How Ronald Reagan Brought Price Controls To Medicare

David Henderson has the scoop:

Just before I became the health economist with Reagan’s Council of Economic Advisers, the final steps were being taken to implement DRGs for paying hospitals under Medicare. DRG stands for Diagnosis Related Groups. The idea was to get out of cost-based reimbursement, which gave an incentive to have high costs, and replace it with a system of prices. That made sense. But what made it a system of price controls was that the government, along with DRGs, made it illegal for hospitals to charge even a penny more than the price the government came up with.

Then, a year or two after I left the Council, the Reagan administration took the next step of imposing price controls on doctors under Medicare. Doctors were no longer allowed to do what was variously called “extra bill” or “balance bill.” They couldn’t charge even a penny more than Medicare paid. That’s what made it a system of price controls. Moreover, under later regulations, if a doctor takes even one Medicare patient, then he has to charge Medicare rates to all his Medicare patients even if those patients would rather ensure access by paying the whole bill (Medicare plus a doctor’s additional charge) out of their own pocket. It is this system of price controls that is causing many doctors to take no Medicare patients.

Now Henderson is a libertarian and he thinks this is a bad thing. I disagree with him. But I think it’s an important point here because it illustrates a lot about the real structure of the health care debate in the United States of America. The whole reason this system of price controls works is that Medicare represents a really big client base. Henderson writes that “many” doctors are opting out of Medicare altogether, but the reality is that extremely few doctors are actually in a position to turn this giant pool of customers away. Outside of very large cities with high concentrations of high income people, it just doesn’t work. What’s more, we could easily expand and extend this model. Most generally, one key point here is that though a system of Universal Medicare would require higher taxes it would lead to lower levels of health care spending so if you financed it with a flat or even regressive tax we’d be better off.

And there are more modest ways to expand the model. You could say that doctors who want to be eligible to get paid by the government to treat Medicare patients need to offer all patients the Medicare price. That would lead to a further increase in the number of doctors who refuse to treat Medicare patients. But you could follow up by saying that all doctors who want to be eligible for payment by any insurance plan taking advantage of federal tax subsidies need to offer all patients the Medicare price. Some doctors would retire early in response, but the vast majority would have nowhere to run. Then you might worry about a decreased pipeline of future doctors but this would be the time to make medical school free.