Medicare, Medicaid, and the Hospital Cost Crisis

Hospital prices have been increasing steadily while the overall quality of care for the American taxpayer has not. Meanwhile, Americans have been fed the same, lazy narrative: hospitals are struggling, margins are thin, and any effort to rein in spending will harm patients. A new report from the Paragon Health Institute dismantles these claims, showing how provisions in the Affordable Care Act (ACA), Section 340B, and provider tax schemes have actually driven prices high. To restore competition to American healthcare, lawmakers should pass site-neutral payment reform, put an end to provider tax financing schemes, and repeal the ACA’s prohibition on physician-owned hospitals. When markets are allowed to function, prices fall and quality rises.

Hospital prices have been outpacing other expensive categories: college tuition, childcare, and housing. Paragon’s report also found that the price of hospital services has increased 281%, 93% more than overall inflation and 131% more than wage growth. In fact, hospital prices are the leading driver of the 320% increase in insurance premiums that Americans have experienced over the past 25 years. Even still, only 2% of hospital revenue comes from patients, with $18 billion coming from investments as of 2024. Instead, a primary source of their revenue is the government. More than half of hospitals make money on Medicare and at least one-third make money on Medicaid. Hospitals are no longer competing for patients, they are competing for tax dollars, leaving Americans to foot the bill as the cost of living increases. 

The hospital lobby has accumulated this much political capital by insisting they are financially distressed. This report demonstrates that this is far from true. The average hospital operating margins hit 6.4%. Despite claiming to lose money on Medicare, hospitals report an average of 5% to 8% Medicare marginal profit, with one in four hospitals reporting operating profits on Medicare.

Beyond chasing tax dollars, hospitals have also been shielded from normal market pressures.  Hospitals exempt from taxes are allowed to borrow at interest rates 1.66 percentage points lower than taxable corporations. CEOs at these tax-exempt hospitals saw a pay raise of 30%+ from 2012 to 2019, while the wages of their nurses only increased 2.3%.

These costly distortions are a product of government error.

First, government policies encourage hospitals to merge and buy out smaller physician-owned practices. For example, Medicare erroneously pays hospital-owned facilities up to 217% more than other types of medical practices for the same procedures. Inevitably, hospitals then buy independent practices and charge these higher prices. As a result, the healthcare market is increasingly dominated by de facto hospital monopolies, where patients pay more and have fewer choices.

Next, the 340B drug program allows hospitals to buy drugs at 25-50% below the wholesale price and then bill Medicare at full market price, generating arbitrage profits on top of other revenue streams. To increase profits using this loophole, hospitals are incentivized to acquire independent practices to expand their 340B eligibility and the use of more expensive drugs to maximize the spread between the discounted price and reimbursement. All at the expense of the American taxpayer.

The Affordable Care Act (ACA) took an axe to competition by banning physician-owned hospitals. Physician-owned hospitals delivered higher quality care at lower costs because doctors were the ones making clinical and operational decisions. By shutting them out of the market, the ACA insulated consolidated hospital systems from an arguably better competitor.

Certificate-of-Need (CON) laws also restrict competition by requiring that new facilities or services get approval from the government before beginning operations.

Finally, states are allowed to recycle hospital money to effectively launder funds from federal taxpayers through provider taxes. A state will increase or establish a provider tax, collect the tax from medical care providers in the state, the federal government is then required through the federal matching system to match their new Medicaid spending dollars. Then, states will hand the money back to the same providers, with a some extra, and the state will keep the extra dollars. Hospitals and states are the only ones who benefit from these practices, while the American taxpayer is left holding the bill, with nothing to show for it.

Americans spend over $1.6 trillion annually on hospital care. Still, Americans have yet to see an equal output in the quality of care they receive. While commercial hospitals are incentivized to merge and buy out independent practices, studies have found that physician-owned hospitals consistently outperform legacy hospitals with lower comparable costs, less intensive procedures, and in arguably the most important statistic, mortality. Two-thirds of commercial hospital spending is now on costs not related to patient care. These patterns make it clear that the hospital cost crisis is not one of resources but one of incentives.

Lawmakers should enact site-neutral payment reform, ensuring that identical services receive identical payment regardless of the setting. Lawmakers should also limit 340B and provider tax financing schemes, roll back CON laws, and lift the ban on physician-owned hospitals. These reforms would increase competition between hospitals, shifting incentives toward delivering quality, efficient care to the American taxpayer.