Implications of Physician Ethics, Billing Norms, and Service Cost Structures for Medicare's Fee Schedule

Medicare Part B pays physicians through a fixed fee schedule designed loosely as a system of average-cost reimbursement. This paper examines four difficulties faced by systems of this kind. First, Medicare's payment model would be improved if it accounted for the medical value and cost-effectiveness of treatments in addition to their input costs. Second, uniformly applied fee schedules are inefficient when physicians vary in their approaches to medical practice. Allowing Medicare to account for regional differences in practice styles, which are substantial, may have significant benefits. Third, differences in physicians' billing practices have similar, largely unstudied, implications. Proficient billers receive relatively high payments for incremental service provision, resulting in unintended variation in effective wages. Fourth, differences in services' cost structures point to an additional weakness in Medicare Part B's payment model. Average-cost reimbursement implies larger profit margins for capital-intensive services than for labor-intensive services. As implemented, Medicare's fee schedule has encouraged significant expansions in the adoption, utilization, and development of capital-intensive tests and treatments.