Code Red: Two Economists Examine the U.S. Healthcare System

July 10, 2008

Healthcare Reform—Plan B

Filed under: Health Reform — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 7:49 am
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William White:


Health reform has been slipping in the polls and now ranks behind Iraq and the economy. If the past is prologue, there is a good chance that this time next year we won’t be any closer then we are now.  This raises an obvious question: What’s plan “B”?

In the past the default option has been to rely on our haphazard patch work of safety net providers to serve the uninsured while we continue to debate payment reform.  President Bush summed this approach up well in a speech last year “I mean, people have access to health care in America. After all, you just go to an emergency room. The question is, will we be wise about how we pay for health care.” (

Many people (including me) would argue providing emergency room care is a pretty meager standard.  But even accepting this standard, it’s not clear how much longer the system can continue to deliver.  The safety net is still there.  But it is eroding fast. Many safety net providers are being pushed to the limit.  Issues include not only the overall volume of care, but a mismatch between need and resources.  Many of the hospitals that face the biggest uncompensated care burdens are those with the least ability to deal with them.  The payer mixes of urban intercity hospitals and physicians are notorious.  Some rural and even suburban hospitals and doctors face similar problems.  On the demand side, the number of uninsured seems is almost certain to rise due to rising insurance costs, while a slowing economy is likely to make things worse.  The bottom line is that going forward, we can’t count on the safety net to continue be there for the uninsured. If we want (yet again) to default to our traditional plan “B”, it seems like this time around we are actually going to have to plan for it.

How?  One solution is simply to set up a program to target deserving providers and send money.  But subsidy programs have a way of mushrooming (witness critical access hospitals) and Congress and the States could balk.  You recently mentioned some ideas about redistributing the burden between providers as an alternative.  I’d like to hear them.

– Will

David Dranove:


We always knew it would come to this.  When health care markets had little to no competition, nonprofit providers could easily make enough money to treat the uninsured.  This hidden cross-subsidy was a fundamental feature of our health care system.  Competition pressured providers to become efficient—thank goodness for that—but it also pressured them to cut back on charity care. Now that many providers are doing well financially, we have not seen a resurgence in charity care.  If anything, many nonprofits are reinvesting their earnings in facilities designed to attract well-heeled patients, seeking even greater profits from the health care “haves” while abandoning the have-nots.

As you point out, I have been working on this problem with a number of government officials here in Illinois (they shall remain nameless so as to protect the innocent.)  We are tinkering with some ideas that may help a little.  Or maybe even a lot.

It all goes back to the traditional role of nonprofits in the U.S. health economy.  In exchange for enormous tax breaks, nonprofits were supposed to provide community benefits.  At one time, community benefits meant charity care.  But the definition has expanded to include lots of activities that look more like loss leaders than true acts of charity.  Here in Illinois, charity care is scarcely more than 10% of community benefits.  But shouldn’t charity care be the #1 priority?  Many nonprofits seem to have lost their way.  No wonder some economists call them “for profits in disguise.”

So why don’t we ask the nonprofits to once again earn their tax exemptions?  Either provide charity care or, if they prefer,  form financial partnerships with saftey net providers.  The level of support would be based on the hospital’s total revenues and the system can be run entirely through the private sector.  I call this the “floor and trade” system.  There might be exemptions for providers that are struggling to make ends meet or those that are already doing their part by treating a lot of Medicaid patients.  There are likely lots of good ways to tinker with this approach on the margins.  But I am optimistic about the basic idea.

Illinois has CON, which raises one more possibility.  CON protection grants a certain degree of market power.  Why not require recipients of CON approval (and, therefore, beneficiaries of future protection) to also pay into the floor and trade system?  I have proposed an across-the-board requirement, not just limited to nonprofits.  Ambulatory surgery centers, specialty hospitals, you name it.  If the state grants you special rights, then give something back.

Competition still works in all the ways we hoped it would.  But competition combined with a lack of political will has wreaked havoc with the safety net.  I think that my proposal preserves the best of competition while doing something for the have-nots.


1 Comment

  1. David,

    Your comment that many nonprofit hospitals provide relatively little uncompensated care raises a general issue, namely mounting skepticism about the community benefits received in exchange for nonprofits’ tax exempt status. Reflecting this skepticism, a Sloan health administration program alumnus recently made the following modest proposal to me: Get rid of nonprofit status for hospitals and convert existing ones to for-profits. In support, he made two arguments. First, the primary rationale for nonprofits is safety net care. To the extent we want to continue to provide it, there are better ways to do it. Second, for-profit firms are in any case inherently more efficient then nonprofits and large gains could be realized from conversation.

    As we have discussed here, there’s certainly room for improvement in the current system of tax subsidies for nonprofits. Hospitals’ obligations are cloudy and benefits are often are ill matched to demand for uncompensated care. But in response to my alum’s comments, I think focusing on charity care misses a key point. Namely, that for modern community hospitals, assuring quality, not providing charity care, is the primary rationale for nonprofit organization, and in this context, efficiency issues are not as simple as they might appear.

    Nonprofits may have their historical origins in alms houses. But since the early 20th Century, the determinant of success or failure of modern nonprofit community hospitals hasn’t been their ability to give care away. It has been their success in attracting paying patients to generate operating revenues. I don’t think this success has hinged on reputations for altruism. Rather, I’d agree with our colleague Burt Weisbrod that the key attraction for paying patients has been the perception that nonprofit organization results in better quality care in the face of problems with monitoring performance. In particular, he suggests advantages from less focus on profits and the bottom line, which are readily observable, and more attention to patient care, which is more difficult to evaluate. This leads to a second point. Efficiency isn’t just about lower prices. It is about value for money taking into account quality. Tax advantages and regulatory barriers certainly are contributing factors to the continuing success of nonprofits. But as I read it, the empirical literature is in fact quite mixed on the relative performance of for-profits and nonprofits—it’s not a slam dunk that for-profits do a better job.

    Looking to the future, comprehensive health reforms and reductions in tax subsidies could both have important impacts on nonprofits. However, nonprofit community hospitals experienced substantial growth in the early 20th century when tax advantages were less marked. Moreover, they continued to dominant the industry after the introduction of Medicare and Medicaid substantially reduced issues with uncompensated care in 1965. My guess is that as long as there are real or perceived quality advantages, nonprofits will endure even if reforms reduce tax advantages and/or indigent care becomes less of an issue. What seems more critical for their future is what happens with efforts to improve quality indicators and increase transparency about performance. If Burt Weisbrod’s theories are correct and new monitoring efforts succeed in making healthcare more of a commodity, this could substantially reduce the attractions of nonprofit ownership as an organizational form.


    Comment by Will White — August 25, 2008 @ 6:16 pm

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