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In 1985 Congress commissioned a review of the DRG system. But rather than stick to a retrospective, the authors of the report expanded its scope, using it as an opportunity to push for expanded physician price controls. The theory was that DRGs, focusing only on hospital payments, hadn’t gone far enough. According to Smith’s Medicare history, the authors of the review believed “the most viable approach…was to aim at increasingly global control of physician payments.” A program passed on a promise to avoid control of the medical system was now looking to control its entire payment structure.
Who was behind this push for global control? Joseph Antos, an American Enterprise Institute health policy scholar who served as a senior economist in the Reagan administration —a role he describes as the “designated health and everything else person”—attended many senior staff meetings during which the new system was drawn up. “This was a group that consisted of high-level people, often political appointees from all sorts of different agencies,” Antos tells me. “I don’t think many of them were health policy experts. I know none of them were economists.”
The system they were planning would become known as the resource-based relative value scale, or RBRVS. It attempted to divide physician’s services into roughly equal work units and make payments accordingly. The assorted high-level officials had a naive confidence in their ability to accurately align the amount of work that went into a procedure with the amount of payment a physician received. “They knew that there was a problem paying physicians,” Antos says. “They thought they knew what the problem was. This was going to be a new system that was going to rationalize the old system.”
Antos, the only economist in the group, wasn’t so sure. And so he began to ask questions: “How does the government know what the relative values should be? How is this related to any market-clearing process that anybody’s ever known?” One idea was to set prices by committee. Antos pointed out that “asking committees of doctors to guess how much work is involved in something is the same thing as just setting prices.”
In an October 2010 essay for The American, Antos described the initial plan as being “based on academic theory with its roots in the Soviet Union.” Just as the Soviets made all economic decisions—how many tanks to build, how many jackets to sew, how much food to produce—through central planning, the RBRVS system is an effort to centrally plan medical prices. But as in the Soviet Union, those prices are not informed by market-based signals, which are generated by the interaction of supply, demand, and willingness to pay. In particular, the RBRVS system ignores how much value a patient receives from a service.
Thanks at least in part to Antos’s questions, 1986 came and went with no major overhaul of the physician reimbursement system. But Antos eventually left for a new post. And in 1988 researchers at Harvard University finalized a study that would bring a modified form of prospective payment to physicians. In December 1989, as part of an omnibus budget proposal, President George H.W. Bush signed the RBRVS system into law. It would take effect in January of 1992.
Antos, who eventually transitioned to a senior position at the Health Care Financing Administration (HCFA, now the Centers for Medicare & Medicaid Services within the Department of Health and Human Services), was put in charge of implementing the system—not in spite of his skepticism but because of it. “I had a long connection to it, so I understood it,” he says. “And [HCFA Administrator Gail Wilensky] didn’t mind that I was against it, because she was an economist and also agreed that it wasn’t going to work.”
The Socialist Calculation Problem
Why would an economist be so skeptical of the system? Even from a purely technocratic perspective, it is an enormous challenge. Antos warns of the “technical difficulty of creating a prospective payment system that wouldn’t totally screw everything up.”
But the problem goes deeper than that. Medicare’s twin payment schemes are inevitably beset by what George Mason University economist Arnold Kling calls “the socialist calculation problem.” The bureaucrats in charge of setting prices have to come up with a rational basis for the prices they set. They have to be justified, somehow, which is where the complex rate-setting formulas come into play. But without price signals, the result is almost always an arbitrary formula based on a limited, imperfect set of factors. When all is said and done, says Kling, “it’s just a made-up formula. It has to be.”
The other problem is that any payment system inevitably ends up being manipulated by savvy payees. “You price on the basis of one thing, but then people optimize their behavior to that thing,” says Kling. In a sense this is the primary job of health care administrators: to understand payment systems and squeeze every possible dollar out of them.
In the wake of the two payment reforms, hospitals began to manipulate the system through “upcoding”—systematically shifting patients into higher-paying DRGs. Research by economists at Dartmouth University suggests that during the early 1990s, hospital administrators figured out ways to substantially increase the number of Medicare cases they billed to higher-paying DRGs. Payment games continue today. In October the Senate Finance Committee released a report accusing several large home health care companies of abusing Medicare’s payment rules by pushing employees to perform extra therapy visits, thereby qualifying for Medicare bonus payments, even when those visits weren’t strictly necessary. But for many health care providers, that’s the business. Hospital administrators “are people whose job it is to game the system,” Kling says. “They know every little detail of the rules.”
Playing by the rules, and getting the most out of them, becomes the focus. Over time, the rules cease to guide the game and instead become the purpose of the game. Activities that are coded and paid for become the activities that providers do the most. The system encourages covered procedures, such as surgeries and child delivery, while discouraging doctors from spending time in nonpaid activities such as emailing patients or monitoring health data collected electronically at home by the patient. The provision of care bends to fit the shape, however quirky, of the payment rules.
Which may explain why controlling physician payments failed to restrain the growth of Medicare spending. As Antos expected, the system did not work. The RBRVS system took effect in 1992. By 1997 Congress had the mole mallet out once again.
The Unsustainable Growth Rate