What is Causing the Increase in Rural Hospital Costs?

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Project completed:
August 2003
In their March 2002 report, the Medicare Payment Advisory Commission (MedPAC) discussed how rural hospitals reported inpatient costs per discharge have risen faster than urban hospital costs in every year from 1990 through 1999. There is a lack of research that evaluates why rural hospital costs have risen faster than urban hospitals, and a lack of research explaining the variance in rural hospital costs. MedPAC has put forth two recommendations that hinge on assumptions regarding how costs of providing care to Medicare beneficiaries differ in rural and urban areas. First, they recommended a low-volume adjustment for hospitals with limited number of discharges. Second, they recommended elimination of the payment differential in Medicare s base payment given to rural and urban providers.

This project examines why reported costs per Medicare discharge have risen faster at rural hospitals than at urban hospitals and what factors contribute to the wide variance in costs among rural hospitals. Using Medicare Cost Report data for 1995-2000, we create a model for explaining changes in hospital costs. Our model is based on the assumption that hospital boards want to improve the quality of care, access to care, employee compensation, and hospital profitability. Because the objective of hospital boards is assumed to stretch beyond maximizing profits, we develop a cost function that includes variables to detect differences in hospital missions and financial resources. Our model tests the degree to which key variables can explain differences in hospital costs and changes in hospital costs over time.

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