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Maryland's Medicare experiment needs to end

Maryland has long been praised for its distinctive "all-payer rate setting" hospital system in which all insurers pay the same administratively-determined price for given procedures at hospitals. Advocates promote the Maryland rate-setting system as a simple alternative to our fragmented health care system. But they conveniently overlook a hard fact — Maryland's system is expensive, and the rest of the country is helping foot the bill.

Once a prominent feature of the U.S. health care landscape, with 10 states operating similar systems in the 1970s and 1980s, all-payer rate setting systems have fallen out of favor. Maryland's system, which has been in place since 1977, represents the last all-payer regime in the U.S.

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Absent an all-payer system, hospitals collect markedly different payments from each insurer. Commercial insurers typically pay much more than Medicare and Medicaid (roughly 75 percent more on average, according to a recent study). Even within the group of commercial insurers, some can use their greater bargaining power to negotiate better rates than others.

In light of this complexity, an all-payer system seems to bring some appealing transparency and simplicity to rate setting. Rather than negotiate separate rates, each insurer pays the same price, which in the case of Maryland is determined by an independent rate-setting commission.

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But how high should the uniform payments be? Allowing commercial insurers to pay the low Medicare or Medicaid rates would be unacceptable to hospitals, which have long argued these prices are not high enough to cover costs. At the same time, requiring Medicare and Medicaid to pay the much higher commercial prices would be too costly for those programs. In the end, Maryland settled somewhere in the middle.

For that to work, though, Medicare must be willing to pay more in Maryland than it does anywhere else in the country.

States do not have the authority to simply dictate that Medicare increase its payments. Instead, the Centers for Medicare and Medicaid Services (CMS) sets Medicare hospital payment rates at a national level. But CMS has granted Maryland a "Medicare waiver," agreeing to pay the rates set by its commission. This agreement is of no small consequence.

The waiver's bottom line is that Medicare spends more in Maryland than it otherwise would. The extra cost to U.S. taxpayers is reportedly $1.5 billion per year, over $1,600 per Maryland Medicare beneficiary. It is hard to explain why the rest of the country should so generously subsidize health care in the nation's wealthiest state.

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It may be understandable that Maryland's system was initially subsidized. In the 1970s the federal government made an explicit effort to subsidize states to experiment with alternative health care payment designs, hoping they could find ways to control costs.

But that argument can't justify a permanent subsidy. Although taxpayers have been supporting Maryland's system for nearly 40 years, Maryland has not been successful in controlling hospital costs.

It's true that Maryland hospital costs per admission have grown more slowly than in the rest of the country. But that glosses over the more important point: due to increases in the number of admissions, overall hospital spending has actually grown faster than average in Maryland. In other words, more federally-funded Medicare dollars have flowed into the state over time.

To their credit, under a recently-updated agreement with CMS, in order to keep its waiver, Maryland will have to limit its total hospital cost growth for all payers to 3.6 percent per year. That may sound reasonable, but it's not clear this solves the problem.

First, the 3.6 percent limit is largely arbitrary. That figure represents the 10-year annual growth rate of the state's economy rather than a measure of health care cost growth. Additionally, nationwide per-capita spending in Medicare has slowed to a crawl in recent years — averaging as low as 1 percent per year. Even if overall spending growth picks up — as many predict it will — agreeing to pay Maryland's rates while costs grow at 3.6 percent a year maintains a very generous level of subsidization to the state.

Ultimately the new agreement centers on the wrong goal: rather than working to eliminate Medicare's subsidy, it largely preserves it. After 40 years of Maryland's failure to control its costs, reconsideration of the substantial federal subsidy to its "experiment" is long past due.

Benedic Ippolito is an economist at the American Enterprise Institute. His email is benedic.ippolito@aei.org.

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