Hospitals respond to Medicare payment shortfalls by both shifting costs and cutting them, based on market concentration.

The coverage expansions planned under the Affordable Care Act are to be financed in part by slowing Medicare payment updates to hospitals, thereby reigniting the debate over whether low prices paid by public payers cause hospitals to increase prices to private insurers--a practice known as cost shifting. Recently, the Medicare Payment Advisory Commission (MedPAC) proposed an alternative explanation of hospital pricing and profitability that could be used to support policies that pressure hospitals to reduce overall costs rather than to only raise prices. This study evaluated the cost-shift and MedPAC perspectives using 2008 data on hospital margins for 30,514 Medicare and privately insured patients undergoing any of seven major procedures in markets where robust hospital competition exists and in markets where hospital care is concentrated in the hands of a few providers. The study presents empirical evidence that, faced with shortfalls between Medicare payments and projected costs, hospitals in concentrated markets focus on raising prices to private insurers, while hospitals in competitive markets focus on cutting costs. Policy makers need to examine whether efforts to promote clinical coordination through provider integration may interfere with efforts to restrain overall health care cost growth by restraining Medicare payment rates.