Changes in Hospital Service Mix and Cost Allocations in Response to Changes in Medicare Reimbursement Schemes

This paper tests whether cost allocations are manipulated in response to cost-plus reimbursement. After 1983, Medicare started reimbursing hospitals for inpatient services on the basis of rates set prospectively, but continued to reimburse outpatient services based on cost. Using data from Washington State, we find that hospitals responded by increasing outpatient services to Medicare patients -- the ratio of Medicare outpatient revenues as a percentage of total Medicare revenues increased after 1983 to a significantly greater extent than for non-Medicare patients. We also find that allocations of common costs to outpatient departments after 1983 significantly exceeded those to inpatient departments, compared to the allocation pattern prior to 1983. These results are robust to alternative controls and cost function specifications.