When Medicare introduced the Prospective Payment System (PPS) in the 1980s, it was billed as a revolution. Hospitals would be paid the same flat amount for the same service. The idea was fairness and discipline.
I remember it well because I started my career before PPS. Back then, cost reports were on paper, and hospitals were reimbursed for every allowable expense they could justify. CFOs worked overtime to squeeze every penny. Then PPS arrived, and suddenly the rule was clear: equal pay for equal care.
For a while, it worked.
But today, PPS has been smothered by exceptions and add-ons. Instead of a flat-rate system, we have a patchwork quilt that favors some institutions over others and reinforces inequities across the country.
Teaching Hospitals: A Windfall System
Nowhere is this situation more clear than in the billions of dollars directed to teaching hospitals. Through Direct Graduate Medical Education (DGME) and Indirect Medical Education (IME) adjustments, academic centers receive payments far beyond actual costs. IME, tied to the ratio of residents to beds, has ballooned into a major revenue stream for large hospitals.
Training doctors is vital, but these payments have created two tiers: well-funded academic hospitals on one side, and community hospitals — often delivering the bulk of everyday care — struggling to get by on base-PPS rates.
DSH Payments: Good Intentions, Flawed Execution
The Disproportionate Share Hospital (DSH) program was meant to support hospitals serving low-income patients. But the formula is blunt and often political. Well-connected hospitals learned how to maximize it, while many safety-net hospitals continued to scrape for resources. The intent was noble; the results have been uneven.
Wage Index: Inequality by ZIP Code
The wage index adjustment was designed to reflect local labor costs, but in practice it entrenched inequality. Hospitals in places like Boston or San Francisco receive far higher payments than their peers in Mississippi or Arkansas, even for the same procedure. Instead of leveling the field, the wage index has locked entire regions into a chronic disadvantage.
A System of Exceptions
Over time, PPS has accumulated a maze of add-ons: rural hospital adjustments, low-volume bonuses, outlier payments, uncompensated care pools. Each addresses a real issue, but together they hollowed out the PPS original principle.
What was supposed to be a simple system has become opaque and political. Instead of fairness and efficiency, we have distortion and inequality.
Then vs. Now
When PPS began, it felt like a bold corrective — a system that rewarded efficiency and treated hospitals equitably. Having lived through the transition, I believed Medicare had finally drawn a line in the sand.
Now, decades later, PPS survives in name only. Add-ons dominate the landscape, and “equal pay for equal care” is a principle lost to politics and special interests.
Reclaiming the Vision
If Medicare is serious about sustainability, it must strip back these distortions. Teaching hospitals should be funded transparently, not through inflated multipliers. DSH must be recalibrated to follow true uncompensated care. And the wage index — the most inequitable feature of all — needs comprehensive reform.
Until then, PPS will remain what it has become: not a fair, flat-rate system, but a patchwork of exceptions that serve institutions more than patients.
