The recent debate concerning the so-called catastrophic health insurance legislation now before Congress highlights the need for immediate Medicare reform, particularly in the area of chronic nursing home care. Nursing home costs make up more than 40 percent of total out-of-pocket expenditures for the elderly, and they are responsible for a full 80 percent for those who incur very high levels of out-of-pocket expenses.

Yet covering nursing home care under Medicare would entail substantial increases in premiums or taxes, perhaps much greater than those being considered under the current catastrophic bills, which expand coverage for acute-care services only. Such an expansion in benefits, however necessary it seems, is unlikely ever to occur if we cannot control the costs of one of Medicare's "bread and butter" services: physician care.

The rate of increase in physician costs is staggering. In spite of a virtual standstill in enrollment and general inflation, the costs of Medicare Part B, which pays for physician services, were 22 percent higher during the first 10 months of fiscal year 1987 than they were just a year before. What's more, these increases occurred during a period in which most physicians' charges under Medicare were subject to controls. As a result of this rapid inflation, the Reagan administration has announced that Medicare premiums paid by the elderly for physician services will have to rise by an astronomical 38.5 percent next year.

Why are costs rising so fast? The major reason is that doctors are making more money by providing: 1) a greater number of services and 2) more complex services, which pay a higher price. (It is noteworthy that there is little evidence that the extra services are improving the elderly population's health.) What these services amount to is a transfer of wealth from elderly patients to their doctors.

It is hard to blame the physicians, though. An antiquated and ineffective reimbursement system gives them strong economic incentives to bill Medicare for as much money as possible. Unlike hospital payment, which was revamped in 1983 by the diagnosis-related groups (DRG) system, physician payment procedures have hardly changed since Medicare was enacted in 1965. Doctors are paid extra for each service they provide.

Is there a problem with allowing physicians to receive additional revenue every time they provide another service? This issue has been debated for many years in academic circles, often couched in the jargon of whether physicians are able to "induce demand" -- that is, provide services that their patients wouldn't necessarily want if they knew all the facts.

Recent increases in Medicare Part B payments -- 22 percent just last year, when the number of program beneficiaries and general inflation rose by a combined total of only about 5 percent -- clearly show that physicians are in control of program pay-outs by their ability to induce demand. And the problem will get worse, not better. By the year 2000, there will be 15 percent more physicians per elderly person than there were in 1985. Without increased billing, each physician would get a smaller piece of the lucrative Medicare pie. These new physicians, with idle time and empty waiting rooms, would be eager to bill Medicare for even more services, particularly as private insurers clamp down on physician payments for treatment of the nonelderly.

Congress finally confronted the problem in 1986 when it established the Physician Payment Review Commission, or PhysPRC (pronounced "fizzpurk"). In its 1987 report to Congress, the commission focused on establishing fee schedules -- paying a flat fee for a particular service, in contrast to the current system in which payments are based in part on what the physician asks for.

Reforms of this type, unfortunately, are but cosmetic. They will do little, if anything, to get a handle on skyrocketing costs. Study after study has shown that limiting physician fees per service simply results in more services provided (and usually more expensive ones as well).

Past efforts to control physician cost inflation, which have relied on policing physician practices for inappropriate services, have not worked either. There are simply too many physician practices to watch over, and it is difficult, if not impossible, for an outsider to determine which services are appropriate.

If we are ever going to control cost, we must make physicians want to control the number and type of services they provide. This can best be accomplished by building such an incentive into the reimbursement system. Perhaps the most promising way to do this is to pay physicians a fixed amount of money per year for each Medicare beneficiary under their care. This would limit annual inflation to growth in the Medicare population, plus whatever annual increase is deemed necessary to adjust for general inflation. The federal government is funding a number of demonstration projects in this area to assess its administrative feasibility and impact on the quality of care provided.

DRGs were a major step forward in controlling hospital inflation. The next item on the health-policy agenda should be physician payment reform. Major changes in how we pay physicians can allow us to redress our failure to fulfill Medicare's original promise of protecting elderly Americans from devastating health care costs.

The writer is an assistant professor in the Department of Health Policy and Administration at the University of North Carolina School of Public Health.