Medicare’s Real Contribution: Hollowing Out Healthcare

By Peter Earle of the American Institute for Economic Research

As high inflation enters its third year and disinflation slowed, the impact of broad price increases are seeping into increasingly far flung areas. They are seen and felt not only in the prices of capital, producer, and consumer goods, and in the prices of securities and commodities, but also in goods and services procured through the government. 

In some, adjustments have been made. The most recent Cost-of-Living Adjustment (COLA) for Social Security benefits was a 3.2-percent increase. That adjustment affects more than 66 million Social Security beneficiaries and around 7.5 million recipients of Supplemental Security Income (SSI), whose increased payments began on December 29, 2023​. Medicare Part D, and particularly the catastrophic coverage phase, also saw a modification through 2022’s so-called Inflation Reduction Act (IRA). Those changes eliminate the 5 percent coinsurance requirement for enrollees in the catastrophic phase starting in 2024, effectively capping out-of-pocket expenses. In 2025 additional changes will kick in, including a $2,000 annual cap on out-of-pocket drug spending and the elimination of the coverage gap phase. The changes are intended to provide more consistent cost-sharing throughout the year, reducing the financial strain on beneficiaries and in particular those with significant prescription drug needs.

On the other hand, Medicare payments to physicians do not, and have not, been adjusted for inflation. Over the last decade, in fact, the American Medical Association estimates that rates have been cut by ten percent. The reimbursement rates for Medicare are set by the Centers for Medicare & Medicaid Services (CMS) and are updated annually through various fee schedules, primarily the Medicare Physician Fee Schedule (MPFS). In recent years, updates have been minimal and have not kept pace with the rising costs of providing medical care, which has in turn led to financial pressure on healthcare providers. While Medicare Part D changes reduce out-of-pocket drug costs for patients, they do not affect the reimbursement rates doctors receive for their services. Since 2001, physician payments have fallen 30 percent behind the rate of inflation. The difference highlights a broader issue in healthcare policy, where measures to ease financial burdens on patients are not always extended to healthcare providers.

There are several reasons why Medicare payments to physicians are not automatically adjusted for inflation. Budget constraints play a significant role; Medicare costs comprise a substantial portion of the federal budget, and automatic inflation adjustments could significantly increase their budgets. Congress and policymakers often prioritize controlling healthcare spending to manage the overall federal budget and reduce deficits. That physicians represent a far smaller voting bloc than the 19.4 percent (65.7 million) of Americans who are Medicare recipients is undoubtedly a major contributing factor.

The Omnibus Budget Reconciliation Act (OBRA) of 1989 required that Medicare spending not increase overall fiscal spending. That is to say, adjustments to payments, methods, or policy changes are required to be accompanied by finding savings or outright reductions within the program, ensuring its neutrality. For this reason, nominal reimbursement rates have fallen virtually every year. A history of attempts to wrangle government expenditures while contending with rapidly changing technology, demographic shifts, and in the case of healthcare rising longevity is beyond the scope of this article, but offered here. It brings to mind Ludwig von Mises’ many critiques of interventionism, but particularly those which arise of its cumulative effects: each tinkering and tweak leads to unintended consequences, which over time leads to new unintended consequences, further interventions, and on it goes.

In 2023, the CMS approved a 3.37 percent reduction in Medicare physician payments for 2024, which took effect on January 1. This was later reversed in part, as described in this blog post from March 7, 2024.

Last Sunday, Congress released the text of a minibus package, which will likely be signed into law by tomorrow. While the bill’s primary purpose is to keep the government open, it also includes healthcare extenders through the end of the calendar year, as well as several notable healthcare policies … The minibus includes a 1.68 percent reduction to the 3.37 percent cut to the Medicare Physician Fee Schedule (MPFS) conversion factor (CF) that physicians and other clinicians are currently facing. The 3.37 percent CF cut went into effect on January 1, 2024, and this provision would effectively reduce that cut to 1.69 percent for the rest of the calendar year (3.37 percent – 1.68 percent). It will be in effect as of March 9, 2024, and will not impact payments for services delivered between January 1 and March 8, 2024. In other words, the fix is NOT retroactive, but will apply prospectively.

Changes to Medicare reimbursement rates are determined through legislative processes. The reimbursement rates are influenced by various political and economic factors, and automatic adjustments for inflation have not been a priority. Historically, the Sustainable Growth Rate (SGR) formula was used to control spending by tying updates to physicians’ fees to the rate of US economic growth. This, however, has at times led to scheduled cuts in physician payments, which Congress has almost as frequently postponed through temporary “doc fix” measures. The SGR was replaced by the Medicare Access and CHIP Reauthorization Act (MACRA) in 2015, but automatic inflation adjustments were not included in the new system. 

Current policy trends favor value-based payment models over traditional fee-for-service models, with the former aiming to reward quality and efficiency over a sheer volume of services. The emphasis on value-based care has also shifted focus away from across-the-board fee adjustments. Any implementation of automatic inflation adjustments would require consensus among lawmakers, which is likely to be especially contentious today in the face of record debt and deficits, in addition to divergent spending priorities and a widening gulf on views of the proper role of government where healthcare is concerned.

While physicians and other health professionals are at times written off with the same dismissal that “the rich” are broadly, the accelerating insufficiency of Medicare to keep pace with inflation directly and critically impacts medical care in the United States. Financial pressures resulting from stagnant or falling real Medicare reimbursement rates have effects on physicians, patients, and the entire healthcare system.

Declining reimbursement rates, on top of losses in purchasing power, result in reduced access to care, as some physicians have limited the number of Medicare patients they accept or have stopped accepting new Medicare patients altogether. Regardless of the basis upon which medical practices reduce the percentage of Medicare patients among their patient base, the ultimate result is less care for those most likely to be in the Medicare system: senior citizens and individuals with disabilities. Physicians in smaller practices, or practicing in higher cost-of-living areas (big cities in particular) are likely to compensate for the growing gap between expenditures and reimbursements by capping staff compensation, reducing headcount, delaying or forgoing new equipment/technological investment, and minimizing (or eliminating) office space. In some cases, doctors have wrestled with reimbursement rates lagging behind inflationary pressures by increasing their patient volume, opting instead for shorter appointments, longer hours, increased stress, and burnout.

Medicare is an entitlement program, in many ways exemplifying government intrusion into what historically has been a more market-oriented sector. Established in 1965, Medicare is now deeply integrated into the fabric of the medical profession, the insurance industry, the broader healthcare sector, and the lives of U.S. citizens. While the rationale for gradually reducing Medicare funding may seem logical — it seems less so when considered alongside expanded military spending and gifts to foreign governments — the considerable inflation since 2021 poses new risks.

If the widening maw between the expenses of medical practice and Medicare compensation persists or worsens, more physicians are likely to transition to concierge or direct primary care models in which patients pay a retainer for more personalized care. Such a transition would reduce the number of physicians available to the general Medicare population on top of the cost-cutting measures which have already taken place, further denigrating the quality of care provided: fewer available appointments and shorter visits in particular. And if the cost crunch continues, smaller practices are likely to merge with larger healthcare systems or be acquired by hospital networks to achieve economies of scale. A falling number of independent practices reduces competition, lowering the efficiency, accessibility, and quality of healthcare. Over time, those effects will impact not just Medicare beneficiaries, but all consumers of US healthcare services, which are increasingly inundated with an aging Baby Boomer generation.

Inflation was not caused by Vladimir Putin, gas station owners, corporate profits, or ocean shipping firms. Neither was it “9 percent” when the Biden administration took office, “zero percent” in July 2022, or higher everywhere else in the world two Octobers back. The cause of inflation is found in massively expansionary monetary policy operations during the pandemic — a period of time during which incredible demands were made of healthcare professionals at all levels — and aggravated by massive fiscal spending. While in the case of Medicare reimbursement there seems for once to be a reluctance to add to Federal spending, the broader implications of lagging recompense on the healthcare system and the well-being of those who depend on Medicare should be more closely examined.

Given the US healthcare system’s substantial distance from market forces, chances are slim for reform in the near-term. It is nevertheless critical that even in their bloated, interventionist form, government-dominated systems implement incentives that correlate compensation and performance with the provision of quality, adequate healthcare. And at the very least, they should not intensify the financial duress by failing to account for spiraling prices. This can and should be done while simultaneously addressing Washington DC’s large and growing fiscal and monetary mismanagement, which began long before the first utterance of COVID-19.”