Reforming Medicare by Reforming Incentives

Since Medicare is a major reason for the large and rapidly growing national debt, growth in Medicare spending must be brought into line with growth in the gross domestic product (GDP). The most effective strategy for reducing health care expenditures is fundamental reform of the incentives provided to both patients and health care professionals. Medicare's open-ended fee-for-service payment system is a major contributor to the high level and rapid growth of spending. In 2009, the Massachusetts Special Commission on the Health Care Payment System said that fee for service “rewards overuse of services, does not encourage consideration of resource use, and thus cannot build in limitations on cost growth.” The commission concluded that “risk-adjusted prospective global payment models that provide appropriate incentives for efficiency . . . should serve as the direction for payment reform.”

Although the commission did not explain how to get there from here, I believe that the way forward lies in changing consumers' cost-unconscious demand for open-ended fee-for-service models of care. In 1978, I proposed that government bring about a fundamental change in incentives by offering everyone a range of choices of standard health plans with distinct provider networks and by replacing the tax exclusion of employer health insurance contributions with universal fixed-dollar “premium support payments” toward the (risk-adjusted) premium for the health plan of the consumer's choice. Government would pay the price of the least costly plan serving each geographic area, making everyone cost-conscious in their choices. In 1993, I explained in greater detail how the market should be organized to reward economical choices and protect consumers (see box on the principles of managed competition). In my formulation, managed competition is not “vouchers” that turn defenseless people loose in a “free market.”

Under my proposal, health plans would compete on value for money, and over the long term efficient plans would force inefficient ones to improve or risk losing patients. Government would support low-priced plans — not the most costly fee-for-service model, as it does today both in the tax treatment of employer-paid benefits and in Medicare.

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