Improving Hospital Incentives with Better Cost Data

The method currently used by the Centers for Medicare and Medicaid Services to set Medicare payment rates is fairly crude. CMS could draw on cost data that are produced by hospitals’ internal systems to increase the efficiency of the health care system. Under the current Medicare payment system, hospitals are reimbursed for inpatient stays on the basis of each patient’s assigned Medicare severity diagnosis-related group (MS-DRG). The Centers for Medicare and Medicaid Services (CMS) attempts to set reimbursement rates so that the average hospital has the same profit margin for the care they provide regardless of a patient’s MS-DRG. The finding that some services, such as orthopedic surgeries, are systematically more profitable than others, however, suggests that there is still mispricing in payment rates. 1 Such mispricing has encouraged providers to increase capacity and patient volume for the most profitable services and reduce . . .