Medicare Reforms for Reconciliation

Federal health programs represent the most pressing challenge in putting the U.S. budget on sustainable footing.¹ There are numerous ways to reform Medicare, Medicaid, and the Affordable Care Act, and Congress should address problems within all three programs. In FY2024, Medicare spent an astounding $1.58 trillion, while the federal share of Medicaid reached $689.6 billion.² Health spending’s contribution to the U.S. debt means that $1.6 trillion is needed in savings from health care programs between 2025 and 2034³ to avoid a spiraling debt/interest rate cycle, with borrowing getting more expensive. Policymakers should look for all available opportunities, including the current reconciliation debate, to make federal health programs more sustainable.

Policymakers can reform Medicare without cutting benefits. There are many bipartisan and commonsense reforms available that would target wasteful program expenditures and restore fiscal prudence to the nation’s largest federal health care entitlement program. These reforms include site-neutral payment policies, changes to Medicare Advantage (MA), reforming uncompensated care payments to hospitals, ending coverage of bad debt for hospitals incurred outside of the Medicare program, reforming Medicare payments for 340B drugs, better measures of inflation, and reforming hospital reclassification. In total, these reforms could save upwards of $712 billion over the next 10 years while improving the efficiency and effectiveness of Medicare. Because Medicare beneficiaries pay 20 percent of the cost of many Medicare services, these reforms would significantly lower out-of-pocket costs for seniors.

The Extent of the Problem

Medicare is the single largest driver of federal deficits. The 2024 Medicare trustees report estimates that the federal government spent $1.04 trillion⁴ on Medicare in 2023—outpacing defense spending and interest payments⁵ as the primary contributor to the nation’s debt. As Figure 1 (which includes MA spending) demonstrates, Part B spending has grown larger than Part A spending and has been growing significantly faster. This is largely due to the shift of many services from the inpatient setting (Part A) to the outpatient setting (Part B).

Site Neutral Payments

Medicare generally pays a much higher rate for a service performed in a hospital facility than if the same service was provided in an independent physician’s office or ambulatory surgical center (ASC). Implementing a strong site-neutral payment policy allows Medicare to pay the same price for the same service regardless of whether it is delivered in a hospital, an ASC, or a physician’s office.

Medicare currently has some limited forms of site-neutral payment policies. New off-campus hospital outpatient departments (HOPDs) not under construction before 2016 receive physician-equivalent payment rates, and in 2018 the Centers for Medicare and Medicaid Services (CMS) implemented a rule requiring physician-equivalent rates for clinic visits at off-campus HOPDs. These policies are good starting points, but they remain too limited and continue to result in market distortions (hospitals buying up physician offices to bill at higher rates) and limited savings to the program or beneficiaries.

Paragon has developed a set of principles that site neutral reform should follow.⁶ Reform should lower overall spending, avoid payment differentials, avoid rural distortions through overly complex incentives or doubling down on cost-based reimbursement, avoid new hospital spending, and avoid setting prices in the commercial market.

Paragon has highlighted three site-neutral payment policies that would save an estimated $220 billion over 10 years.⁷ First, CMS should apply physician rates to clinic visits and other common services in on-campus HOPDs, which the Congressional Budget Office (CBO) estimated would save $102 billion over 10 years.⁸ Second, policymakers should remove current statutory exemptions that allow grandfathered off-campus HOPDs to avoid site-neutral payment rates, which CBO estimates would save $39 billion over 10 years.⁹ Third, policymakers should create a unified post-acute care payment system based on episodes of care and patient health instead of facility type.¹⁰ CBO estimates that this reform would save $79 billion over 10 years.¹¹

In President Trump’s first term, CMS issued a rule that eliminated the inpatient-only list in Medicare.¹² This list determines the procedures that must be carried out in inpatient settings to receive payment. Congress should consider eliminating the inpatient-only list so clinicians and patients can make these decisions—as well as expand the services that can be provided in ASCs. Such a policy change would result in a shift of some procedures to lower-cost settings such as ASCs and physician offices.

Over the past three decades, many services shifted from inpatient settings to outpatient settings, thanks in large part to medical advancements. Hospitals noticed this trend and have increasingly bought out independent physician practices and converted them to off-campus HOPDs. These purchases increased provider market concentration and are linked to price increases in the commercial market.¹³ As such, Medicare site-neutral payment policies benefit not only taxpayers and Medicare beneficiaries (through lower copayments and premiums) but also the privately insured (through decreasing market concentration and lower costs). Because commercial payers typically base their payments on what Medicare pays, these reforms would likely convey benefits to commercial plan enrollees as well.

A Package of Medicare Advantage Changes

Over half of Medicare enrollees rely on MA to provide coverage, and that number is expected to continue to grow. MA provides a more market-oriented approach to providing health coverage with higher value of care and more competition and choice than traditional Medicare offers, and there are changes that could make MA more sustainable and efficient and improve MA’s regulatory parity and ability to provide even more choice-driven health care coverage. Paragon proposed a package of MA changes last year that we estimate would save $250 billion over 10 years while increasing competition, choice, and efficiency.¹⁴ Not all items in this package would reduce program costs on their own, but taken together they would improve the program for both beneficiaries and taxpayers. The key changes would address benchmark calculations, the quality bonus program, the risk adjustment program, enrollment, and Medigap.

Changes to Uncompensated Care Reimbursement

Medicare currently compensates hospitals for “uncompensated care”, which consists of both financial assistance (e.g. charity care), in which providers do not expect reimbursement from the patients, and “bad debt”—whereby providers expect reimbursement from the patient but are unable to collect. For providers who treat a “disproportionate share” of low-income patients, Medicare reimburses them for their share of uncompensated care. Notably, these uncompensated care costs usually occur outside of Medicare. Medicare also reimburses providers 65 percent of their bad debt. According to a Department of Health and Human Services inspector general report, some hospitals have been found to claim bad debt reimbursements despite failing to fulfill the requirements necessary to do so.¹⁵

Policymakers should remove uncompensated care payments from Medicare, index them to inflation, and base them on a hospital’s share of charity care and non-Medicare bad debt. This would provide an incentive for hospitals to provide more charity care, as they would be compensated at a higher rate. CBO estimates that this proposal would save $87.6 billion over 10 years.¹⁶ Policymakers should also end Medicare compensation of bad debt, which CBO estimates would save $54.1 billion over 10 years.¹⁷

340B Payment Reform

The 340B Drug Pricing Program requires pharmaceutical companies to sell outpatient drugs to qualifying hospitals at a steep discount, usually 25-50 percent of the normal price.¹⁸ Currently, Part B pays these hospitals the average sales price (ASP) plus six percent for outpatient drugs, regardless of whether these drugs were actually acquired at a discount. The first Trump administration finalized a rule in 2017 to reduce Part B’s payment to ASP minus 22.5 percent,¹⁹ but this rule was struck down by U.S. Supreme Court on technical grounds.

Congress should reduce the excessive subsidy that 340B hospitals receive through this program and codify the Trump administration’s rule. CBO estimates that this reform would save $73.5 billion over 10 years,²⁰ while CMS estimates that seniors would save $320 million annually in reduced copays.²¹

Using Better Measures of Inflation

Currently, many mandatory spending programs use the consumer price index (CPI) to update payment rates. However, chained CPI is a more accurate reflection of the impact of rising prices, because it adjusts for how people change what they purchase based on price increases (and that people buy more of goods and services when their relative prices decline). CBO estimates that using chained CPI for health program spending—namely Medicare, Medicaid, and the Children’s Health Insurance Program— could save $27.5 billion over 10 years without having to touch a single benefit.²²

Urban Hospital Reclassification Reform

Due to the design of hospital classifications such as the rural referral center (RRC) classification, a significant number (over 80 percent for RRCs) of “rural” hospitals actually reside in geographically urban areas and have patient populations that are overwhelmingly urban. This classification also comes with increased revenue from Medicare drug payments²³ through the 340B Drug Pricing Program,²⁴ among other inequities. Policymakers should ensure that hospitals’ geographic classifications match up with their actual geographical locations.

Conclusion

Tens of millions of seniors rely on Medicare, but in order to secure the program for them and future beneficiaries, policymakers should reform it and root out wasteful spending. Fortunately, there are numerous actions that Congress can take to secure Medicare without cutting benefits or access. The changes highlighted above would save at least $712 billion over 10 years. Reform would need to involve Congress and the Trump administration taking on entrenched interests, but doing so would stabilize—and, crucially, strengthen—one of the nation’s most important programs. Congress has a rare opportunity in reconciliation to improve Medicare and thus should seize the moment

Footnotes