Implications of Physician Ethics, Billing Norms, and Service Cost Structures for Medicare's Fee Schedule

Abstract

Medicare Part B pays physicians through a fixed fee schedule designed loosely as a system of average-cost reimbursement. This paper examines four difficulties faced by systems of this kind. First, Medicare's payment model would be improved if it accounted for the medical value and cost-effectiveness of treatments in addition to their cost. Second, uniformly applied fee schedules are inefficient when physicians vary in their approaches to medical practice. Allowing Medicare to account for regional differences in practice styles, which are substantial, may have significant benefits. Third, differences in physicians' billing practices have similar, largely unstudied, implications. Proficient billers receive relatively high payments for incremental service provision, resulting in high-powered incentives. Costs associated with variation in billing norms and in the application of physicians' ethics highlight that welfare could be improved by training physicians more uniformly in these respects. Fourth, differences in services' cost structures point to an additional weakness in Medicare Part B's payment model. Average-cost reimbursement implies larger profit margins for capital-intensive services than for labor-intensive services. As implemented, Medicare's fee schedule has encouraged significant expansions in the adoption, utilization, and development of capital-intensive tests and treatments. Note: This paper was prepared for use in the course 'Economics 140: The Economics of Health Care Producers,' at the University of California at San Diego. The course fulfills a general education requirement, which limits the explicit use of calculus.