How Do Hospitals Respond to Payment Incentives?

A literature has found that medical providers inflate bills and report more conditions given financial incentives. We evaluate whether Medicare reimbursement incentives are driven more by bill inflation or coding costs. Medicare reformed its payment mechanism for inpatient hospitalizations in 2007, increasing coding costs. We first examine whether increased extra reimbursements from reporting more diagnoses lead hospitals to report more high bill codes. We find that increases in reimbursements within narrow patient groups led to more high bill codes before 2007 but not after. Using the payment reform, we then test for costly coding by comparing hospitals that adopted electronic medical records (EMRs) to others. Adopters reported relatively more top bill codes from secondary diagnoses after the reform, exclusively for medical patients, with a negative effect for surgical patients. This is consistent with EMRs lowering coding costs for medical discharges but increasing them for surgical ones. We further use a 2008 policy where Medicare implemented financial penalties for certain hospital-acquired conditions. EMR hospitals coded relatively more of these conditions following the penalization, lowering revenues. Together, this evidence is contrary to bill inflation but consistent with costly coding. Reducing coding costs may increase inpatient Medicare costs by $1.04 billion annually