A Maryland experiment shows a better way to reduce health care spending

With a fight over the federal debt limit looming in Washington, President Biden and Republican leaders have been sparring over possible cuts to Medicare and Medicaid. Together, the two health programs constitute the largest share of the federal budget, but as the partisan back-and-forth has shown, slashing benefits is probably politically impossible. It is also not the best way to address health care budget challenges.

Instead of simply cutting, Congress should reshape how health providers, and especially hospitals, are paid. An ongoing experiment in Maryland shows how this can be done.

Maryland’s approach is known as global hospital budgeting. It is based on a recognition of how federal (and private) health dollars are really spent.

The actual breakdown of health spending may be surprising to many Americans. As of 2021, the two largest categories of spending are hospitals, at 31 percent of national health expenditures, and physician and clinical services, at 20 percent. No other category — prescription drugs, nursing care, medical equipment, home health care, insurance costs — accounts for more than 9 percent.

For Medicare, the numbers are even starker: almost 39 percent of spending on hospitals and almost 25 percent on physician and clinical services. Medicaid is similar, albeit with lower spending on physicians, at 13.5 percent.

Put quite simply, more than half of health spending, and more than two-thirds of Medicare spending, is accounted for by the nation’s providers: hospitals, doctors and other medical professionals.

This creates a difficult challenge for policymakers. Providers, especially large hospital systems, have significant power to demand higher prices from commercial insurance payers. As a result, major hospital systems often have annual revenues in the billions of dollars. With this economic weight comes considerable political power, as cuts to hospital payments threaten not only key health services, but also jobs.

Here, the problem becomes especially tricky: Medicare and Medicaid already pay providers less than commercial insurers do. Cutting rates further will push financially troubled hospitals into insolvency while incentivizing physician practices to sell out to large health systems — increasing the market power of those systems and pushing commercial insurance prices even higher.

Maryland’s global budget experiment offers a possible way out. It has shown promise of reducing Medicare’s rate of cost growth without devastating the health care industry.

Maryland was one of about 30 states that established hospital rate setting systems in the 1970s, but it alone retained its system when other states dropped theirs due to performance issues and a wave of enthusiasm for managed care and deregulation during the 1990s and 2000s.

Overseen by an independent state agency, the Health Services Cost Review Commission (HSCRC), Maryland’s system set uniform payment rates for each hospital based on historical costs and patient mix. All payers, including commercial insurers, self-insured employers, self-paying patients and, crucially, Medicare and Medicaid, reimbursed hospitals at those specified rates. This approach achieved considerable success in lowering the cost of an average hospital admission, but it had a crucial weakness: hospitals could grow their total revenues by increasing the number of patients admitted and services delivered, driving overall costs higher. This became especially problematic after a 2000 change in the rate-setting formula.

The global budget experiment addresses this problem while keeping the positive features of the old system.

In 2014, Maryland negotiated a new federal waiver that added “global budgets” to the HSCRC’s all-payer system. This means that every hospital in the state receives a predetermined amount of revenue for the year, with payment rates adjusting as needed so that actual revenues reach the promised budget figure. With this constraint in place, hospitals no longer have an incentive to increase the volume of services, because revenues will not increase. Additional incentive structures reward hospitals with extra funds if they reduce readmissions and complications or meet other quality-of-care measures.

Critically, the waiver specifies that global budgets are set so that per capita hospital revenue growth over a decade will be no more than 3.58 percent, which is 1 percent lower than the projected rise in Maryland’s per capita gross state product. Increases in hospital spending per Medicare recipient in the state are capped at a level below the national rate of growth, generating savings that compensate for the higher Medicare rates paid under Maryland’s all-payer structure — and that compound in future years.

Early results for the global budget system are promising. Between 2014 and 2018, this approach saved $1.4 billion in Medicare hospital spending in Maryland, with a growth rate 8.74 percent below the national average. Overall hospital revenues grew by just 1.92 percent, well below the 3.58 percent target. Reductions in hospital-acquired conditions and rates of readmission all exceeded targets as well.

The all-payer, global budget system also increases equity by stabilizing the revenues of rural and urban hospitals with high numbers of low-income patients. It does this by factoring the cost of uncompensated care into payment rates for individual hospitals, which spreads those expenses across all payers. During the COVID-19 pandemic, global budgeting meant that hospitals in Maryland did not experience the massive revenue falloffs that plagued hospitals in other states.

In 2019, Maryland extended the program to primary care and non-hospital providers such as nursing homes and home health care agencies through a “Total Cost of Care” initiative.

The new system had one larger effect: It pushed hospitals toward cooperating, not competing. As one hospital official told an interviewer, “I think it was not just the HSCRC, but also the concept of collaboration. That you could set a statewide goal, and everyone could work on it. … You were building on a base of trust. In other places, people are vicious competitors.” This represents a partial but significant step toward treating hospitals like social institutions rather than market actors.

By paying hospitals based on the population they serve and the quality of the care they deliver, rather than on the number and price of the services they perform, global hospital budgeting creates potentially transformative changes in American health care. Congress could incentivize the expansion of Maryland-style global budget programs to other states, and with it, the promise of lower health care costs in coming decades.

Adopted widely, the global budgeting strategy provides an out for both Democrats and Republicans from the dilemmas of Medicare politics. More importantly, it could make the U.S. health care system cheaper and more effective for all Americans.

Guian McKee is an associate professor at the University of Virginia’s Miller Center for Public Affairs. His book, “Hospital City, Health Care Nation: Race, Capital, and the Costs of American Health Care,” will be published in March by the University of Pennsylvania Press.