The sordid history of Medicare

Yesterday I linked to Don Boudreaux's excellent letter responding to a recent NPR story on Medicare. I fear I may have given the NPR report short shrift, however, as the information contained is really deserving of an entire blog post. A close reading provides an excellent summary of the dangers of good intentions, the virtues of libertarianism and why government should stay as far away as possible from health care.

David Kestenbaum and Chana Joffe-Walt from our Planet Money team report that doctor pay has confounded policy wonks, economists and presidents for decades.

CHANA JOFFE-WALT: In 1965, Joe Califano had to answer a question. He didn't know it was such a big question, or a question that would change the course of health care in American for the next five decades. It just seemed simple: How should the government pay doctors?

DAVID KESTENBAUM: Califano was President Lyndon Johnson's adviser for domestic affairs. And the government was about to get into the health insurance business in a huge way - about to launch the largest health insurance plan we've ever had: Medicare. But the idea made doctors nervous, so LBJ, Califano and lawmakers made what seemed like a small concession. The government told doctors: We will pay you for every procedure you do. How much will we pay you? Whatever you think is right.

I wonder how many people struggle with how to compensate those who render them services. Personally, I have never found it that difficult. If a plumber or auto mechanic consistently finds that the only solution involves a whole slew of expensive parts replacements and labor, there are a number of steps one can take: Go elsewhere for another estimate. Ask friends for names of reputable service providers they use. Scour the internet to see if the information you find dovetails with what the plumber or mechanic are telling you. And if, after paying the person and discovering the problem still persists, it might be worth shunning them entirely and opting for a competitor.

The government and Medicare, however, have little access to that information. How do they know if the doctor was earnestly looking out for the best interests of the patient or just looking to run up the bill by piling on unnecessary procedures? They can't.

This dearth of knowledge results in bad decisions and outcomes, such as simply paying doctors whatever they demanded. Predictably, the move led to abuse and wildly inflated costs.

JOFFE-WALT: Califano shakes his head describing that call now. But he says, look, the government needed doctors to participate. If doctors didn't accept Medicare, wouldn't see patients covered by Medicare, the whole thing would fail.

Mr. JOSEPH CALIFANO (Former Adviser, Domestic Affairs): We were on edge. We were on edge.

KESTENBAUM: About?

Mr. CALIFANO: About whether doctors would agree to take Medicare patients.

KESTENBAUM: Why were you worried they wouldn't participate? You were going to pay them whatever they wanted.

Mr. CALIFANO: They were so opposed to it. I mean, they reluctantly - believe me, within two years, they love it. But they really didn't understand what a bonanza this was going to be for them.

A graduate of Harvard Law School and currently in the employ of Columbia University, it's not at all obvious that Califano lacks for intelligence. Nevertheless, he opted for a system in which the main goal was not the careful stewardship of taxpayer dollars, but the participation of doctors. That was the metric he was being measured by, the result being that doctors received a "bonanza" while taxpayers were left feeling a bit lighter in the wallet. Such are the incentives that bureaucrats operate under.

KESTENBAUM: Turns out, doctors had been giving out a lot of free care to old people and now they were going to get paid for that, and within limits, whatever they asked for.

Dr. Lucian Leape was a practicing surgeon at the time.

Dr. LUCIAN LEAPE (Surgeon): We found out what the general fee for our service was and charged that or maybe added 10 percent, 'cause of course I'm better than average. And so it was an incentive for doctors to charge what they thought was reasonable for them, and then of course to increase it every year by, say, 5 or 10 percent.

This is simply amazing. While left-wingers commonly would have you believe that government is the only barrier which prevents society from degenerating into a vicious miasma of greed and selfishness, where the poor and the elderly suffer untimely deaths marking the ends of a miserable existence, we find out that prior to the establishment of Medicare society was actually quite compassionate. Doctors rendered free services to those who needed it (there was probably some subsidization as doctors likely charged those who could pay more to make up for their lost income) out of their own free will.

In the name of creating a world where old age didn't automatically mean suffering and hardship, however, liberals managed to throw sand in the gears of this system, if not wreck it completely. Charity previously borne of genuine compassion and free will was now forced upon workers through the confiscation of their earnings in the form of payroll taxes. Doctors, meanwhile, were transformed from societal givers into takers as they took advantage of the system to charge higher rates, the bill for which was presented to the rest of the country.

By varying degrees both doctors and patients were turned into wards of the state.

KESTENBAUM: Medicare solution for how to pay doctors put into cement this idea of fee for service, paying doctors per procedure for every test, every scan. That sounds reasonable, but it served as a nudge to err on the safe side - to do more tests, to do that exploratory surgery.

JOFFE-WALT: LBJ and Califano, all their people, all realized they created something of a monster right away. I mean, two years after Medicare passed, LBJ is pleading with Congress to let him change the way Medicare pays physicians. Califano remembers it well.

Mr. CALIFANO: By late '67, the budget data was just stunning. I mean 1968, we knew that system should be changed. We asked Congress for authority to change it.

JOFFE-WALT: But you just created it.

Mr. CALIFANO: I know it. But we saw what was happening with costs so fast. So fast.

KESTENBAUM: But they couldn't change it. Doctors now like the system. They were getting paid for work they'd previously done for free. And that was that. This system, with all its problems, stayed in place for almost 30 years. Meanwhile, medicine got more expensive.

Medicare, in other words, helped to stoke some of the very health care inflation that we are now promised more government intervention will solve. Medicare's establishment, along with other government moves such as the subsidization of health insurance through the tax code, have helped produce this graph:

(click to enlarge)

Moving along:

JOFFE-WALT: Figuring out prices for health services is really hard. We have an idea of what we should pay for toothpaste. Back surgery, no idea.

KESTENBAUM: And yet, in 1986, one man was convinced he could calculate the prices. An economist at Harvard by the name of William Hsiao; an economist with a small voice and a big, kind of weird idea.

Professor WILLIAM HSIAO (Harvard University): So the question is: Can we find a rational method that could be used to set physicians' fees?

JOFFE-WALT: Professor Hsiao decided, okay, the market does not work for health care services. So I will calculate the right prices for each and everything a doctor does.

KESTENBAUM: Hsiao brought in groups of doctors and asked them some pretty crazy sounding, almost philosophical questions like: How much mental work does a regular checkup require? He had them compare everything they did to one reference point. For surgeons, it might be a hernia repair: How technically hard is it, how stressful, how many supplies? Hsiao had doctors do this for thousands of procedures.

JOFFE-WALT: Congress loved this idea: An economist, a rational way of answering this annoying question. And Congress said if you can really do this, we will adopt your method. We will make it law.

KESTENBAUM: Now, if someone was talking about changing how you got paid, you'd pay attention - and doctors did.

JOFFE-WALT: While Hsiao was creating his Relative Value Scale, he'd invite groups of doctors in to advise him. And the doctors would bring their own advisors, consultants - lobbyists, really. Hsiao wouldn't let them in the room, so they'd sit outside. And then those consultants started coming out with their own relative value studies that were more favorable to whatever group of doctors they represented.

Prof. HSIAO: So then they were trying to trump us. And so it took tremendous amount of work, took years out of my life and my hair turned gray.

JOFFE-WALT: During that time?

Prof. HSIAO: Mm-hmm.

JOFFE-WALT: In 1992, Congress adopted Hsiao's Relative Value Scale, that enormous spreadsheet. And it worked for a while until just a few years later, it didn't anymore.

KESTENBAUM: There are different explanations for what happened. Hsiao blames lobbyists. Lobbyists and doctors say, sorry, health care just is expensive, and most of the time, Medicare actually underpays us.

Unbelievable. In the midst of the Cold War the U.S. government found itself taking a page out of the Soviet Union's playbook by trying to rely on experts instead of markets to calculate prices. It was essentially an act of economic sorcery in which a variety of ingredients were thrown into a cauldron, stirred, some incantations about value and costs recited (okay, maybe not), and a model known as the Relative Value Scale conjured forth. No such methodology could provide a workable tool to govern compensation for something as complicated as the entire health sector, and indeed it didn't, with Hsiao's efforts ultimately for naught.

The entire effort was proof once again that the knowledge of one Really Smart Person, even with credentials as impeccable as Harvard, is no match for the collective intelligence of the millions of people operating in the marketplace.

We already know that Medicare is a disaster. It suffers from huge amounts of fraud, efforts to curtail which have met with little success. Doctors hate it and it's a fiscal nightmare with unfunded obligations to the tune of at least $34 trillion over the next 75 years. In addition to all this we know the program has been plagued since its inception, operating under a model with encouraged costs to skyrocket -- attempts which to fix have confounded experts -- and coming at a significant detriment to civil society.

With such a track record, why would any sane person turn over additional responsibility for health care to the federal government? Real health care reform should involve scaling back such intervention, not the granting of vast new powers.

Related: Scott Grannis posts his own thoughts on the NPR piece.