Medicare Spending Cuts and Hospital Productivity Gains

In this column for The Wall Street Journal‘s Think Tank, published February 25, 2011, Drew Altman and guest co-author Dana Goldman examine hospital productivity gains, and what they may mean for hospitals’ ability to absorb spending reductions.

To keep nurses and doctors in health care, and prevent them from shifting to information technology or other sectors, hospitals must pay more and more. This, argued economist William Baumol, is why average costs in labor-intensive industries (such as health care or education) rise over time: They have to compete with other industries experiencing productivity growth. The result for health care? Higher costs but little productivity growth.

This matters for Medicare. When the Affordable Care Act was passed, it was financed in part by planned reductions to future increases in payments to Medicare providers, including hospitals, skilled nursing facilities, and home health agencies. By 2019, the reductions would amount to $575 billion in savings, and in 2014, Medicare spending was reduced by $54 billion, according to the Congressional Budget Office.

Now these were reductions in increases, not outright cuts, like getting a salary increase that is smaller than you need to keep up with your rising bills. Even so, Mr. Baumol’s reasoning suggests that hospitals’ costs–which include wages, medical supplies, and high-tech equipment—are rising faster than their Medicare revenues. The result? They would lose money and be forced to skimp on staffing and care. Quality of care would suffer.

In prepared testimony to Congress in 2011, the chief actuary of the Centers for Medicare and Medicaid Services noted: “Providers for whom Medicare constitutes a substantive portion of their business could find it difficult to remain profitable and, absent legislative intervention, might end their participation in the program (possibly jeopardizing access to care for beneficiaries).”

So are hospitals weighed down by stagnant productivity and rising costs? The results of a new study led by one of us–Dana Goldman–suggest otherwise. The Schaeffer Center for Health Policy and Economics looked at hospital care for heart attacks, heart failure, and pneumonia, taking into account the severity of the cases treated. They found that hospital productivity increased significantly from 2002 to 2011, growing faster than had generally been predicted.

The study doesn’t completely address concerns about the ACA’s spending reductions to Medicare. It covered the 2002-11 period and does not necessarily show whether hospitals can sustain productivity gains in the future, when the ACA spending reductions hit. Those reductions are tied to economy-wide productivity increases that generally exceed productivity gains in the hospital sector, and they are not adjusted to account for the severity of illness hospitals will be treating as the population ages and patients are likely to be sicker.

What can be said? The nation’s hospitals appear to have been more resilient and able to improve productivity than many expected. Time will tell whether this means hospitals will be able to absorb Medicare spending reductions better than expected.

Dana Goldman directs the Schaeffer Center for Health Policy and Economics at the University of Southern California.