Medicare and the Development of Rate Setting

Via Incidental Economist and White Coat Notes, I found a pretty good paper on the developments that led to Medicare's Prospective Payment System (PPS) in 1982.  PPS is the price setting mechanism that specifies what price hospitals are paid for the services they render.  Under PPS they get a per diem rate set by the federal government.  Prior to the advent of PPS Medicare just paid cost- hospitals sent in the bill and Medicare paid it.

The paper describes how Medicare from inception was beset with massive price inflation, with expenditures running at 5 times what was expected a mere 8 years after full implementation.  That inflation quickly led to cost control efforts, first with Nixon in 1972.  Though ineffective at controlling prices, that reform enabled state pricing regulation such as Maryland's all payer system.  Coincidentally, they were the first state to seek out pricing regulations and they are the only state that kept them.

Carter took another bite at the apple but whiffed, with hospitals successfully killing his proposal in Congress.  Carter's efforts were not for naught however as the price hospitals paid was a commitment to voluntary cost controls.  The voluntary effort showed modest success for two years, before hospitals fell off the wagon at roughly the same time Reagan came into office.  The outcome of this combination was not what you'd expect.

Republicans had hung their hats with the hospitals against Carter and been made to look like fools.  Their antipathy for government spending overruled their hatred of regulation, with some added incentive that Social Security was bankrupt (and I mean "we don't know where next month's payments will come from" bankrupt).  This led to a monster Social Security reform bill, part of which involved robbing the Medicare trust and paying for it by using PPS to bring costs in line with the balance.  Most legislators didn't even know what a DRG was, to them it was just a Social Security bill.

Some lessons to draw from this:

• "Single Payer" means absolutely nothing when it comes to reining in prices.  What matters is political consensus and the will to enforce it.
• Compare how Reagan and Dole reacted to their challenges to say, George W Bush and Tom Delay.  The GOP has fallen a long, long way.
• That said, cost control reform doesn’t happen without major bipartisan support.  72 and 82 both involved mixed leadership.  Carter's efforts failed in large measure because Republicans made hay by standing with the hospitals.
• Major reform involves lots of actors with lots of motivations.  Republicans put aside their antipathy to regulation when it allowed them to save money.
• Successful reform requires provider participation.  They won't come to the table unless you hit them with a really big stick first, one big enough that whatever reform you seek looks like pain relief to them.  TEFRA served this purpose with PPS.
• All reform is temporary.  Providers will eventually subvert any cost control regime given enough time, as Medicare's current finances demonstrate.
• Finally, crises really are opportunities.  The Social Security debacle was the backdrop for PPS and it gave everyone more backbone then they would have had otherwise.