Monday, November 1, 2010

Why Price Controls Don't Work

If this doesn't put you off of government-run healthcare, nothing will.
The problem for a government price controller is that he can never know when the price structure is “right.” He can know when physicians are unhappy with their prices because they will complain, but that does not necessarily mean that those prices should be raised. He cannot know when prices are too high, because physicians benefiting from that mistaken generosity will not complain. The bias is always to raise prices, not lower them.

Medicare tries to solve that problem by limiting how much average prices may rise using the infamous sustainable growth rate (SGR) formula. That formula sets an arbitrary limit, unrelated to conditions in the market for physician services, on year-to-year increases in physician payment rates. Just as the price controller cannot know the “right” structure of relative prices, he also cannot know the “right” average price or its rate of growth. Again, the only signals come from those who want more, not less.

The inevitable result is that Congress breaks its own price control rules. In an annual rite of political contrition, Congress overrides the cuts in Medicare physician payment called for by the SGR. To maintain the fiction that someday we will take those reductions, they are pushed off to the next year—compounding both the amount to be cut and the political problem. As a result, Medicare is scheduled to reduce physician fees by 23 percent on December 1, and another 6.5 percent on January 1. Cuts of that magnitude are political suicide, and if imposed would cause millions of senior citizens to lose needed care.
Using one inadequate formula to make up for another, a built-in bias to inflating prices, no way to know when prices are "right"; what's not to love?

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