Summary: During the 1980s, despite federal attempts to contain cost growth, Medicare hospital expenditures rose by half--from $32 billion to $48 billion. Although costs grew throughout the decade, their rate of growth slowed immediately after the introduction in 1983 of Medicare's prospective payment system, which offers hospitals incentives to provide care more efficiently than under the cost-based reimbursement system. By 1988, however, other trends in hospital care, such as the shift to outpatient services and the rise in case complexity, again fueled cost growth. Several factors stimulated hospital cost increases, the single most important being the rapid adoption of new medical technology. Because hospitals do not compete for patients on the basis of price, hospital managers tried to gain a market edge by offering the most state-of-the-art medical services. Reimbursement methods that passed these costs on to insurance companies and other third-party payers only served to stimulate this medical arms race. As a result, the cost of care soared, with hospitals offering new services, paying higher wages to their employees, and devoting more resources to each patient. Despite the expense associated with treating AIDS patients, the disease played only a modest role in driving hospital cost growth in the 1980s. Nor were the costs for malpractice insurance a major factor in rising costs during that period. Administrative costs, in fact, played a far larger role.
