Hospital Payment and Quality: Evidence From a Natural Experiment

High hospital prices are a main driver of high health care spending. Several proposals to adjust Medicare’s hospital fees or regulate commercial hospital prices exist, but a key unresolved question is the extent to which hospital prices affect hospital quality. This study leverages a natural experiment by which hospitals quasi-randomly received positive versus negative Medicare fee changes to examine the impact of Medicare fee changes on hospital quality.

We leverage plausibly exogenous changes in Medicare’s geographic payment adjustment to study the causal effect of Medicare hospital fee changes on hospitals’ quality investment decisions and quality outcomes. Key to our empirical strategy is an administrative board, Medicare’s Geographic Classification Review Board (MGCRB), that makes entirely rule-based decisions about which applicant hospitals get approved versus denied Medicare fee increases via “reclassification” to a neighboring payment area by which hospitals are quasi-randomly assigned to receive a positive fee shock, a negative fee shock, or no fee change. Using a stacked difference-in-differences design that treats each MGCRB board decision year as its own experiment with consistent pre- and post-periods to account for differential treatment timing, we isolate the causal effect of Medicare fee changes on hospital quality.

The study includes 29,541 hospital-years, spanning 14 years of 1,550 distinct hospitals reimbursed under the Medicare Inpatient Prospective Payment System affected in 4,955 instances by 3,436 distinct MGCRB case decisions between federal fiscal years 2006 and 2019. New MGCRB reclassifications led to an estimated 2.1% increase in Medicare inpatient fees and a 1.9% increase in Medicare outpatient fees, on average. Loss of reclassification led to an average 2.3% decrease in Medicare inpatient fees and a 2.2% decrease in Medicare outpatient fees (F-statistic 596). On average, plausibly exogenous increases in Medicare fees increased hospitals’ expenses on administrative and clinical functions, but fee decreases left hospital expenses largely unchanged. Medicare fee increases raised patients’ satisfaction with hospitals and tended to improve hospital mortality as well as select clinical quality measures.

Plausibly exogenous Medicare fee changes affected hospital quality investment decisions and outcomes.