices.

It is true that hospitals have had to spend more money to purchase necessary and desirable improvements in the quality of hospital care. They have had to meet the rising costs of the goods and services they buy. They have had increased expenditures because of changes in the case mix brought on by the aging of the population.

But much of the increase in cost is due to the fact that the present system of health care reimbursement reduces, almost to the vanishing point, incentives for the economical use of precious medical resources. At present 91 percent of hospital expenditures are paid for by third parties. As a result, no one-not the doctor, not the patient not the hospital administrator-has an incentive to consider the costs of his decisions.

That is why a study of lab tests found that the mean cost of lab tests prescribed by internists ranged from $10 to $170, a difference that was not accounted for by the severity of the illnesses being treated.

That is why well-intentioned hospital administrators now preside over 100,000 unneeded hospital beds that cost the American public more than $2 billion a year to maintain.

That is why the number of CAT scanners has increased sevenfold from 147 to 1,100 in the last 2 years and why metropolitan Washington, D.C., has at least 20 of these machines when the Society of Neurologists says that no more than 7 are needed.

That is why one hospital installed a costly intensive care unit which managed to increase the average duration of hospitalization for pulmonary edema by 46 percent (2.3 days) without reducing mortality rates one bit.

Dr. Schultze has talked about the many effects of increased hospital costs on the overall economy.

I would like to point out what could have been done with the resources that would have been freed had hospital costs been controlled by limits similar to those you have proposed, Mr. Chairman.

Senator NELSON. To go back to page 2 of your statement, where you state, "Hospital expenditures will comprise 40 percent of total health care expenditures in 1978-$73 billion;" that is up from where, where was it in 1977, 1978?

Dr. AARON. I do not have the exact numbers for 1977.

Hospital costs are estimated to be $65.6 billion in fiscal 1977 and $73 billion in fiscal 1978. They accounted for approximately 40.4 percent of total health care costs in 1977 and 40.8 percent in 1978.

Senator NELSON. Where you state that a study of lab tests "found that the mean cost of lab tests prescribed by internists ranged from $10 to $170, a difference that was not accounted for by the severity of the illnesses being treated," I do not understand that.

What do you mean? Do you mean for the identical illnesses?

Dr. AARON. The point is that doctors not facing incentives to economize on such things as lab tests, tend in many cases to prescribe them for reasons that may not be medically justified.

Senator NELSON. What I am trying to get at is, are you saying that the cost of a particular test, or a set of identical tests in various labs, vary for the same tests from $10 to $170?

Dr. AARON. No, sir.

Senator NELSON. You are saying that for the treatment of the same condition in a particular patient, because of what the doctor prescribes, the costs range for the lab tests?

Dr. AARON. Actually, it is some of both. The difference is in the number of tests prescribed, and it is the fact that there is wide variation in the cost of giving tests among different labs, some of both factors are at work.

In that connection, the FDA has estimated that as much as 50 percent of hospital X-rays are unnecessary, and that as much as 30 percent are done purely to protect the physician against malpractice. Senator NELSON. What percent?

Dr. AARON. The costs are mean drug costs prescribed by individual physicians for groups of roughly similar patients. The differences in costs represent differences in the volume and type of tests ordered by the physicians. The researchers could not account for any of the variation in drug costs by differences in the patients seen by the physicians. Senator NELSON. What is the current cost of the CAT scanner? Dr. AARON. The price of the CAT scanner will depend upon the characteristics of the machine. For example, the list prices can range from $96,500 for a head only scanner to over $700,000 for a full body highest speed scanner. The average list price for a full body scanner is around $650,000.

Mr. Chairman, I was on page 3, where in 1968, expenditures in general short-term hospitals were approximately $14 billion a year. They are now $58 billion a year, up $44 billion in 10 years. If during this period, hospital costs had risen only 111⁄2 times faster than the CPI, rather than almost 211⁄2 times as fast, total hospital spending today would be $44 billion, $14 billion less than we are currently spending. An increase in hospital expenditures 50 percent greater than the general inflation rate would have accommodated technological change while imposing a constraint on hospitals' cost increases.

Of that $14 billion, roughly $51⁄2 billion would have taken the form of reduced Federal expenditures.

Senator NELSON. If I am reading this correct, you are saying that, if $14 billion had been saved, we would be spending $44 billion this year, instead of spending $58?

Dr. AARON. That is correct. The other $81⁄2 billion would have accrued to businesses and individuals as direct savings.

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The Federal share could have paid for drugs for the elderly and eliminated cost-sharing under medicare.

It could have paid the entire Public Health Service's budget.

The private share would have saved $8.4 billion or an average of $160 for each four-person family—a saving equal to about half the tax cut now being discussed in Congress.

The $8 billion would have accrued to private parties to reduce direct health insurance premiums.

Senator NELSON. You are including the share of the premium for health insurance, as well as the payments made by people who have no insurance?

Dr. AARON. Yes, I am, and I am also including the savings to businesses from the lower premiums.

Dr. GALBRAITH. May I interrupt? Mr. Secretary, I am not disputing your general case, and I am not disputing your analysis of why increases have occurred in this uniquely soft market where people can to a considerable extent set their own prices, and also their own demand. But for purposes of complete accuracy, is it not necessary to emphasize that during this period, procedures that were previously available only to relatively affluent cases now also became available to less affluent patients under medicare and medicaid or private insurance plans? These must have been a fairly substantial factor in the increase of costs during this time.

Dr. AARON. There is no question about that, and that is why I used the 11⁄2 times of the price consumer standard rather than the general cost level.

The cost of things hospitals buy have not risen considerably faster than the general price level, so allowing the additional 50 percent includes some adjustment for increasing the quality of care to the average patient.

Senator NELSON. Is it your argument that hospital costs have risen 20 times faster than the general inflation, but if they had risen. in hospitals 11⁄2 times the inflation rate, we could have accommodated the increase, the additional expense of technology that has been added, and at the same time, held the hospital inflation rate at 12; is that what you are saying?

Dr. AARON. I am not saying that. We have not done a precise calculation of the exact division between the proliferation of services indeed medically necessary, and proliferation of services medically unnecessary.

What we do observe is an industry characterized by the conditions that Dr. Schultze described, and which Dr. Galbraith just alluded to in which there are no incentives facing any decisionmaker to economize on scarce resources, and the result has been the generation of excess capacity, and the prescription of what are in many cases unnecessary services.

I would not at this time presume to make an exact division.

I would like to conclude with a couple of remarks about the recent reduction in the rate of increase in hospital expenses.

We attribute this development to a number of factors, the most notable I think has been the announcement of the Administration's cost containment proposal.

Senator NELSON. Do you have figures that show a rather compelling association between the announcement of the proposal by the Administration and the voluntary reduction in costs?

Dr. AARON. I find the pattern fairly provocative, let me say. Beginning in about July last year, the rate of increase in medical and in hospital costs, according to the American Hospital Association began sharply to decline, and that decline continued into this year.

That rate of increase had been level, or increasing during the prior period, and, as you know, we sent up our proposal early last year, and I cannot help but feel some of that decline has been due to the increased awareness of the serious problem of rising hospital costs.

It has also, undoubtedly, instilled in the minds of many in the hospital industry the prudence of slowing price increases at least while the specter of Federal legislation looms.

We hope that the voluntary program you propose, Mr. Chairman, would have a similar effect. But we fully agree with you on the need for a trigger that would mandate limits if voluntary approaches fail. Your plan gives the hospital industry every opportunity to meet, voluntarily, the reasonable and generous limits it contains.

Senator NELSON. I agree with that. I believe the Administration's proposal is good, but this is a compromise we proposed in the event that the Administration bill fails.

Dr. AARON. We understand that. We are appreciative of those efforts.

In particular, on your plan, we think it leaves room for States to impose effective cost control programs if voluntary efforts fail; or for the Federal Government to set limitations when and where needed.

Your plan will reduce hospital expenditures $34 billion between now and 1983. In so doing, it will help curb inflation, reduce Federal expenditures, and give individuals and business firms relief from what amounts to a hospital inflation tax.

Thank you, Mr. Chairman.

Senator NELSON. Thank you very much, Dr. Aaron.

We appreciate your testimony, and the very valuable statistics. that you have presented in your testimony.

I know that everybody is busy, and so you are free to stay or free to leave.

Thank you very much, Dr. Aaron.

Dr. AARON. Thank you.

Senator NELSON. Our last witness today is Dr. John Kenneth Galbraith, professor of economics, Harvard University, Cambridge, Mass.

STATEMENT OF DR. JOHN KENNETH GALBRAITH, PROFESSOR OF ECONOMICS, HARVARD UNIVERSITY, CAMBRIDGE, MASS.

Dr. GALBRAITH. Thank you, Mr. Chairman.

I have no formal statement. I have a number of points bearing on previous testimony on the problem in general, which I will go over in a relatively informal way, and as briefly as possible.

I am, Mr. Chairman, a longstanding member of the Committee on National Health Insurance, to which I have a firm commitment. But I am not speaking on behalf of the committee, or in any organized context. I am here only as a concerned observer of this extremely important problem.

I should like to emphasize at the outset that the best way to control inflation in health costs, and indeed the only way to control inflation

in health costs, is as part of a broad and serious effort to control inflation generally.

The recent record shows that inflation in health costs have been more serious when inflation has been serious and have diminished more than proportionately when inflation has been less serious.

This means that any anti-inflation policy cannot single out health care as a special case. It must deal with the problem of inflation wherever strongly organized groups are able to advance their prices or their incomes. Any effort to separate hospitals and physicians as being somehow different from other groups is poor policy.

This means that the control over inflation in health care must be part of the general willingness to take on not only the doctors and the hospitals but the other powerful groups that are in a position to raise their prices or advance their incomes.

I would in this connection draw attention to one of the excellent semiofficial studies that have become available.

Senator NELSON. Will you identify it?

Dr. GALBRAITH. "Health, A Victim or Cause of Inflation?", is the general title, and in it there is a study by Chris A. Theodore and Judith S. Warner. With your permission, Mr. Chairman, I will read just one paragraph into the record:

Economic controls on the health sector were in effect from August 1971 through April 1974. During this period the rate of increase in physicians' fees [namely the cost of doctors' fees], declined dramatically, as did the rates of price increases in all sectors of the economy. This period was particularly significant for physicians' fees because it marked a reversal in the pattern of fee increases which had been established in the previous decade. Fees increased only 3.1 percent in 1971 to 1972, and 3.3 percent from 1972 to 1973. Under the economic stabilization program, percentage increases in physicians' fees were lower than such increases in the "all income less medical care" and "all services less medical care" components of the consumer price index, thus reverting to a pattern similar to that which existed from 1945 through 1960.

I will not read further but I believe this study is important at a time when there is a tendency to dismiss any forthright action of this sort as being somehow unwise or un-American and to avoid even the discussion of such action.

I find percentage increases in physicians' fees were lower than such increases in the "all income less medical care" and "all services less medical care" components myself, when taking this minority position, comforted by the public opinion polls. They show that firm action on incomes and prices, which is disapproved by people with any substantial measure of political influence, is consistently approved by the American people as a whole.

Senator NELSON. What is approved?

Dr. GALBRAITH. A poll about a month ago, on the question of how the American people reacted to general direct intervention on incomes and prices, showed a majority in favor and a very large majority in the lower-income brackets.

Thus I would urge that the problem of control of health costs not be separated from the problem of control of inflation in general. Second, Mr. Chairman, I would urge again that the worst way to control inflation is to single out health care as a special case.

I am not in disagreement with the two earlier witnesses as to the basic figures in this industry. Health care costs have increased substantially more than the consumer price index. But I am disturbed