The Magazine

The Medicare Monster

An entitlement problem too big to ignore

Sep 26, 2011, Vol. 17, No. 02 • By YUVAL LEVIN
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That design is at the heart of our health care crisis too. Today’s “fee-for-service” Medicare pays all doctors and hospitals the same price for a given service​—​regardless of quality, efficiency, outcome, cost to the provider, or patient satisfaction. Medicare recipients play no part in determining who gets paid and how much, and have no sense of what their care costs. Health care providers have no financial incentive to deliver better care at lower cost since they get paid the same regardless. All this creates an enormous incentive for volume rather than efficiency​—​which yields massive economic distortions and higher costs. And because Medicare is the largest payer for health care in most parts of the country, its structure defines the entire health care system: Hospitals and doctors shape their accounting and billing (and therefore also their practice of medicine) to suit Medicare’s demands; Medicaid and most private insurers often use Medicare’s payment codes and methods to make things easier on doctors. Medicare shapes how nearly everyone in the American health care system thinks about economics, and it does so in a way that makes very little economic sense​—​spreading staggering inefficiency throughout the system, and inflating the costs that leave more and more people uninsured. 

This calls for real structural reform of Medicare, not just tinkering at the edges or increasing taxes to pay for an unreformed program. President Obama has acknowledged as much​—​saying in July that “if you look at the numbers, then Medicare in particular will run out of money and we will not be able to sustain that program no matter how much taxes go up”​—​though he has yet to offer any solution. 

The health care law he signed last year avoided structural reforms of Medicare, opting instead for still more price controls, which reduce the amount that Medicare pays per procedure. But such price controls, which have been tried for decades, only exacerbate the problem. By paying less for each service, they drive doctors to segment their work into more individual procedures and to perform more such procedures, undermining efficiency and further inflating costs. 

Obamacare’s only nod toward addressing the problems of the fee-for-service system were small pilot programs to reward providers for organizing their work more efficiently (as determined by experts in Washington), rather than simply billing for volume. But such small experiments, which also have been attempted in Medicare for decades, have no hope of succeeding precisely because the structure of the larger program shapes the economics of the entire health sector. Pilot programs (and even the Medicare Advantage program, under which some seniors choose to have private insurers manage their benefits) are not significant enough to change how doctors and hospitals approach the business side of their work. They therefore often end up being less efficient than even the larger Medicare program, since they do not enjoy the advantages of command-and-control health care (like using Medicare’s muscle to force price reductions that shift costs elsewhere) but cannot change the providers’ incentives and so cannot draw on the far greater advantages of market economics either. 

An effective reform would have to loosen the stranglehold of the fee-for-service system, which means it would have to fundamentally change the way Medicare works. If Medicare is going to shape the economics of health care, it should at least do so in a way that comports with modern economics​—​creating efficiency through consumer pressure, competition, and innovation, not through central planning and price controls.


Premium Support

The basic outline of that kind of reform has been clear for decades. Rather than providing insurance directly to all American seniors​—​setting payment rates, making coverage decisions, and directly paying doctors and hospitals​—​Medicare would assign to each senior roughly the amount it would have spent on his coverage and allow him to spend that “premium-support” subsidy on a private health insurer of his choosing. The private insurers would have to provide at least the same minimum level of coverage as Medicare does, but they could organize their plans​—​any coverage beyond the minimum, their payment rates, their arrangements with doctors, and so on​—​as they liked. If a senior chose an insurer that charged less than the premium-support payment provided by Medicare, he could keep some or all of the difference, giving him a strong incentive to shop around and choose carefully (and giving insurers a strong reason to offer cheaper plans). If he chose a plan that cost more than the premium-support level, he would have to make up the difference out of his own pocket. 

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