Henry J. Aaron, Ph.D.

Congress has just extended the life of the sustainable growth rate (SGR) — the formula that Medicare uses to calculate physicians’ fees — for 6 more months. The SGR was enacted in 1998 to hold down the growth of these fees. It replaced a formula with the same objective that wasn’t working. It ties the annual growth of Medicare fees to growth of the real gross domestic product, Medicare caseloads, and practice costs. But it ignores the principal reason that health care spending outpaces income growth: the increasing number and complexity of medical interventions. The SGR purports to control total spending on physician services, but it controls only prices, even though spending is the product of the price and the number and intensity of services. According to the formula, the more the number and intensity of services grow in one year, the more prices must be cut in the next. To make matters worse, the formula calls for any excess of cumulative spending since the formula was enacted in 1998 to be made up as well. Thus, the implied price cuts can be large, and they grow if cuts are deferred. In 2010, the implied fee cut was 21%, with further annual cuts of around 5% in several succeeding years. Rather than cut fees, Congress has just suspended the application of the SGR formula and boosted fees by 2.2% effective June 1, 2010. As in years past, however, Congress left the formula on the books and promised to cut fees later.