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The congressional formula that determines the annual Medicare payment update for physicians, the sustainable growth rate (SGR), was supposed to cut Medicare doctors’ pay each year starting in 2002. But that congressional formula is so flawed and unworkable that every year since 2003, Congress has stepped in to stop it from going into effect. In 2013, without another congressional “doc fix,” the physicians would have had a pay cut of 26.5 percent.

The formula is called the sustainable growth rate because it links Medicare physician pay increases to the performance of the general economy, not to the market-based conditions of supply and demand that would determine the price of medical services. So if Medicare physcians’ pay in any given year rises faster than economic growth, then their pay is automatically reduced the following year.

There’s an added dimension to this problem: Every year the pay cut is delayed, the size of the cut the following year is bigger.

So, instead of abolishing the formula, Congress sets off an annual panic among Medicare physicians. It’s a classic example of the fundamental foolishness of imposing administrative prices, plus price controls, that are divorced from economic reality. The annual congressional panic is proof that this approach doesn’t work.

The good news is that the House Energy and Commerce Subcommittee on Health is holding a hearing on February 14 to discuss repealing and replacing the SGR. But any repeal of the SGR should be replaced by a rational payment system. The best payment system would reflect the competitive structural reform that Medicare desperately needs— defined contribution (or “premium support”).

Under premium support, the government would give competing health plans a market-based payment to provide medical services, whether the plan is a private plan, an employer plan, or traditional Medicare. Just as health insurance plans do today in the Federal Employee Health Benefits Program (FEHBP) that serves federal workers and retirees, plans would negotiate competitive rates with physicians, and the market would determine physician payment. Negotiated prices in a competitive market are the best way to secure quality care at a reasonable cost.

Major structural changes to Medicare, however, will take time. Meanwhile, Congress should fix a badly broken Medicare physician payment system. The best course is to freeze Medicare payment rates for five years and then end the SGR entirely with a transition to a Medicare premium support program. As outlined in Heritage’s The First Stage of Medicare: Fixing the Current Program, Congress should enact related Medicare physician payment policies:

  • Allow price flexibility among specialties. During the payment freeze, “if certain medical specialties or services merit an increase or a decrease in any given year, the Medicare Payment Advisory Commission could recommend changes to Congress based on a market survey of physician services, and Congress could enact them on an expedited basis.”
  • Remove the cap on how much a doctor can charge. “Doctors should be allowed to charge more than the capped amount of physician reimbursement, as they were before Congress changed the law in 1989.”
  • Enforce price transparency. “[I]f physicians decide to charge more than the government reimbursement, they should be required to disclose their prices and fees for medical services beforehand.” This facilitates price competition among doctors and specialists—keeping costs down for beneficiaries.
  • Allow private contracting. Under a law enacted in 1997, a doctor can contract privately with a Medicare patient only if the doctor agrees to refrain from treating and submitting claims for all other Medicare patients for a period of two years. This is absurd. Medicare patients should be free to spend their own money, without submitting a claim to Medicare for reasons of privacy or any other reason that seems good to them—if they wish to do so. This statutory restriction does not exist in any other government program.

In the meantime, Congress should put an end to this annual nonsense. Then, get on to the big job of restructuring Medicare into a competitive program that will meet the medical demands of the 77 million baby boomers now starting to enter retirement.