Can price controls induce optimal physician behavior?

Recently, budget-conscious policymakers have shifted their attention to the physician services market and have begun to consider a wide variety of price regulatory schemes for moderating expenditures in this market. In a recent article in this journal, Feldman and Sloan warned that price controls on physician services may cause undesirable declines in service quality, independent of their budgetary ramifications. Our aim in this article is to reconsider the effects of price controls in the broader context of insurance coverage and moral hazard. Our ultimate goal is to assess the benefits of price controls independent of specific assumptions about the controversial issues of demand inducement and income targeting. Using a simple extension of the Feldman/Sloan model, we find that price controls can be and almost certainly are welfare-improving as long as consumers are sufficiently well insured, regardless of where one stands on the inducement issue. The salutary effects of price controls, on the other hand, can be compromised by income-targeting behavior on the part of physicians. We also introduce evidence from Medicare's recent fee freeze to evaluate the possibility of income-targeting behavior empirically. While formal studies of income targeting suggest that its magnitude is small in cross-section, we warn that its effects may be larger over time; this is what our descriptive evidence suggests. We conclude that more dramatic short-term progress on physician fee inflation will require stronger measures, such as putting physicians at risk for consumer expenditures.