The Wrong Way to Constrain Health Care Costs

I believe that a lot of people on the left hate economics. There are even economists who hate economics. (At the New York Times, for example.)

Economics is the science of incentives. And most economists learn early in their careers that an efficient, workable society is one in which individual incentives are aligned as closely as possible with desirable social goals (Adam Smith’s observation, for example, that in most markets producers find it in their self-interest to meet other peoples’ needs).

This is why most economists reject socialism — a system in which everyone at the bottom has a self-interest in undermining a plan imposed by a few people at the top.

Turns out, there is something worse than socialism. It involves giving everyone an incentive to undermine the top-down plan and then imposing a collective punishment on all of them when they respond to the perverse incentives. Believe it or not, that is the way President Obama proposes to control health care costs.

President Obama is not alone. This is the way a lot of European countries try to constrain health care spending. It is also the way our federal government tries to control Medicare costs. At the risk of oversimplification, it works something like this.

The federal government sets the fees for all doctor services, but leaves the doctors free to decide how many of those services to perform. The fee for a patient visit is strictly regulated, for example, but the number of visits is not. Then the government announces that if total collective Medicare spending fails to moderate, it will impose an across-the-board percentage reduction in all doctor fees. This sets up a vicious cycle in which everyone’s incentives are perverse. The more doctors act in their self-interest, the more social waste there is and more they are collectively punished.

From the individual physician’s point of view, there is nothing he or she can do to affect the total amount of spending. The doctor’s own behavior is such a small part of the whole system, it is imperceptible. But the doctor knows the only way he can increase his own income — or just maintain his standard of living — is to increase the number of services. Care that might have been more efficiently delivered in a single patient visit, for example, gets spread out over two or three visits. Then when the collective spending fails to meet the target, the government imposes another across-the-board fee reduction and the cycle starts all over again.

Suppose we could magically put the doctor in a room with a Medicare official and free them to agree on a different compensation system. Given that opportunity, every primary care physician in the country could think of ways to save taxpayers money and increase his own income at the same time! Services provided over three visits, for example, might be provided with one visit plus a phone call or two, or one visit plus an e-mail exchange — provided that the government pays more for the one visit.

In the language of economics, if doctors could freely recontract with Medicare, they would repackage and reprice their services in ways that are mutually beneficial to themselves and to Medicare. They would substitute higher-quality visits for lower-quality ones, economize on the use of real resources and economize on the patient’s time as well.

What makes all dysfunctional systems dysfunctional is that people do not have the opportunity to make such mutually beneficial adjustments. And, unfortunately, most of the private payers are every bit as bureaucratic as Medicare and they tend to pay the same way Medicare pays.

What Obama should be doing: thinking of ways to free doctors in the manner just described. My advice on how to do that is here. What Obama is going to do instead: impose more perverse incentives on all providers.

In his speech to Congress the other night, he endorsed the idea of an “automatic trigger” to cut payments to hospitals and physicians if Medicare spending fails to meet a target. According to the New York Times, this idea stems from a paper written last year by Obama advisor David Cutler and single-payer advocate Judy Feder.

C’est la vie.

Comments (16)

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  1. Joe S. says:

    Excellent post.

  2. Ken says:

    As John Goodman has said before, the left only knows two ways to try to control costs: squeeze the providers and deny patients care.

  3. Andrew says:

    I don’t think that a meeting between a Medicare official and a physician will solve the problem.

    The decision on how much to spend belongs to the patient, and he can make the correct decision only when he also contributes to the cost of the care, even though for only a certain percentage of it.

  4. ObamaLied2US says:

    I am so discouraged now. He told us that we have these fellows out of GITMO, now that looks like it won’t happen anytime during his 8 years in office. Then he promised us over a million jobs; that hasn’t happened and look like it won’t because private employers are not hiring. Then he promised us free health care; now it looks like that won’t happen.

  5. John R. Graham says:

    I have little doubt that “automatic trigger” will end up being the policy choice of the Obama regime. This is the way Canadians’ access to medical services is rationed. Originally, provincial governments fixed the fee-schedules with the providers. (More precisely, they inherited the incumbent Blue Cross/Blue Shield fee-schedules.) They quickly learned that doctors shortened consultations and increased their frequency. So, they simply imposed “global budgets”, with the result that surgeons might have used up all their time in the OR by October, for example.

    In recession, the government just swings its axe without warning. Government planning does not result in an effective plan: It just prevents patients, doctors, and hospitals from planning for themselves.

  6. Mark P. says:

    John, I would not have guessed that you are a believer in the target income theory of physician behavior. Whatever happened to “they aren’t going to pay me enough so I am going to find some patients who aren’t on Medicare (just as I did for Medicaid). Or I will take my financial lumps and go play golf.”

  7. Chris ewin, MD says:

    Mark P. is so correct….
    It’s a lot easier for physicians to set their own prices and let the consumer make the decision on value and quality…..Those of us who don’t accept third party fees have cut their overhead tremendously.
    And, the patients couldn’t be happier.
    If Obama tries to make us “work” for the government….Docs can make a choice to comply,
    quit their day job or find other work….It would be a travesty to see the exodus of even more physicians…

  8. Glenn Clark says:

    Yes, health care reform will be painfull. My question is who will suffer that pain? If B.O. gets his way, it will be seniors on Medicare, doctors providing service, taxpayers and our children, who will have to live with and service HUGE debt. Why do countries live way beyond their means? Because we let them! Next election, find out who the good ones are and THROW THE REST OF THEM OUT!

  9. Mark Kellen says:

    The proper arrangement is for the physician to be the consultant and give the patient the options. The patient then weighs the risks, benefits, and costs of all the options and makes a choice. Anything else will fail.

    Mark Kellen, MD

  10. Frank Timmins says:

    John’s post is a good explanation of how Medicare works, and the suggestion that anything the current government is working on for the rest of us will be “managed” the same way is certainly a foregone conclusion.

    I think part of the problem is that most people approach the healthcare issue from a flawed assumption, and that is the assumption that it must be “managed” by some third party (government or insurance company). Put another way, why is healthcare approached by economists as something that should be “budgeted”? We don’t budget the national expenditure on food, housing, automobiles or just about any other consumable product or service.

    Of course, the simple response by those ideologues of the left is that “healthcare” is a “right” and therefore must be guaranteed by the government, and that then makes it something that needs to be managed (or budgeted). This is where everything starts going downhill. If someone would just realize that we don’t need to budget, manage or guarantee coverage for everyone to get everyone under the umbrella of healthcare. Simple tax incentives will get the vast vast majority of people in the system. Those few that remain outside the system can still access limited government funded healthcare, and the great majority of the population can be made “individual managers” of their own healthcare.

    That will surely be a helluva lot more efficient than anything bureaucrats and HMOs can do to contain costs.

  11. Bob Blades says:

    There are some very good responses. I wish alot of you were in Congress. The conclusion is that costs are too high yet they think taxes reduce costs as a percentage of GDP.
    The patient needs to be accountable and not abuse the system. One way is higher deductibles. We need to be responsible for our own health care ie weight.
    Portable insurance will help as well as tort reform.
    With 85% of Americans happy with their insurance we don’t need to trash the system. Doctors should be paid appropriately and given incentives.

  12. Dan S says:

    The paper from Cutler and Feder reads like it was produced by the South Park underpants gnomes:
    1)Pass $1 trillion health care reform bill
    2) ?
    3) Enormous savings and longevity

  13. Jennie Fiedler says:

    Makes sense to put healthcare back in the hands of patients and practitioners. Should we ever go single payer by way of HR676, then I would sincerely hope that Medicare beauracrats and doctors could work out TOGETHER how best to compensate and administrate.

  14. Art says:

    You stop too soon in your analysis!

    Now you add 20% more patients and cut fees again, so it becomes impossible to add any more patient visits and to provide more unneeded services to patients to stay in business. What happens? More physicians either quit or go to the specialty practices and fewer new physicians become general practioners and those who remain won’t be able to cope.

    Some will say that most of these “new” 45 million patients will just pay into the system and not use services as they haven’t in the past. But if you make people pay for health insurance you can bet they will use it. American consumers are not stupid!

  15. Devon Herrick says:

    This is another example of pitting one constituency against another. There are far more patients (i.e. voters) than doctors — so politicians give patients relatively free access to see physicians. For the part, doctors are free to see the same patient about as often as the patient is willing to drop by. But to hold spending down, politicians cut reimbursements, which results in a version of rationing by waiting. Many of the Medicaid programs with the broadest eligibility are administered this way. Everybody is eligible but enrollees cannot seem to find providers willing to treat them. When patients do, they are rushed through like cattle through a corral.

  16. Robert Berry, MD says:


    Doctors should not contract or recontract with Medicare. They shouldn’t sign the contracts and play the Medicare game. They should just contract with patients – that way they can take care of the patient’s problem in one visit rather than over several visits and the system becomes rational, centered around the patient’s needs and not some bureaucrats set of criteria, because it is the patient calling the shots.