There are basically five possibilities. To compare them, let:
S = each unit of service, or a package of services
P = the price of each unit of service, or the price of a package of services
Then the government can:
1. Dictate every service it will pay for and the price it will pay for each of them (fix S and P), leaving providers to compete only on amenities, including waiting times.
2. Dictate S, but leave providers free to compete on P, say, through a system of competitive bidding.
3. Dictate P, but leave providers free to compete on what S they will provide for that price.
4. Initially fix S and P, but leave providers free to opt out, substituting different bundles of S & P as long as government’s cost goes down and quality of care goes up.
5. Initially fix S and P, but allow patients to opt out, managing a portion of the funds directly and making their own purchasing decisions.
Alert readers will recognize (4) and (5) as NCPA solutions, (3) as the Rivlin-Ryan plan, and (1) as the status quo. But I’m getting ahead of the story.
Under the current system (Method 1), Medicare establishes a list of about 7,500 physician tasks it will pay, and sets the price for each of them. These prices differ, however, for every city, town, and hamlet in the land. So that in fact there are millions of prices that Medicare is administering every day.
One important drawback of this system is that it’s in no one’s interest to curtail spending. Every provider maximizes profit and every patient maximizes utility by exploiting the reimbursement formulas.