Con: Health-care price setting needs constraints to work
When tasked with explaining the United States’ exceptionally high spending on health care, a prominent economist was famously succinct: It’s the prices, stupid! Assembly Bill 3087 takes this lesson to heart by proposing direct state regulation of health-care prices. Soberingly, all but one prior effort at this kind of price regulation collapsed. Price setting can under-deliver for many reasons, but its downfall is all but assured if California doesn’t learn from past failures.
The desire to take on health-care prices is understandable. The United States spends almost 18 percent of gross domestic product on health care — nearly twice that of many other wealthy countries. California, with nearly $300 billion per year in healthcare spending alone, is no exception. Yet Americans spend more, not because they use more, but because they pay higher prices.
AB3087 proposes to task an independent state agency with setting payment rates for all health-care providers. Such authority conveys substantial power to alter the market. However, the temptation for regulators to overreach presents a threat to rate setting’s success.
Economists typically balk at this kind of highly regulated price setting. When markets work well, prices serve as signals of evolving costs, needs and wants: information even the most competent and benevolent regulator cannot feasibly possess. Indeed, evidence from Medicare suggests that regulated prices tend to adapt very slowly to evolving conditions. This blunts the incentives of providers to improve or even maintain their quality, and generally fails to encourage high-value care.
Of course, health-care markets differ from well-functioning markets in crucial ways. A growing body of evidence highlights the important role played by the market power of insurance companies, health-care providers and Medicare in shaping private health-care prices. Furthermore, because insurance shields consumers from cost, price shopping seems unlikely to become a central driver of cost control. These distortions imply that health-care falls short of economists’ competitive-market benchmark. Payment regulation is more viable in this setting than in most others.
Fortunately, the potential effectiveness of health-care payment regulation need not be litigated based on theory alone. During the 1970s and 1980s, more than half of the states introduced some form of hospital price regulation or budget oversight. A handful of these states ran all-payer price-setting systems, not unlike the one just proposed for California.
So why did nearly all these systems unravel?
Our own research showed a common thread across failures is that policymakers reached beyond their mandate to control costs and increase transparency. States succumbed to the temptation to use their rate-setting authority as a piggy bank for generating revenue and as an opportunity to pick winners and losers among insurers and health-care providers.
The loopholes and cross-subsidy schemes of the past reflected combinations of interest-group politics and ill-designed, though well-intentioned, efforts to finance care for the poor. Our work shows that these efforts sowed the seeds of instability in past rate-setting regimes. These systems were, with one exception, abandoned.
The sole surviving rate-setting regime can be found in Maryland, and it’s instructive in its own right. While often lauded for being well run, Maryland’s system has a second, perhaps decisive, advantage: It has a longstanding federal subsidy recently valued at more than $1.5 billion per year (thanks to higher Medicare and Medicaid payments). Such a large sweetener, courtesy of federal taxpayers, is arguably the glue that has kept the Maryland system from fraying at the edges.
If Californians want to give rate regulation an opportunity to succeed, they must call on their legislators to erect guardrails on regulators’ future authority. If rate-setting authorities are insufficiently constrained, history reveals that the goals of cost control and transparency are likely to be lost.