The big story concerning Medicare has been the 5.4 percent reduction in physician fees that took effect January 1. The cuts represent the culmination of a ten-year price-fixing experiment on physicians. Medicare officials are estimating that physician fees will continue to be cut through 2005.

The American College of Physicians — American Society of Internal Medicine has estimated that a typical physician can expect to see a reduction in income of $262.82 for each one percent of his practice devoted to Medicare patients. Thus, a doctor whose practice consists of 40 percent Medicare patients will see a $10,512.80 reduction in income.

Dr. Herman Solomon of Kansas wrote to the American Medical Association newspaper to say that Medicare forced him to retire: "After 31 years in practice, my patients aged with me. Almost 70 percent of the practice was Medicare. Many of these people had become friends as well as patients. I had seen my income diminish yearly. I no longer wanted to work 10-hour days."

The New York Times weighed in with a March 17 article quoting several physicians from across the country who are no longer accepting new Medicare patients. The American Academy of Family Physicians puts the share of family doctors who refuse to take new Medicare patients at 17 percent. Left unattended, a snowball effect will occur.

Physicians who are still accepting new Medicare patients will have more of them coming to their door. In order to avoid accepting a greater number of unprofitable Medicare patients, more doctors will decide to stop seeing them. The process will feed on itself, with a dwindling number of physicians being overwhelmed by new Medicare patients seeking care.

These doctors aren’t selfish. They’ve been losing money on Medicare patients for years and will continue to lose money on the Medicare patients they already have. Many doctors now view public programs like Medicare as charity work, which has crowded out much of the real charity care that they used to provide. The blame for this situation falls squarely on our political elite.

Despite ample evidence that price controls lead to shortages, Congress initiated a fee schedule on Medicare physicians in 1992 in an effort to stop runaway spending. Since then, the price controls have tightened their grip on doctors.

The formula used by Medicare to set physician fees is ridiculously complex. Suffice it to say that physician fees have not kept pace with increasing expenses and a blizzard of regulations and paperwork. On top of this, the fees have been subject to budget neutrality adjustments and, since 1998, to a sustainable growth rate (SGR) that links changes in physician fees to the change in the gross domestic product. If increases in spending on physician services exceed the SGR target, the following year’s fees are adjusted downward.

Last year, these elements came together in a perfect storm that led to the 5.4 percent cut in physician fees. Even with the cuts, federal spending on Medicare is expected to grow 5.2 percent this year to $257 billion and will continue to grow to $294 billion in 2005.

The predictable reaction on Capitol Hill has been a call to adjust the price control formula, but the Bush Administration has said that any increases must be offset by other cuts in Medicare spending. Neither side holds the high ground. Like vapid discussions about the Medicare trust fund, tinkering with the price controls is a pseudo-reform. Physicians should take no comfort over the prospect of loosening the price controls, as it would only be a temporary reprieve.

Federal lawmakers should admit that price controls have been a destructive failure and that fundamental reform of Medicare is necessary. An excellent starting point for reform is Congress’ own system for obtaining health insurance — the Federal Employees Health Benefits Program (FEHBP) — which offers federal employees a choice of competing private health insurance plans. Medicare should be transitioned into a defined contribution program that takes the best elements of the FEHBP and improves upon it. An important side benefit of this reform would be prescription drug coverage without federal price controls.

Of course, most private plans also set reimbursement rates for physicians, but there is an important difference. Under the FEHBP, both consumers and doctors have the ability to "opt out" of any given plan. If a competing plan does not sufficiently pay doctors or does not offer consumers a quality product, they can choose not to do business with that plan.

The greatest power that a consumer possesses is the ability to walk away. More physicians are exercising that power by walking away from Medicare and its price controls. It won’t be long before new Medicare beneficiaries find themselves on waiting lists because doctors refuse to see them. Transitioning Medicare to a defined contribution program will give beneficiaries the power to walk away from government price controls as well.

Chris Middleton is the Senior Health and Tax Policy Analyst for the Center For Entrepeneurship of the Pacific Research Institute in San Francisco. He can be reached via email at cmiddleton@pacificresearch.org.