Causality and Cost Shifting

In the health care cost shifting debate there are two hypotheses. One is that lower Medicare reimbursements motivate hospitals to seek higher payments from private payers. That’s the classic and pervasive notion of cost shifting. The other hypothesis is that hospitals with high degrees of power command high prices from private payers. This permits such well-paid hospitals to have weak cost controls, resulting in low or negative Medicare margins. That’s a somewhat counter-intuitive story that has been offered by MedPAC in reports to congress and explored in a new Health Affairs paper by three members of MedPAC’s staff, Jeffrey Stensland, Zachary Gaumer, and Mark Miller (summary on the Health Affairs blog).

Which hypothesis seems more likely to be correct? Do low Medicare prices cause high private payments, or do high private payments cause low Medicare margins (via relaxed cost controls)? There is no way to tell from descriptive analysis of observational data. The best evidence would come from a randomized trial. Go ahead and wait for it if you like, but it won’t happen. We can’t randomize hospitals to low and high payments any more than we can randomize them to low and high market clout.

The best we can do is look for natural experiments that can be exploited by well-designed observational studies. Sometimes there is exogenous (uncorrelated with private payment) variation in Medicare payment, such as that induced by the 1997 Balanced Budget Act. In a credible and well designed study, Vivian Wu exploited that phenomenon to deduce that, on average 21% of Medicare payment reductions are shifted to private payers. She also found that market concentration mattered, that in markets with the most dominant hospitals cost shifting rates were as low as 5%. (I reviewed Wu’s paper in a prior post.)

Wu’s results are consistent with other work, and I’m generally satisfied that cost shifting from public to private payers does occur, but at a level much lower than claimed by the hospital or insurance industries. However, that does not mean MedPAC’s hypothesis is incorrect. In fact Wu’s results actually strengthen it. In truth (or so I believe) payer-specific revenues, costs, and market power are, at least in part, simultaneously determined. There is no causal chain that runs only one way or another. Relatively dominant hospitals do cost shift (in the classic sense found by Wu, though at a relatively low rate) and they are also able to accommodate high cost structures and low/negative Medicare margins (as per the MedPAC interpretation). There’s really no disagreement between the two views.

Of course it would be very nice to see a convincing study that explores the issue explicitly from the MedPAC perspective. As the authors make clear themselves, the paper by Stensland, Gaumer, and Miller only illuminates the hypothesis and shows that it might plausibly be true. But it does not show evidence that is necessarily consistent with a causal connection between market power and costs. That ‘s not a critique, just a fact.

Theory-minded economists might dismiss the notion that an organization would allow revenue to drive costs. Don’t all organizations minimize costs to maximize profit, independent of revenue? Stensland, Gaumer, and Miller think that nonprofit hospitals would not.

When nonprofit hospitals have more resources, they tend to spend those resources because nonprofit hospitals do not have shareholders to distribute profits to. The nonprofit hospital’s expenditures could be on service-line expansions, such as a new cardiac surgery wing; on acquiring physician practices; on patient amenities, such as larger rooms; or on other capital expenditures that help the hospital maintain and expand its market share of private-payer patients.

On the other hand, in theory for-profit hospitals should minimize costs irrespective of revenue and should maximize revenue over each payer independently. For such hospitals, neither cost shifting theory should hold. If costs don’t vary with revenue then they can’t explain Medicare margins. And a revenue maximizing firm cannot compensate for low Medicare payment with high private payment because, as for profit entities, they’re already maximizing private payment independent of other revenue sources, including Medicare.

Well, that’s theory. The world is often messier. In her empirical study Wu did not find a statistically significant relationship between cost shifting and hospital profit status writing that, “cost shifting is not determined solely by institutional characteristics.”

Market power, costs, private, and public payment are almost surely all related and nothing definitive can be learned without exogenous variation in at least one of these factors. Though work that exploits just that exists, the cost shifting debate will no doubt continue, due in part to the allure of descriptive work based on the weak assumption that costs are exogenous (i.e. outside the control of administrators). But one thing ought to be settled. When two things are simultaneously determined it cannot be said which causes which. Do low Medicare margins cause higher private payments or vice versa? The answer is yes (but to a small degree). And the key mediating factor is market power.

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