Maryland is the only state in the nation to enjoy a federal exemption that allows it to regulate how much hospitals can charge patients, much like the state public service commission regulates utility rates. Under the system administered by state's Health Services Cost Review Commission, hospital patients are charged the same rate no matter where they seek care, and health insurance companies all contribute equally to help cover the cost of uncompensated care for people who lack the means to pay. The result has been that hospital costs as well as overall spending on health care have risen more slowly in Maryland than anywhere else in the country.

You might think that a system that has served the state well for 35 years is something the federal government would want to see continue. Instead, Maryland now faces the loss of its federal waiver because, in effect, it's done too good a job in controlling hospital costs. It's a Catch-22 situation that makes the state look bad for doing the right thing, and it makes no sense.

The system has worked all these years because in exchange for keeping the rate of hospital cost increases lower than in other states, the federal government grants Maryland larger Medicare (and to a lesser extent Medicaid) payments to offset the costs of uncompensated care. Maryland receives those larger payments as long as it can show that that the average cost of a hospital stay is less than the average in other states.

But here's the catch: One way the state has managed to restrain rising hospital costs has been to encourage physicians and health providers to focus on preventive care and outpatient treatment that allows patients to avoid extended hospital stays, which are now needed only for the most serious cases. So do the math: Fewer people are staying in hospitals, but they're much sicker so they remain there longer. As a result, the average cost of a hospital stay — the figure the government uses to calculate Maryland's eligibility for a waiver — has increased.

It's a paradox that while overall Medicare and Medicaid spending have remained flat or even declined slightly, average hospital costs have begun to approach the level of other states. John Colmers, the head of the cost review commission, says that if the goal is to have fewer hospital admissions while delivering better care and containing costs overall, the government's existing formula is counterproductive and needs to be revised.

What the state should be looking at is a change in the eligibility formula that gives doctors, hospitals and health insurers more incentives to slow the rise of heath care costs overall instead of focusing narrowly on hospital costs. But to do that the cost review commission will need some new tools in its arsenal, including new ways of bundling payments to physicians with the payments made to hospitals, and so-called accountable care organizations that encourage physicians and hospitals to assume greater responsibility for entire populations rather than just individual patients. Such organizations would need to develop population-based payment mechanisms that can work not only in rural areas, where they are already operating, but in urban and suburban areas as well.

Figuring out how to do all that will be a challenge, but the alternative of the state losing its power to set hospital rate increases and larger Medicare and Medicaid payments would mean higher hospital and health care costs for everyone. That's what Maryland's unique system has managed to avoid for the last 35 years and the benefits have gone to all the state's residents regardless of ability to pay. It allows hospitals to focus on quality of care and expense management instead of revenue, and it has restrained the overall rise in health costs more effectively than any other state in the country by sharing the burden of uncompensated care equally among everyone who pays into the system. That's the argument Maryland needs to be making to convince the feds not to penalize the state for its success.