Modern medicine is remarkable.
But for Americans, the wonders of modern medicine come at a steep cost: Total U.S. health spending exceeded US$4.1 trillion in 2020, or $12,000 per person. How those trillions of dollars are spent can seem like a mystery.
The biggest portion of that – hospital care, which makes up 31% of total spending – is now subject to transparency rules that are supposed to make it easier for patients to understand what their treatments cost. But so far hospitals’ compliance has been minimal.
Things are both more transparent and murkier when it comes to the second-biggest chunk of America’s annual medical bill: payments to physicians and for clinical services, which account for 20% of total health care spending, or $810 billion. How much a patient is charged for a hip replacement or a flu shot is the result of a highly technical process involving secretive committee meetings, doctor surveys and federal regulations.
A few decades ago, the federal government developed a seemingly scientific approach to solve these questions. As an expert on health care policy, I’ve learned that the formula is simple. But coming up with numbers for that formula is far more complex.
For the longest time, the federal government tried its best to stay out of the examination room. By and large, medical care was a private endeavor, and physicians and other providers charged what they wanted – or what they thought patients could pay.
Then, in 1965, Congress established Medicare and Medicaid, which are federal programs that provide health insurance for the elderly and poor, respectively. Practically overnight, they turned the government into the largest spender on health care. That meant the Johnson administration had to figure out how to compensate physicians who had long been opposed to government involvement in health care and derided it as “socialized medicine.”
To minimize opposition, an agreement was forged that seemed innocuous enough: Physicians would be allowed to charge Medicare “customary, prevailing and reasonable fees,” and the federal government would not question them.
Yet the inflationary nature of this approach became quickly apparent as many physicians happily took the federal government up on this offer. Doctors often charged Medicare two to four times more than what they charged commercial insurers. The need for changes seemed inevitable.
A new payment system
It took another two decades to create a more evidence-based approach that relied less on a doctor’s discretion and aimed to rein in spending.
After a comprehensive study conducted by Harvard researchers and the American Medical Association, the federal government developed a framework that paid providers based on the resources and skills required for various treatments. The formula, which its creators dubbed the resource-based relative value scale, includes three steps to calculate how much money a physician could charge for a procedure.
First, you have the “relative value…