Framing Medicare Cost Controls

Ezra Klein has written a thought-provoking post on how to think about Medicare cost controls that uses a number of framing devices that merit careful scrutiny.

One of the dirty little secrets of the health-care system is that Medicare has done a much better job controlling costs (pdf) than private health insurers.

This doesn’t strike me as much of a dirty little secret. Medicare accounts for roughly one-fifth of medicare expenditures in the United States, and it sets centrally administered prices through its D.R.G. system. No private health insurers approaches the scale of Medicare, and thus no private health insurers exercise the same pricing power. 

The problem is that Medicare can’t control costs too much better than private insurers or, as you see from the article above, doctors will simply abandon Medicare. In a world where there’s only Medicare and Medicare decides to control costs, doctors can either take the pay cut or stop being doctors. And as we see from other countries, lots of people want to be doctors, even if being a doctor doesn’t make you particularly wealthy. But in a world where Medicare is just one of many payers and Medicare decides to control costs, doctors can simply stop taking Medicare patients and a lot of legislators will lose their jobs.

Note the framing here: payment reductions are characterized good cost control. Deep payment reductions are really good cost control. And if providers refuse to accept payments below a certain level in this framework, that is an artifact of the excessive success of the cost controls. This doesn’t strike me as intuitive. 

Moreover, the problem identified in the above paragraph is that there are many payers rather than one centralized payer. One could just as easily argue, as James Capretta has, that the existence of Medicare FFS has been the barrier to private sector innovation in payment reform and care delivery. 

Here’s another way of looking at it: cost controls are good cost controls when they reflect changes in the underlying price of the service being offered. Rather than cutting payments according to a mechanistic model, providers should be given more discretion to organize their practices in ways that deliver high-quality care at low cost, i.e., the health system should facilitate rather than hinder business-model innovation. One way to move in this direction would be to bring market prices to Medicare, as Robert F. Coulam, Roger Feldman, and Bryan E. Dowd have proposed:

To accomplish this, both traditional fee-for-service (FFS) Medicare and private Medicare Advantage (MA) would submit bids for the government’s business; the federal contribution to premiums would be set to equal the lowest bid in each market area. This competitive pricing system would penalize plans that bid too high–their beneficiaries would pay higher premiums–providing an incentive for plans to offer their best prices. Meanwhile, low-bidding plans would be rewarded with increased enrollment. Such an approach would reduce Medicare spending by 8 percent, shoring up the program’s finances while empowering consumers to make sensible choices about their health care. 

To be sure, this would only be a first step. Regulations that insulate large general hospitals from competition are, in my view, among the most pressing obstacles.

Ezra continues with a discussion of SGR:

In fact, the dominant opinion is that Medicare can’t control its spending. A lot of this, as far as I can tell, has to do with the failure of the Medicare Sustainable Growth Rate, which looms oddly large in punditry on this issue. The Medicare SGR was a small formula that Republicans inserted into the 1997 Balanced Budget Act that was meant to save a bit of money — $12 billion over 10 years, or 3 percent of the bill’s Medicare cuts, to be exact. The formula was wrong, and it quickly required massive cuts that would destroy the program, and that the SGR’s authors never intended. 

According to Ezra’s framework, however, the massive cuts are best characterized as evidence that Medicare was controlling costs too well. The flaw in the formula was that it controlled costs so well that doctors simply abandoned Medicare. And the critique of the Medicare cost controls from the right has been that the PPACA Medicare cuts are too close to SGR for comfort.

Meanwhile, the SGR formula actually has cut costs in Medicare dramatically. The cuts have been less than the flawed formula would’ve demanded, but vastly more than would’ve been likely in its absence. As James Van Der Water and Jim Horney document, the byproduct of the compromises required to keep the formula’s cuts from taking effect is that “the reimbursement rate for physicians next year will still be 17 percent below the rate paid in 2001, adjusted for subsequent increases in the costs that physicians incur in providing services as measured by the [Medicare Economic Index].” This is why physicians are so upset. Meanwhile, the vast majority of Medicare cuts passed in the last 20 years have been implemented as scheduled.

This suggests that SGR was still relatively good news, and I think that’s fair to say. But again, the question is about the structure of the PPACA Medicare payment reforms and whether that structure will facilitate improvements in underlying cost-effectiveness. That much is not clear. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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