This article originally appeared on Forbes.
The U.S. health care system is rife with problems. One fundamental problem affecting the entire health care system is the meaningless pricing systems that are the inevitable result of our third-party payer system.
In a well-functioning market, prices are set to cover all costs plus a competitive return on capital and reflect basic economic concepts of value and scarcity. Such economic logic does not apply to prices in the health care industry – especially for hospital charges, where many hospital executives dismiss charges as meaningless, as was most recently noted by The Wall Street Journal online.wsj.com/news/articles/SB10001424052702303650204579375242842086688.
The debate over new trauma centers in Florida highlights the problems created by hospitals’ economically irrational pricing systems.
The leaders of the Regional Medical Center at Bayonet Point believed that the residents of Pasco and surrounding counties were ill-served by the available trauma centers that take an hour or more to reach by ambulance – without taking into account weather related hindrances. Consequently, these innovators received the requisite approvals, opened the new trauma center, and are now serving the needs of residents in Pasco and surrounding counties in need of trauma services.
Anyone that has ever taken an economics 101 class should recognize the beneficial market process that is occurring here. An entrepreneur, seeing an under-served need and the ability to fill that need, established a market presence to better serve their potential customers. And, in most instances, many of the critics of the Pasco Regional Medical Center would be praising their actions for ensuring that the medical marketplace remains competitive. The benefits from greater competition being improved efficiencies, greater product innovations, and more affordable pricing.
But, this is the healthcare market. Instead of competition being universally embraced, apologists for the existing trauma centers now facing a new competitor argue that there is now a “glut” of trauma centers. This glut of trauma centers creates a shortage of qualified physicians for each center and inefficiently divides the fixed sum of money that will be spent on trauma. The consequences, according to the central planners, will be the inability of all of the trauma centers to cover their fixed costs, driving up the cost of healthcare and leading to a long-run decrease in regional trauma services.
The arguments against the new trauma centers boil down to a static vision of the market where central decision-makers claim to have superior information regarding the needs and wants of consumers (in this case patients). Of course, the root cause of the actual problem lies in the ineffective and incomparable pricing mechanisms indicative of the current health care system.
The current hospital market establishes charges for its services through a complex and convoluted process that often creates a unique dichotomy between the cost of providing care and the prices actually received by the hospital to recover those costs. Additionally, because patients’ decisions regarding the pricing of services are secondary to the negotiated agreements between hospitals and third party payers (including Medicare, Medicaid and private insurance companies) patients have little ability to express how much they value certain services or conveniences. Instead hospitals receive revenues based on the negotiated prices between the hospitals and the payers. These prices will most likely vary significantly from the charges (or list prices) of the services and from hospital to hospital, and may or may not reflect the costs of the actual services received.
There is then distortions regarding the actual costs of alternative hospitals services due to subsidies.
Hospitals, must bear the burden of providing services to patients who fall below the Federal Poverty Level. These costs have been estimated at $30 billion a year. The government provides subsidies to hospitals to cover these costs, which incidentally do not reflect the true costs of serving these populations.
Non-profit hospitals receive an additional subsidy in the form of legal tax avoidance including sales taxes, property taxes and income taxes. These subsidies are estimated to be quite substantial too – about $20 billion. However, an analysis conducted by Modern Healthcare “found no correlation between [profit] margins and spending on free care”, raising questions regarding the efficacy of the tax-break subsidy provided to not-for-profit hospitals.
These examples illustrate that the hospital pricing system is in dire need of repair. More transparency and aligning hospital charges with actual patient responsibility will be a step in the right direction. Ideally, national policies will begin to address this problem and empower individual patients and medical providers to reignite the innovation and efficiency potential of the U.S. health care system.
Wayne Winegarden is a Contributing Editor with EconoSTATS at George Mason University and a Sr. Fellow in Business and Economics at the Pacific Research Institute.