Cost Shifting and the Future of the U.S. Health System

by Reihan Salam

There is an ongoing debate over whether medical providers really engage in cost shifting, i.e., do providers charge private patients more when Medicare payments are cut? The intuitive problem with this idea is that it suggests that providers aren’t always trying to charge patients as much as they possibly can. The key, according to James Robinson, seems to be market concentration. That is, the intuition is correct — providers will charge as much as they can; it’s just that they can’t charge private patients more in a more competitive environment. The following is from Robinson’s abstract:

The study presents empirical evidence that, faced with shortfalls between Medicare payments and projected costs, hospitals in concentrated markets focus on raising prices to private insurers, while hospitals in competitive markets focus on cutting costs. Policy makers need to examine whether efforts to promote clinical coordination through provider integration may interfere with efforts to restrain overall health care cost growth by restraining Medicare payment rates.

John Goodman suggests that this bodes ill for the PPACA-governed U.S. health system. Austin Frakt has suggested that cost shifting is not a large and pervasive phenomenon. He cautions that the Robinson paper demonstrates association and not causation, as it does not account for unobserved measures of hospital quality.

Yet Frakt has also raised concerns about the potential for provider integration to exacerbate cost growth:

A growing number of observers, however, are voicing concerns about the potential for increased hospital market power, especially if hospitals control the flow of money and access to other providers in the ACO or if several hospitals in a market join forces.

Historically, public programs have been largely immune from the effects of provider market power since they use administered prices rather than negotiating rates. The ACO model could, thus, reduce public health care spending relative to trend even in the face of provider consolidation. As Figure 1 illustrates, however, market power is clearly relevant to private-sector costs and premiums. Though scholars debate the extent to which hospitals can and do shift costs from public to private payers, a period of high hospital market power relative to insurers and declining public payments presents theperfect conditions for this to occur. It was precisely these conditions that gave rise to the high private hospital margins – and high premium increases – of the late 1980s. The possibility of seeing public-sector savings but negativeconsequences for the private sector will make itimportant to take a broad view when evaluatingthe success of ACOs.

This is one reason why some critics believe that PPACA is a stepping-stone to a more tightly-centralized U.S. health system. By increasing hospital market power, the reformed system will drive up private-sector costs and premiums, thus strengthening the political case for imposing administered prices on a wider swathe of the health sector. 

One alternative, as recommend by Clayton Christensen and Jason Hwang, et al., is to facilitate entry by specialized providers that can “cherry-pick” and “cannibalize” the most profitable business lines from large hospitals, driving down costs. Unfortunately, large hospitals played a significant role in shaping PPACA and they’ve met and will most likely continue to meet with success in imposing steep barriers to entry. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.