Six Billion Physician Fees

Even though prices don’t have the same meaning in the medical marketplace that they do in other markets, they still have the power to influence provider behavior.

Take Medicare, which has a list of some 7,500 separate tasks it pays physicians to perform. For each task, there is a price that varies according to location and other factors. Of the 800,000 practicing physicians in this country, not all are in Medicare, and no doctor is going to perform every task on Medicare’s list.

Yet Medicare is potentially setting about 6 billion physician fees across the country at any one time.

Is there any chance that Medicare can set fees and approve transactions in a way that does not cause serious problems? Not likely.

What happens when Medicare gets it wrong? One result is that doctors face perverse incentives to provide care that is costlier and less appropriate than the care they should be providing. Another result is that the skill set of our nation’s doctors becomes misallocated, as medical students and practicing doctors respond to the fact that Medicare is overpaying for some skills and underpaying for others.

Every lawyer, every accountant, every architect, every engineer—indeed, every professional in every other field—is able to do something doctors cannot do. They can repackage and reprice their services. If demand changes or if they discover a way of meeting their clients’ needs more efficiently, they are free to offer a different bundle of services for a different price. Doctors, by contrast, are trapped.

Suppose you are accused of a crime and suppose your lawyer is paid the way doctors are paid. That is, suppose some third-party payer bureaucracy pays your lawyer a different fee for each separate task she performs in your defense. Just to make up some numbers, let’s suppose your lawyer is paid $50 per hour for jury selection and $500 per hour for making your final case to the jury.

What would happen? At the end of your trial, your lawyer’s summation would be stirring, compelling, logical, and persuasive. In fact, it might well get you off scot free if only it were delivered to the right jury. But you don’t have the right jury. Because of the fee schedule, your lawyer skimped on jury selection way back at the beginning of your trial.

This is why you don’t want to pay a lawyer, or any other professional, by task. You want your lawyer to be able to reallocate her time—in this case, from the summation speech to the voir dire proceeding. If each hour of her time is compensated at the same rate, she will feel free to allocate the last hour spent on your case to its highest valued use rather than to the activity that is paid the highest fee.

Now can you see why Medicare misallocates scarce healthcare resources and delivers inconsistent levels of care? It’s shouldn’t be a mystery. What’s puzzling is that too few people understand the problems that arise when third parties set the fee schedules and a genuine price system is not allowed to operate and perform its invaluable role.

For details, please see my Independent Institute book, Priceless: Curing the Healthcare Crisis.

[Cross-posted at Psychology Today]