Understanding Medicare’s Impact on Innovation

A Framework for Policy Reform

The United States leads the world in per capita healthcare spending, but other countries achieve comparable outcomes at significantly lower cost. Medicare, a defined-benefit universal insurance program for the elderly and the largest buyer of healthcare, discourages cost cutting and encourages wasteful innovation. For one, Medicare pays physicians and hospitals separately, preventing integration and delivery innovation because most providers cannot afford to adopt a noncompliant organizational structure. Second, Medicare covers all “medically necessary” care, a vague term that promotes development of expensive technologies, often of dubious value. Third, Medicare contributes to artificially high prices. Medicare physician payment rates are adjusted by a physician committee that has no incentive to introduce payment reductions. Medicare payment rates influence prices throughout the entire healthcare system because contracts between private insurers and physicians use Medicare payment rates as a benchmark. Since its introduction in 1965, Medicare has caused a dramatic expansion in hospital infrastructure, increased medical device patenting, and led to the diffusion of imaging technologies. However, it has also prevented entrepreneurial experimentation and development of cost-cutting, disruptive innovations. While politically challenging, moving Medicare from a defined-benefit to a defined-contribution program could go a long way to address waste in the US healthcare system.