Review of Industrial Organization 22: 297–312, 2003.
© 2003 Kluwer Academic Publishers. Printed in the Netherlands.
Changes in the Effects of Mandatory Rate
Regulation On Growth in Hospital Operating Costs,
JOHN E. SCHNEIDER
University of Iowa, College of Public Health, Department of Health Management and Policy, 200
Hawkins Drive, E-204 GH, Iowa City, Iowa 52242, U.S.A. E-mail: email@example.com
Abstract. We conduct a panel data ﬁxed effects analysis of hospital costs from 1980 through 1996.
Consistent with the ﬁndings of similar studies, hospitals residing in all-payer rate regulated states
in 1984 and 1991 had operating costs approximately 3 to 4 percentage points lower than their less
regulated counterparts. However, by 1996, the effect of rate regulation on hospital costs was reduced
to approximately −0.4 percent, a result that narrowly achieves statistical signiﬁcance (p = 0.09).
Hospitals residing in relatively concentrated markets, measured by the Herﬁndahl-Hirschman Index,
were more likely to have higher operating costs, an effect that increased in magnitude over time. The
results support the conclusion that hospitals in markets with comparatively less rate regulation or
more competition have lower operating costs than their regulated or less competitive counterparts.
Key words: Deregulation; health care; hospitals; regulation; regulatory reform
In recent years there has been a resurgence of state and federal regulations aimed at
controlling various aspects of the health insurance industry, most notably managed
care organizations. The majority of these regulations have targeted the quality of
care delivered by insurers and the providers with which they contract, optimal
hospital capacity, and rates paid by third-party payers to providers. The latter
variety of regulation is not new to health care; virtually all short-term acute care
hospitals were subject to a form of rate regulation from the early 1970s through the
mid 1990s. Six states – Connecticut, Maryland, Massachusetts, New Jersey, New
York, and Washington – enforced mandatory hospital rate setting for all third-party
payers (referred to as the “all payer” states).
Similar to other industries in which rate regulation has been employed, rapid
inﬂation in costs and the absence of a system to cross-subsidize consumers with
limited ability to pay were among the chief motivations of hospital rate and ca-
pacity regulation. However, hospital rate regulation began to unravel in the late
1980s, for a number of reasons. The cross-subsidization of those unable to pay for
inpatient hospital services was one of the chief nominal goals of state rate regula-