Hospitals have recently been receiving a lot of criticism because of the apparently high profits they are making under a Medicare program that was adopted in 1984 to cut government health-care costs.

Newspaper reports have suggested that the Department of Health and Human Services has set hospital payment rates too high under the program -- which is known as the Prospective Payment System -- and that the results have been excessive profits on Medicare patients and, in some cases, the sacrificing of the quality of medical care by hospitals seeking to cut costs and increase their profit margins.

These reports, which are vigorously disputed by the industry, were prompted by an HHS audit of hospital profitability and by Senate committee hearings late last year on the quality of patient care. They come at a time when Congress is considering a freeze in the Medicare budget for the coming fiscal year, or only a modest increase of 1 percent at most -- well below the actual increase in hospital operating costs and the general rate of inflation.

Regardless of whether some hospitals have made high profits under the new Medicare program, the government should not "reward" the efficiencies generated by the Prospective Payment System (PPS) by freezing or slashing funds for health care. PPS has achieved the very results anticipated by the government when it adopted the program, and it would be a mistake to penalize hospitals for implementing the sort of cost-containment measures required by it.

Under PPS, hospitals are reimbursed a fixed amount per Medicare patient, depending on the medical procedure involved. HHS sets the payment for each procedure in accordance with a nationwide average rate and certain costs specific to the hospital involved.

Before this system was adopted, hospitals were paid basically at their cost of service, including the number of days the Medicare patient spent in the hospital. Under the new system, since the payment to the hospital is a fixed one, hospitals have been given a direct financial incentive to reduce their own costs.

Thus there has been introduced into the health system an incentive to be efficient. The more a hospital is able to lower its cost of treating Medicare patients, the greater its profits. The government has benefited from this efficiency through reduced Medicare expenditures.

In response to the PPS program, hospitals made reductions in staffs and inventories; they reduced the length of patient stays, increased outpatient treatment and eliminated unnecessary testing. Whereas employment in the industry had been increasing at the annual rate of 3 or 4 percent, it is now decreasing. Employee salary increases, which had been running at an annual rate of 8 to 10 percent, have dropped to 5 percent or less.

The benefit to taxpayers from PPS was immediate and dramatic: the government experienced the lowest annual rate of increase in the history of Medicare, saving about $2 billion on its estimated Medicare outlays for 1984. The solvency of the Medicare trust fund was enhanced, thereby prolonging the life of a social program that at one time was thought to be on the verge of bankruptcy.

But has all this efficiency reduced the quality of patient care, as some have suggested? So far there is little indication that it has. Despite isolated reports of inadequate treatment, there is no empirical evidence that the Medicare public has suffered poorer care under the new system than under the old, and there is ample evidence that more efficient health-care systems do not necessarily sacrifice the patient to the pursuit of profits.

The evidence to which I refer is the experience of health maintenance organizations, health-care providers that offer a full range of health services at a fixed rate per enrollee. HMOs compete with traditional health insurance companies. They generally have their own medical staffs and contract with other organizations, such as hospitals, to provide direct care for their members.

Just as hospitals are now motivated to keep their costs lower than the predetermined amount they will receive from Medicare for providing a given service, HMOs have long been motivated to keep their costs lower than the predetermined enrollment fee they have received from their members for virtually all services needed. Not only has enrollment in HMOs increased substantially over the past decade, indicating consumer satisfaction with the quality of service, but all studies and surveys have shown that the quality of care provided by HMOs is equal to or better than that provided by others.

As I noted earlier, it would be a mistake for the government to react to reports on Medicare profits by freezing or reducing hospital payments. There are two reasons. First, when the program was adopted, there was considerable concern in the industry because PPS would place hospitals at financial risk if they failed to implement effective cost-cutting measures. It seems contrary to fundamental notions of fair dealing for the government, after adopting a program that put hospitals in a position of possible financial loss, to penalize them with further budget cuts for adopting efficiencies mandated by the government.

Second, if it becomes clear to hospitals that the Medicare program is going to be funded on the basis of the government's perception of what profit is appropriate for them, over the long run they will conclude that lowering costs or implementing more efficiencies in health- care delivery will simply result in reducing their incomes. In effect, the government will be imposing the same sort of rate regulation on hospitals that it has recently abandoned in other industries because it frustrated efficiency.

When initiative and efficiency in health care are not rewarded to any greater extent than inefficiency, efforts at further cost containment will cease and the government's health care bill will again rise at an increasing rate.