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IMPACT OF INFLATION ON THE ECONOMY AND

SMALL BUSINESS—HEALTH CARE

FRIDAY, AUGUST 18, 1978

U.S. SENATE,
SELECT COMMITTEE ON SMALL BUSINESS,

Washington, D.C. The committee met, pursuant to recess, at 2 p.m., in room 424, Russell Senate Office Building, Hon. Gaylord Nelson, chairman of the committee, presiding:

Present: Senator Nelson. Also present: Alan L. Chvotkin, counsel; and Judith Robinson, staff of Senator Nelson.

Senator Nelson. The committee will please come to order.

This is a hearing of the Senate Select Committee on Small Business, into the effects on the American economy of inflation in the health care industry in general, and the hospital industry in particular.

In the debate over hospital cost containment this year, in both the House and the Senate, it is my feeling that insufficient attention has been paid to the adverse destructive economic effects of failing to bring this inflation under control.

Expenditures for medical services now comprise almost 9 percent of the GNP and over 10 percent of disposable income. Only two decades ago, medical services comprised less than 5 percent of our national expenditures. Quite simply, health care costs have been rising faster, for a longer period of time, than any other major sector of the economy.

Businesses are particularly hard hit by the escalation of health costs. Besides their impact on the rate of overall inflation, rising health costs require businesses to pay higher fringe benefits, and increased social security and corporate taxes to support medicare, medicaid, and other Government health care programs.

The costs of health benefits are also reflected in the higher cost of materials and services purchased by business. They are reflected in higher production costs, and ultimately they are passed along as increased prices to the consumer.

Labor negotiations around the questions of health benefits have become increasingly difficult due to health care inflation—as witnessed by last year's acrimonious coal strike, in which the most significant issue was not wages, but the cutback of health benefits.

There are currently pending in Congress a number of amendmentsincluding, one of my own—which will give Congress a meaningful opportunity to save billions and billions of health care dollars in the coming years.

The savings associated with these amendments would be significant-indeed, dramatic.

As I pointed out earlier this week, one would think that all Members of Congress would jump at the chance to strike such a telling blow against inflation and spending. Thus it is ironic that with all the ostentatious rhetoric about inflation and balanced budgets, that noisy squadron of candidates for President, Vice President, or taxpayer lover of the year is strangely silent on this issue. They are willing to tilt at windmills but don't ask them to tilt with any problems in the real world.

For that reason, I have called these hearings to ask some experts in economics and in corporate and governmental management to address themselves to the serious underlying problems associated with inflation in this sector of the economy. Some of the questions I would hope to have answered include:

What is the nature and dimension of inflation in the health care industry in general, and in the hospital industry in particular?

Why has inflation in this industry been so much higher in recent years than in other sectors of the economy?

What has been the effect of this inflation in the last 2 decades on economic growth? On the general rate of inflation in the economy? On taxes and employment? On disposable income? On health insurance premiums and Government programs? On production, employee, and other costs to American business—including small business?

What is the potential future effect on these economic factors of continued health industry inflation at recent rates? What would be the potential effect of significantly reducing the rate of inflation in this industry below current levels?

I want especially to thank our witnesses this afternoon for agreeing to participate in these hearings on such short notice. Our witnesses today will be:

Dr. Charles L. Schultze, Chairman of the President's Council of Economic Advisers;

Dr. Henry Aaron, Assistant Secretary of Health, Education, and Welfare for Planning and Evaluation; and

Dr. John Kenneth Galbraith, of Harvard University.

This afternoon's hearing is being conducted by leave of the Senate granted on August 15. Because of the short period of time between the decision to convene the hearing and today, the Select Committee's preference for advance copies of testimony has been waived.

Let me add that the hospital cost containment compromise that I have introduced-amendment No. 3478 to H.R. 5285—will be called up in the event that we fail to adopt the Administration's proposalS. 1391. The latter would save $60 billion over a 5-year period; the compromise would save $30 billion over 5 years $11.6 billion would be Federal expenditures, and about $1.5 billion State expenditures.

Dr. Schultze does have another appointment that he has to be at by 3 o'clock. I will call ou Dr. Schultze first, and then I will ask Dr. Galbraith and Dr. Aaron to come on up.

Dr. Schultze, you may proceed.

STATEMENT OF HON, CHARLES L. SCHULTZE, CHAIRMAN, COUN

CIL OF ECONOMIC ADVISERS, EXECUTIVE OFFICE OF THE
PRESIDENT, WASHINGTON, D.C.
Dr. SCHULTZE. Thank you, Mr. Chairman.

I appreciate and the Administration appreciates the opportunity you have afforded me to discuss again this very important subject.

I think there has been much said and much written on the direct and obvious impact on the American people, and particularly on the rate of inflation of exploding medical care costs.

I can recite just a few of those very briefly and go into another matter.

In the period since 1966, the price of medical care has risen on the average about 5 percentage points a year faster than the general rate of inflation.

Our ability to measure accurate medical prices is admittedly not very great, but yet it is clear that the excess of medical care cost increases over other costs have been a major factor in this 10-year period in pushing the rate of inflation.

As we all know in the case of hospital costs, the cost of a semiprivate room has risen about 15 percent a year, more than 9 percentage points more rapidly than the overall inflation rate.

Mr. Chairman, the direct effects of rapidly rising health care costs on consumers are obvious, and I will not belabor them further, but starting on page 4 of my testimony, I want to take a look at what is not quite so obvious—the large number of ways in which rising medical care subtly and indirectly add still further to inflation. Let me first list those ways and then briefly discuss some of the more important.

În the first place, increases in medical care prices raise the cost and hence the premium for automobile and similar liability insurance.

Rising medical care costs increase the payroll tax rate required to pay for medicare. The employer share of these taxes is a direct cost of doing business, and the rise is passed on to consumers in the form of higher prices.

Medical care inflation adds to the cost of fringe benefits under employer-financed health plans also a direct cost of doing business that tends to be passed on in higher prices. When it is not passed in higher prices, it is passed on in lower wages. These indirect and direct costs rises are fed into higher prices, which in turn give rise to still further wage increases through formal cost of living and escalator clauses in wage contracts and the general impact of rising prices on the size of wage bargains.

This process gives rise to still further price increases, and so the initial impetus is magnified to a larger ultimate effect on inflation.

Premiums for various kinds of insurance are influenced by rising medical care costs—particularly automobile liability insurance, which accounts for about 1 percent of consumer spending.

Senator Nelson. Will you recite that figure again, please?

Dr. SCHULTZE. I said various kinds of insurance-particularly automobile liability insurance, whose premiums account for about 1 percent of consumer spending, are influenced by rising medical care costs.

So when you look at the impact of medical care costs on consumers, you not just look at what they spend for medical care, but the indirect effect on this item of their budget, because it raises premiums on all those kinds of insurance which pay medical costs.

Senator Nelson. My staff has a figure that says that over $300 in the cost of every new Ford automobile is health expenditures by that company, and that General Motors now pays more money to Blue Cross and Blue Shield than it pays to U.S. Steel or any other supplier of its goods and services. Is that a figure you are familiar with?

Dr. SchultzE. I cover that section.
I cover it in a slightly different way, but I do cover that.
Senator NELSON. All right.

Dr. SCHULTZE. So the first indirect way in which medical care costs hit consumers apart from the obvious is through its influence on the cost of liability insurance.

Second, as you know, the medicare program is financed by a payroll tax of 2 percent today compared to a 0.7-percent rate when the program was inaugurated.

An important part of this increase stems from the fact that hospital care costs have risen much more rapidly than inflation generally.

Mind you, this is not just higher taxes. It is a higher tax rate.

Half of these taxes are paid by employers and treated as a cost of doing business. This rising payroll tax rate thus adds to cost and price inflation.

Business costs, and here are some of the points you are talking about, have also been increased by the rise in insurance premiums paid by employers.

Health insurance has become a major fringe benefit for American workers. In the mid-1950's, employers paid the full cost of their workers' health insurance in only 10 percent of group health plans. By 1970, the proportion had risen to 40 percent. Since then, I am sure the proportion has risen further.

In manufacturing, employee health benefits account for 8 percent of production costs.

The importance of health insurance payments to employer costs has grown remarkably in recent years. As an example, as you noted, General Motors spends more on health insurance than it buys from U.S. Steel

Health insurance premiums are the fastest rising component of employer costs. For American industry as a whole, employer payments for health and life insurance rose 100 percent from 1966 to 1972, while wages rose only 47.7 percent.

Within the economics profession, there is no clear consensus on the extent to which the higher cost of fringe benefits results in higher prices.

On the one hand, new 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.

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