The price of price controls.

ALTHOUGH the Clinton health plan seems dead, Democrats in Congress have retained one of its most important and troubling elements: price controls. The House majority plan, for example, would impose limits on and hospital fees after five years if spending targets were not met. Supporters of price controls should know that this approach has already been tried. Not only did it fail to rein in costs, it actually helped accelerate the growth in health-care spending.

The beginning of wisdom in this area is to recognize that physicians contribute to health-care costs not only by charging fees but also by prescribing medication and ordering tests, consultations, hospitalization, surgery, and various other procedures. The bill for these activities is a more important factor in rising health-care spending than payments to the doctors themselves; indeed, from 1960 until 1991, the cost of physician services remained between 16 and 20 per cent of total health spending. Thus it should be obvious that any plan to control overall spending by restraining physician fees would be doomed to failure.

Nevertheless, in 1983 the government froze Medicare reimbursements to physicians, an experiment that Congress extended until 1986. During the same period, other measures designed to control costs were instituted, including payment to hospitals based on "diagnosis-related groups" (DRG), utilization review, and preauthorization by private insurance companies. After an initial decline between 1983 and 1984, the rate of increase in overall spending began climbing again. The explanation is that physicians across the nation responded to fee limits by increasing the volume and intensity of services delivered.

In 1990 the government again attempted to control prices for Medicare patients, introducing the Resource Based Relative Value Scale (RBRVS), a complex system designed to assign monetary values to physicians' work. Many physicians signed on to this scheme in the hope that it would redress longstanding inequities in rates of reimbursement for cognitive work (e.g., diagnosis) and procedural work (e.g., surgery). In its final form, the RBRVS cut reimbursements for most physicians drastically. The system's chief architect acknowledged that if these rates were adopted by other major third-party payers, the stream of talented people interested in the study and practice of medicine would begin to dry up. Furthermore, recent data show that this round of price controls was followed by another increase in the rate of medical cost inflation (see graph).

This macroeconomic picture, in which price controls lead to faster growth in spending, is the direct result of government meddling in the microeconomics of physicians' practices. Consider an internist in private practice who charges $100 for an office visit. If, because of freezes, other price controls, and inflation, this payment dwindles to $50, several things might happen. First, the internist could do nothing and accept a reduction in gross income of up to 50 per cent (depending on the extent to which office visits make up his practice). Few practices could survive such a cut.

Second, the physician could seek to raise the fees charged to patients not affected by the price control. Such cost shifting continues to soften the blow of government-imposed restrictions on reimbursements, at the expense of rising private-insurance premiums. Third, the physician could try to do more intensive procedures, which are reimbursed at a higher level. This tendency explains the rush to procedure-oriented subspecialties and away from primary care that we have witnessed in the past ten years.

Fourth, the physician could simply try to schedule more office visits, i.e., increase volume. This is the only option available to many physicians whose practice consists largely of elderly patients on Medicare. (Excess volume of services is driven mainly by price restrictions, not by the fear of malpractice litigation, as is commonly believed. A study of "defensive medicine" done under the auspices of the American Medical Association supports this point.) Increasing the volume of services increases total spending.

Cost-driven volume increases have other negative results. Our internist, forced to increase the number of patients he sees per day, will find that the time he can spend with each patient is very limited. This has to reduce the quality of care and harm the doctor-patient relationship. It also adds to costs by promoting increased reliance on expensive laboratory tests and consultants, since the internist can no longer devote the time required to manage complicated cases.

The loss of control, a direct result of medical price constraints, is one of the major sources of dissatisfaction among practicing physicians. Add to this scenario the plethora of administrative hassles, difficulties getting reimbursed by third-party payers, and escalating costs for insurance, materials, and personnel, and it is easy to see why many physicians are retiring early or taking salaried positions. Why put up with the responsibilities of private practice when quality of life, professional satisfaction, and income are declining? Over the long term, the medical profession will attract a less talented pool of applicants.

If price controls on physicians have seriously distorted medical practice, lowered the quality of care, and at the same time contributed to an upward spiral of overall costs, why persist with such a catastrophic policy? One obvious answer is that it is politically expedient to target physician income rather than address the perverse incentives built into the third-party reimbursement system.

Kathryn Langwell, formerly with the Congressional Budget Office, writes in the Spring 1993 issue of Health Care Financing Review: "Controlling the prices of services would be a straightforward means to reduce spending. Prices are easier to measure and to monitor, whereas decisions that affect quantity and quality of care require more complex processes and subjective judgments about the value of specific services to individuals and to society. Thus, policies that would affect the price of services are perceived by many as the most manageable approach to achieving control over health spending in the short term." (Italics added.)

It's understandable that policy makers and regulators charged with controlling health-care spending would be attracted to seemingly simple solutions. But we need to think about the long-term impact of price controls on patients and doctors, whether or not that's convenient for the government's central planners.