In 1986 Thomas Jefferson University Hospital in Philadelphia had the best year financially in its history, showing a profit equal to 8.9 percent of total revenue. By next year, it expects only 1.8 percent.

A major reason for the drop, said Mark Richards, associate hospital director, is Medicare, the government insurance program that pays most medical expenses of 33 million elderly. In 1986 Jefferson earned an $11.5 million profit on Medicare patients; it expects to lose $18 million on them in 1991.

Only a big surplus on non-Medicare patients keeps the hospital in the black. But Richards says Jefferson needs a surplus to help pay for emergency repairs ("the boiler needs replacement"), renovations, purchase of high-tech equipment such as MRI machines, and part of the cost (the rest is borrowed) of major capital projects such as its new $30 million trauma center.

Jefferson's experience is not unique. In recent years Congress, trying to curb Medicare outlays, has not been raising the amount of money it reimburses hospitals for treating Medicare patients as fast as hospital costs have been increasing. The result is that hospitals all over the country complain of being shortchanged and having to do without the surpluses they need for contingencies. In some cases the survival of the hospitals is threatened.

"Medicare is no longer covering the actual costs of caring for patients," says Joan Lewis, vice president of the District of Columbia Hospital Association. On average, according to Carol McCarthy, president of the American Hospital Association, Medicare pays 6 percent less than costs.

The squeeze on hospitals is likely to get even worse as a result of Congress's decision to cut $15 billion over the next five years from previously projected Medicare payments. It made the cuts in an effort to trim the federal budget deficit and in the belief that there is plenty of room for hospitals to cut costs.

Government officials do not dispute that, on average nationwide, Medicare payments today probably do not fully cover hospitals' costs on Medicare patients. In 1990, according to estimates by the Prospective Payment Assessment Commission (PROPAC), which advises Congress on hospital issues, the average hospital was losing 2.5 percent on its basic Medicare payments for inpatient stays, which are by far the largest source of Medicare revenues for hospitals. Worse figures are projected down the road.

But officials like Stuart Altman, the interim president of Brandeis University and chairman of PROPAC, point out that these figures are averages. In 1988, PROPAC estimates, about 49 percent of all the nation's hospitals profited on Medicare patients, some a lot.

"For every guy who's getting murdered there's another guy who's doing very nicely," said Bruce Vladeck, president of the United Hospital Fund of New York.

The "winners" are often urban teaching hospitals with a high proportion of beds filled every day that get extra Medicare payments for the costs of interns and for their high level of poor patients. But not all urban teaching hospitals do well. Experts haven't yet sorted out the reasons why some do, while seemingly similar ones don't.

Jefferson's profile is like that of many hospitals that do well -- an urban teaching hospital that on average fills 84 percent of its beds. Richards said it is "an efficient hospital," but has a high proportion of severely sick patients whose extra care is really not paid for under the Medicare rates. Richards thinks that factor, or problems with the way the Medicare payment rate for the Philadelphia region is computed, may be the explanation for why Jefferson is having problems.

More typically, according to PROPAC, Medicare "losers" tend to be small, inefficient, often rural, with little business, Medicare or otherwise.

The real problem for these hospitals and larger ones as well is not that Medicare pays too little but that they aren't controlling costs, according to Altman and Medicare administrator Gail Wilensky. And to many experts, the larger issue is that 325,000 of the nation's 930,000 hospital beds on average are empty every day.

Don Young, PROPAC executive director, said that even though overall Medicare payments per case, from the basic payment plus certain add-ons, have been keeping up with inflation in recent years, hospital costs have been rising faster. "The bottom line is that they ought to be able to do a bit better on holding down costs," he said.

Wilensky said some hospitals are making "wasteful capital expenditures" trying to "maintain market share" by expanding and adding new equipment despite empty beds and "a duplication of technology within the same hospital or the same area." A hospital loses if it adds capacity or puts in new technology, then can't capture enough extra business to cover the costs.

Before 1983, Medicare paid hospitals whatever their costs came to, providing little impetus to cut costs. But since then, for inpatient care, it has been providing a flat payment for each different type of illness, fixed in advance and covering the whole stay regardless of length. If a hospital's costs exceed the payment because it keeps patients in longer than other hospitals or uses nurses inefficiently, it loses. If costs are less, it profits. Wilensky said the whole point is to push hospitals to improve efficiency.

That is how it looks to Wilensky, but not to Jefferson administrators. In 1986 the hospital had a Medicare surplus of $11.5 million, because in the early phases of the new fixed-payment system, it was able to hold down the growth of costs. But the easiest cost-control opportunities are exhausted, Richards said. Now, because of a "scarcity of nurses and other technical personnel . . . we find that costs are rising" but total Medicare payments aren't rising as fast.

By 1990, Richards said, Jefferson's average cost on a Medicare inpatient was $12,288, yet it got only $10,488 from Medicare in fixed payments and add-ons for interns and other items. But on non-Medicare inpatients, its average cost was $8,841 and receipts $10,835. Overall on Medicare inpatients, Jefferson lost $11.8 million in the year ending June 30, and it also lost $2.1 million on Medicare outpatient cases -- a total of $13.9 million.

Luckily, its non-Medicare operations, despite losses on Medicaid and free care, showed a surplus of $25.2 million, although $7.4 million of this was not from the care of patients but from gift shops, flower stores, parking lots, cafeterias, charitable gifts and interest.

The bottom line for the whole hospital: an $11.3 million profit on revenues of $318 million, or 3.6 percent. Richards expects to lose $17.8 million on Medicare in 1991, and the overall hospital margin will drop to 1.8 percent.

At Methodist Hospital of Indiana, another big urban hospital, officials expect a surplus of $25 million on total income of $400 million this year, even though the Medicare portion of its business will lose $12.5 million, according to senior vice president John Fox.

But next year he expects a Medicare loss of $28 million because of the new Medicare provisions, plus a Medicare labor-cost readjustment. As a result, the Indianapolis hospital overall will be "struggling to break even on operations."

Although average hospital profits nationwide on the care of patients (including non-Medicare) dropped to about zero by 1989, according to the American Hospital Association, hospitals still averaged about 5 percent total profit overall, because revenues from gift shops, flower stores, charitable gifts and the like increased. But hospitals say some margin on patient care, their real business, is a must.

The Bush administration is already considering more Medicare cuts and it appears Rep. Fortney "Pete" Stark (D-Calif.), chairman of the House Ways and Means subcommittee on Medicare, will be thinking along the same lines in future years when Congress again turns to major deficit reduction.

"Medicare is not driving them broke -- absolutely not," said Stark. The real problem, he said, is that for many hospitals "there is no incentive for them to hold down costs. They can cost-shift, expand without any rationale, move out to the suburbs where they have less uncompensated care."

"I think it's pretty clear the hospital industry isn't going to get Congress to fund business as usual," said Wilensky.