In an attempt to help stop spiraling inflation during 1970’s, Congress thought it would try placing price controls on the fees doctors could charge under Medicare. While the increase in doctors’ fees was in fact held to about three percent a year after price controls were imposed, the cost balloon swelled out elsewhere: Doctors’ claims for services rendered under the program jumped dramatically, and the overall cost of Medicare continued to go up about 10 percent a year. Price controls failed completely to keep Medicare costs down.
Why did this happen? In a free market, the minute controls are imposed to keep prices below market-clearing levels, demand for the good or service in question rises, supply begins to dry up and quality of the goods that are sold declines. Shoddiness develops and shortages emerge. Just the opposite appeared to happen with Medicare. Why?
The reason is, Medicare is not a free market; it is a gigantic welfare program in which the taxes people pay as workers to support the program are completely disconnected from the benefits they receive as Medicare recipients. The Congress would have us believe there is a lot of “competition” in Medicare. It’s true that under Medicare Parts A (inpatient and skilled-nursing services) and B (physician services), patients may choose their own doctors and hospitals, and under the Part-D Prescription Drug program they may choose from among a wide range of private-sector drug “insurance” plans. But despite this competition on the supply side, these are one-sided markets because while producers compete, someone else is paying the bills for consumers. With no skin in the game, consumers have no effective brake on their demand, and health-care providers under Medicare have every incentive to provide more services.
To be effective, markets require not only competition among producers seeking to maximize profits but also consumers with skin in the game and incentives to optimize product quantity and quality while minimizing their expenditures. Competition among producers without consumers with skin in the game is the economic equivalent of one hand clapping. It takes two to Tango, a pair of hands to clap and producers and consumers alike with skin in the game to make markets work.
In a welfare program like Medicare where government pays the bills for consumers, a surfeit of demand is soon matched by a shortage of supply even though that might not appear to be so initially. When physician fees are capped, the number and complexity (or volume and intensity) of services furnished to Medicare beneficiaries simply increase, including more frequent and intensive office visits, and a rapid increase in the use of imaging techniques, laboratory services, and physician-administered drugs, which will lead to price caps on pills and procedures in fairly short order. (According to a study by the World Bank, for every dollar that price controls reduce doctors’ fees under Medicare, physicians recoup 40 cents by increasing volume.)
Yet despite this confirmation of the laws of economics, Congress persists in its hubris to eclipse the economic laws of nature and continues to impose price controls on doctors’ fees and now with a too-cute-by half measure reinforces the caps on prices with additional regulatory limitations intended to staunch increases in physician service utilization—all of which goes under the Orwellian euphemism of the “sustainable growth rate system.” Under the SGR system, the price-controlled fee the government allows physicians to charge under Medicare is allowed to creep upward each year subject to the sustainable growth rate (SGR) formula, which ties annual fee increases to GDP growth and contains an expenditure target that mandates a reduction in physician payments in the following year if the volume of physician service utilization in the current year exceeds certain volume parameters.
Dr. Hunter is former staff director of the Joint Economic Committee and currently consults for the pharmaceutical industry and serves as Senior Fellow at the Institute for Policy Innovation.