FTC Staff Comment Before the Ohio Senate Health and Human Services Committee Concerning Certificate of Need Regulation Related to H.B. 332

TESTIMONY OF
Mark D. 	Kindt
Regional 	Director
Cleveland Regional 	Office
Federal 	Trade 	Commission
Before 	the
V890065
COMMISSION AUTHORIZED
Senate Health 	and Human Services 	Committee
Ohio 	Senate
On
Certificate 	of 	Need Regulation
As 	Related 	to 	H.B. 	332
June 	21, 	1989

Mr. 	Chairman, 	my 	name 	is 	Mark 	Kindt. 	I 	am 	Regional
Director 	of 	the 	Federal 	Trade 	Commission's 	Cleveland 	Regional
Office. 	It 	is 	a 	pleasure 	to 	be 	here 	today. 	With 	your
permission, 	I 	will 	offer 	a 	brief 	statement 	on 	behalf 	of 	the
staff 	of 	the 	Cleveland 	Regional 	Office 	and 	the 	Bureau 	of
Economics. 	I 	am 	also 	providing 	you 	with 	copies 	of 	testimony 	on
this 	subject 	that 	was 	presented 	on 	behalf 	of 	the 	staff 	of 	the
Bureau 	of 	Economics 	in 	response 	to 	a 	recent 	request 	from 	the
North 	Carolina 	State 	Goals 	and 	Policy 	Board. 	Before 	I 	begin,
however, 	I 	must 	state 	that 	my 	testimony 	today 	and 	the 	testimony
before 	the 	North Carolina 	Board are 	the 	views 	of 	the 	staff 	of 	the
Federal 	Trade 	Commission 	and 	they 	do 	not 	necessarily 	represent
the 	views 	of 	the 	Commission 	itself 	or 	any 	individual
Commissioner.
I 	will 	now 	address 	briefly 	the 	history 	and 	effect 	of
Certificate 	of 	Need, 	or 	"CON", 	regulation. 	Certificate 	of 	Need
legislation 	was 	first 	enacted 	by 	the 	State 	of 	New 	York 	in 	1964.
With 	a 	major 	push 	from 	the 	federal 	government 	in 	the 	form 	of 	the
National 	Health 	Planning 	and 	Resources 	Development 	Act 	of 	1974
and 	its 	1979 	amendments, 	all 	but 	one 	state 	-- 	Louisiana 	-- 	had
enacted 	CON 	legislation 	by 	1980. 	The 	key 	justification 	for 	this
form 	of 	regulation 	was 	the 	belief 	that 	health 	care 	providers,
particularly 	hospitals, 	would 	undertake 	excessive 	investment 	in
unregulated 	health 	care 	markets. 	As 	a 	result, 	it 	was 	believed
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that, 	absent 	regulation, 	the 	costs 	of 	health 	care would 	be 	higher
than 	necessary.
Over 	the 	past 	15 	years, 	at 	least 	16 	studies 	have 	examined
the 	success 	of 	CON 	regulation. 1 	There 	is 	near 	universal
1
agreement 	among 	the 	authors 	of 	these 	studies 	and 	other 	health
economists 	that 	CON 	has 	been 	unsuccessful 	in 	containing 	health
care 	costs. 	I 	will 	briefly review 	these 	studies 	in 	Part 	A below.
One 	reason 	that 	CON 	may 	have 	been 	unsuccessful 	in 	constraining
health 	care 	costs 	is 	that 	it 	restricts 	the 	ability 	of 	new 	firms
to 	enter 	a 	health 	care 	market 	and 	compete 	against 	incumbent
providers. 	I 	will 	discuss 	this 	in Part 	B. 	Finally, 	while 	health
care 	providers 	and 	insurers 	may 	have 	lacked 	adequate 	incentives
to 	control 	costs 	15 	or 	20 	years 	ago, 	substantial 	progress 	has
been 	made 	in 	providing 	the 	incentives 	that 	will 	lead 	unregulated
health 	care 	markets 	to 	control 	costs. 	This 	is 	discussed 	in 	Part
C of 	this 	testimony.
Allow me 	to 	expand 	briefly on each of 	these 	points.
For 	references 	to 	those 	studies, 	see 	Statement 	of 	Keith
B. 	Anderson, 	Special 	Assistant 	to 	the 	Director, 	Bureau 	of
Economics, 	Federal 	Trade 	Commission, 	Before 	the 	North 	Carolina
State 	Goals 	and 	policy 	Board, 	March 	6, 	1989, 	notes 	4 	and 	6. 	A
more 	recent 	study 	is 	Keith 	B. 	Anderson, 	"Regulation, 	Market
Structure 	and 	Hospital 	Costs: 	A Comment 	on 	the 	Work 	of 	Mayo 	and
McFarland," 	Bureau 	of 	Economics 	Working 	Paper 	#173, 	May 	1989.
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A. 	The 	Available 	Economic 	Studies 	Conclude 	That
Certificate 	of 	Reed 	Regulation 	Has 	Hot 	Been
Effective 	in 	Reducing 	the 	Costs 	of 	Health
Care.
At 	least 	16 	studies 	of 	the 	effectiveness 	of 	Certificate 	of
Need 	regulation 	in 	reducing 	the 	cost 	of 	providing 	health 	care
services 	have 	appeared 	in 	the 	last 	15 	years. 	Three 	of 	these
studies 	were 	written 	by 	the 	staff 	of 	the 	Bureau 	of 	Economics 	of
the 	Federal 	Trade 	Commission.
These 	economic 	studies 	are 	in 	near 	total 	agreement 	that
Certificate 	of 	Need 	regulation 	does 	not 	achieve 	the 	goal 	of
lowering 	the 	costs 	of 	health 	care. 	While 	a 	few 	studies 	do 	find
some 	reduction 	in 	hospital 	beds 	where 	there 	is 	CON 	regulation,
overall 	the 	studies 	find 	that 	the 	costs 	of 	health 	care 	are 	no
lower where 	there 	is 	Certificate of 	Need: 	some 	studies 	find 	costs
are 	the 	same 	whether 	or 	not 	CON 	regulations 	are 	present, 	others
find 	that 	costs 	are 	actually 	higher 	where 	there 	is 	CON
regulation. 	The 	majority 	of 	these 	studies 	have 	examined 	the
effect 	of 	CON 	on 	hospital 	services. 	However, 	similar 	results
have 	been 	found 	in 	studies 	of 	nursing 	homes 	and 	of 	firms
providing 	home 	health 	care 	services. 	In 	addition, 	a 	recent
theoretical 	analysis 	of 	CON 	regulation 	suggests 	that, 	even 	if 	CON
effectively 	limits 	the 	number of 	hospital 	beds, 	it may 	not 	reduce
the 	costs 	of 	a 	stay 	in 	the 	hospital.
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Why 	have 	Certificate 	of 	Need 	regulations 	been 	ineffective?
Perhaps 	the 	answer 	lies 	in 	the 	fact 	that 	CON 	regulation 	does 	not
alter 	the 	incentives 	of 	either 	consumers 	or 	providers 	of 	health
care 	services. 	Proponents 	of 	CON 	regulation 	were 	concerned 	that
providers 	had 	excessive 	incentives 	to 	compete 	on 	the 	basis 	of
quality 	and 	insufficient 	incentives 	to 	compete 	on 	the 	basis 	of
price. 	Enactment 	of 	CON 	regulation 	does 	not 	alter 	these
incentives.
CON 	regulation 	may 	affect 	quality 	competition 	among
hospitals 	by 	foreclosing 	certain 	avenues 	hospitals 	could 	use 	to
achieve 	their 	goals. 	However, 	it 	does 	not 	eliminate 	any
incentives 	to 	be 	extravagant. 	In 	some 	cases, 	existing 	hospitals
were 	probably 	able, 	perhaps 	with 	a 	delay, 	to 	obtain 	approval 	for
arguably 	uneconomic 	projects 	even 	with 	CON 	regulation. 	Other
hospitals 	were 	able, 	the 	evidence 	suggests, 	to 	find 	new 	ways 	to
compete. 	For 	example, 	if 	the 	CON 	law 	required 	approval 	only 	for
some 	kinds 	of 	capital 	investments 	-- 	~., 	new 	beds 	the
hospitals 	could 	add 	other 	kinds 	of 	fancy 	equipment. 	If 	all
equipment 	was 	covered 	by 	CON, 	hospitals 	could 	compete 	by
providing 	additional 	staff. 	Thus, 	CON 	regulation 	did 	not 	lower
costs 	by 	ending 	supposedly 	unnecessary 	expenditures , 	it 	merely
redirected any 	such expenditures 	into 	other 	areas.
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B. 	COif 	Regulation 	Interferes 	with 	Competition
and 	Innovation in Beal th Care lIarkets. 	.
The 	foregoing 	discussion 	suggests 	that 	CON 	regulation 	has
been 	ineffective.
have 	been 	harmful.
But, 	more 	than 	that, 	these 	regulations 	may
The 	CON 	regulatory 	process 	may 	increase
prices 	to 	consumers 	by 	protecting 	health 	care 	providers 	from
competition by new 	entrants. 	CON 	also 	reduces 	the 	possibility of
entry 	by 	firms 	that 	might 	provide 	services 	of 	higher 	quality 	or
lower 	cost 	than 	existing 	firms 	and 	that 	might 	replace 	providers
that 	are 	not 	effectively 	meeting 	consumer 	needs. 	CON 	regulation
may 	also 	interfere 	with 	competition 	and 	improvements 	in 	the
quality 	of 	care 	by 	delaying 	the 	introduction 	and 	acceptance 	of
innovative 	alternatives 	to 	costly, 	less 	effective 	treatment
methods.
Because Certificate of 	Need 	regulation delays 	or 	reduces 	the
prospect 	of 	new 	entry 	and 	expansion, 	it 	increases 	the 	likelihood
that 	providers 	will 	exploit 	whatever 	market 	power 	they 	have,
individually 	or 	collectively, 	to 	raise 	prices 	above, 	or 	reduce
quality 	below, 	the 	competitive 	level. 	That 	is 	why 	the 	Federal
Trade 	Commission 	has 	cited 	the 	entry 	barrier 	created 	by 	CON
regulation 	as 	a 	factor 	significantly 	contributing 	to 	the
potential 	for 	anti-competitive 	effects 	from 	hospital 	mergers. 2
2 	American 	Medical 	International, 	104 	F.T.C. 	at 	200-201
(1984); 	Hospital 	Corporation 	of 	America 	[Chattanooga
acquisitions], 	106 	F.T.C. 	at 	489-496. 	In 	affirming 	the
Commission's 	decision 	in 	Hospital 	Corporation 	of 	America, 	Judge
Posner 	agreed 	that 	CON 	regulation 	can 	create 	a 	barrier 	to 	entry.
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To 	the 	extent 	that 	CON 	regulation 	reduces 	the 	supply 	of
particular 	health 	services 	below 	competitive 	levels, 	prices 	for
these 	services 	can be 	expected to 	be 	higher 	than they would 	be 	in
an 	unregulated 	market. 	Curtailing 	services 	or 	facilities 	may
force 	some 	consumers 	to 	resort 	to 	more 	expensive 	or 	less-
desirable 	substitutes, 	thus 	increasing 	costs 	for 	patients 	or
third-party 	payers. 	For 	example, 	if 	nursing 	home 	beds 	are 	not
available, 	the 	discharge 	of 	patients 	from more 	expensive 	hospital
beds 	may 	be 	delayed 	or 	patients 	may 	be 	forced 	to 	use 	nursing
homes 	far 	from 	home.·
CON 	regulation 	may 	also 	interfere 	with 	competition 	by
delaying 	the 	introduction 	and 	acceptance 	of 	innovative
alternatives 	to 	costly 	treatment 	methods. 	Regulators 	may 	lack
the 	information to 	determine 	how many 	such 	facilities 	are 	needed,
or 	they 	may 	not 	respond 	rapidly 	enough 	to 	changing 	market
conditions. 	It 	is 	difficult 	to 	predict 	demand 	for 	innovations 	in
medical 	practice. 	Providers 	have 	strong 	financial 	incentives,
which 	health-planning 	agencies 	lack, 	to 	gather 	information 	and 	to
adjust 	to 	unexpected 	changes 	in 	costs 	or 	demand. 	Thus, 	reliance
on 	market 	forces 	is 	likely 	to 	provide 	more 	rapid 	and 	desirable
responses 	to 	changing conditions 	than CON 	regulation.
[Hospital 	Corporation of 	America v. 	Federal 	Trade 	Commission, 	807
F.2d. 	1381, 	1387 	(7th Cir. 	1987).]
- 	7 	-

C. 	Health 	Care 	Markets 	Can 	Function 	Effectively
Without Certificate of Meed Regulation.
As 	noted 	previously, 	Certificate 	of 	Need 	regulation 	was
imposed, 	in 	part, 	in 	the 	belief 	that 	consumers 	lacked 	adequate
incentives 	to 	seek 	out 	lower 	cost 	health 	care 	and 	that 	providers
did 	not 	have 	sufficient 	incentives 	to 	keep 	their 	costs 	down. 	It
was 	observed 	that 	patients 	did 	not 	pay 	directly 	for 	the 	cost 	of
the 	health 	care 	services 	they 	consumed 	and 	that 	the 	private 	and
government 	insurers 	who 	did 	pay 	the 	bills 	generally 	reimbursed
the 	provider 	for 	whatever 	costs 	were 	incurred 	in 	caring 	for 	each
individual 	patient.
However, 	recent 	changes 	in 	health 	care 	markets 	have 	altered
these 	incentives 	and 	therefore 	should 	increase 	the 	likelihood
that 	unregulated 	competition 	will 	provide 	health 	care 	services
efficiently. 	While 	private 	and 	public 	insurance 	still 	pay 	for
the 	vast 	majority 	of 	health 	care, 	consumers 	and 	employers 	have
become 	more 	sensitive 	to 	the 	costs 	of 	health 	insurance 	and 	have
therefore 	sought 	ways 	to 	increase 	incentives 	for 	health 	care
providers 	to 	provide 	quality care 	at 	the 	lowest 	possible 	cost.
One 	indication 	of 	this 	increased 	attention 	to 	cost 	control
is 	the 	growth 	in 	health 	maintenance 	organizations 	(HMOs) 	and
preferred 	provider 	organizations 	(PPOs). 	PPOs 	and 	HMOs 	tend 	to
promote 	cost-containment 	by 	encouraging, 	or 	requiring, 	patients
to 	use 	cost 	conscious 	providers.
- 	8 	-
In 	1988, 	HMO 	enrollment 	was

31.4 	million. 3 	This 	represented 	more 	than 	a 	five-fold 	increase
from 	the 	6.0 	million 	enrolled 	in 	1976. 4 	Similarly, 	an 	estimated
total 	of 	45 	to 	50 	million 	people 	currently 	have 	the 	option 	of
using 	a 	preferred 	provider. S 	In 	December 	1984, 	only 	1.3 	million
were 	enrolled 	in plans 	with a 	PPO option. 6
Increased 	sensitivity to 	health care 	costs 	is 	also 	reflected
in 	the 	percentage 	of 	firm 	health plans 	requiring 	insurer 	approval
before 	admitting 	a 	patient 	to 	a 	hospital 	or 	requiring 	second
opinions 	prior 	to 	surgery. 	By 	1987, 	preadmission 	certification
was 	required 	by 	over 	one-third 	of 	company-offered 	health 	plans,7
compared 	with 	2 	percent 	in 	1982. 8 	In 	1987, 	more 	than 	40 	percent
of 	employee 	health 	plans 	mandated 	a 	second 	opinion 	prior 	to
3 	As 	0 f 	June 	1988 , 	there 	were 	643 	HMOs 	in 	the 	Uni ted
States. 	(Telephone 	interview 	by 	Keith 	Anderson, 	Special
Assistant 	to 	the 	Director, 	Bureau 	of 	Economics, 	Federal 	Trade
Commission, 	with 	David Glazer 	of 	InterStudy, 	Feb. 	10, 	1989.)
4 	Health. 	United 	States. 	1987, 	table 	112, 	p. 	170.
6
5 	There 	are 	currently 	637 	PPOs 	in 	operation 	in 	the 	U. S.
(Telephone 	interview 	by 	Keith 	Anderson, 	Special 	Assistant 	to 	the
Director, 	Bureau 	of 	Economics, 	Federal 	Trade 	Commission, 	with 	Ed
Pickens, 	American Medical 	Care 	and Review, 	Feb. 	10, 	1989.)
Jon 	Gabel, 	Dan 	Ermann, 	Thomas 	Rice, 	and 	Gregory 	de
Lissovoy 	(1984), 	"The 	Emergence 	and 	Future 	of 	PPOs," 	Journal 	of
Health 	Politics, 	Policy 	and Law, 	11 	(Summer), 	p. 	306.
7 	Steven 	DiCarlo 	and 	Jon 	Gabel 	(1988), 	"Conventional
Health 	Plans: 	A 	Decade 	Later," 	Research 	Bulletin, 	Health
Insurance Association of America, 	p. 	11.
8 	Jeff 	Goldsmith 	(1984), 	"Death 	of 	a 	Paradigm: 	The
Challenge 	of 	Competition," 	Health Affairs, 	3 	(Fall), 	p. 	14.
- 	9 	-

surgery, 9 	while 	only 	28 	percent 	of 	plans 	did 	so 	in 	1984. 10
Finally, 	the 	use 	of 	copayments 	and 	deductibles 	in 	private 	health
insurance 	plans 	has 	increased. 11 	These 	changes 	increase
incentives 	for 	consumers 	to 	purchase 	less 	expensive 	health 	care
and 	forgo 	unnecessary 	treatments.
Government-funded 	programs 	have 	also 	introduced 	changes.
As 	you 	are 	well 	aware, 	the 	Medicare 	system 	has 	converted 	payment
of 	hospital 	operating 	costs 	to 	a 	prospective 	payment 	approach.
Many 	states 	have 	been 	experimenting 	with 	cost 	containment
. strategies 	for 	their 	Medicaid 	programs. 	Several 	states 	have
begun 	using 	HMOs 	or 	other 	capitation 	and 	case-management
strategies 	to 	provide 	care 	to 	Medicaid 	patients. 12 	Some 	states
9 	DiCarlo 	and 	Gabel 	(1988), 	p. 	11. 	Moreover, 	an
additional 	10 	percent 	required 	a 	second opinion 	in 	some 	cases.
10 	Goldsmith 	(1984), 	p. 	14.
11 	Between 	1982 	and 	1984, 	the 	percentage 	of 	insurance
plans 	paying 	100 	percent 	of 	hospital 	charges 	for 	the 	first 	days
of 	hospital 	care 	fell 	from 	67 	percent 	to 	42 	percent. 	The
percentage 	paying 	100 	percent 	of 	surgical 	fees 	fell 	from 	42
percent 	to 	26 	percent. 	In 	1982, 	only 	4 percent 	of 	plans 	required
an 	annual 	deductible 	of 	$200 	or 	more 	per 	family. 	(Goldsmith
(1984), 	p. 	12.) 	By 	1987, 	the 	average 	plan 	had 	an 	deductible 	of
$330. 	(Computed 	from 	figures 	in DiCarlo and Gabel 	(1988), 	p. 	14.)
12 	Under 	a 	capitation 	plan, 	a 	provider 	receives 	a 	fixed
payment 	per 	month· 	which 	depends 	on 	the 	number 	of 	covered
patients 	who 	select 	that 	firm 	or 	individual 	as 	their primary care
provider. 	This 	payment 	is 	independent 	of 	the 	costs 	of 	any 	care
provided 	to 	any 	particular 	patient. 	In 	some 	cases, 	states 	have
used partial 	capitation plans 	where 	the 	provider receives 	a 	fixed
fee 	to 	cover 	some 	set 	of 	basic 	services. 	However, 	additional
payments 	are made 	if 	the 	patient 	needs 	care 	not 	covered under 	the
capitation 	agreement. 	(Deborah 	A. 	Freund 	and 	Edward 	Neuschler
(1986), 	"Overview 	of 	Medicaid 	Capitation 	and 	Case-Management
Initiatives," 	Health 	Care 	Financing 	Review 	(Annual 	Supplement),
- 	10 	-

have 	used prospective 	reimbursement 	plans 	to 	pay 	for 	nursing 	home
costs. 13
These 	changes 	have 	affected 	the 	demand 	for 	health 	care.
Between 	1975 	and 	1986, 	hospital 	usage 	rates 	declined 	more 	than
one-third. 14 	While 	some 	of 	this 	decline 	was 	probably 	the 	result
of 	technological 	change 	in 	health 	care, 	economic 	incentives 	also
appear 	to 	have 	played 	an 	important 	role. 	Before 	Medicare
introduced 	its 	prospective 	reimbursement 	system, 	hospital 	usage
rates 	declined 	more 	slowly 	for 	senior 	citizens 	than 	for 	younger
patients. 	Between 	1983 	-- 	when 	prospective 	reimbursement 	was
introduced 	-- 	and 	1986 	-- 	the 	most 	recent 	year 	for 	which 	I 	have
data 	-- 	senior 	citizen 	usage 	declined 	at 	8.3 	percent 	per year,
the 	same 	rate 	as 	for 	the 	population at 	large. 15
pp. 	21-30.)
13 	James 	H. 	Swan, 	Charlene 	Harrington, 	and Leslie 	A. 	Grant
(1988), 	"State Medicaid Reimbursement 	of 	Nursing Homes, 	1978-86,"
Health Care 	Financing Reyiew, 	9 	(Spring), 	pp. 	33-50.
14 	In 	1975, 	the 	rate 	of 	hospital 	use 	was 	1,254.9 	days 	of
care 	per 	1,000 	persons. 	(National 	Center 	for 	Health 	Statistics,
Health, 	United 	States, 	1978, 	DHEW 	Publication 	No. 	(PHS) 	78-1232,
Public 	Health 	Service, 	U.S. 	Government 	Printing 	Office, 	1978,
table 	101, 	p. 	308.) 	In 	1986, 	the 	rate 	was 	only 	833.1 	days 	of
care 	per 	1,000 	persons. 	(National 	Center 	for 	Health 	Statistics,
Health, 	United 	States, 	1987, 	DHHS 	Publication 	No. 	(PHS) 	88-1232,
Public 	Health 	Service, 	U.S. 	Government 	Printing 	Office, 	1988,
table 	63, 	p. 	109.)
15 	Between 	1975 	and 	1980, 	hospital 	use 	by 	persons 	aged 	65
and 	above 	declined 	at 	a 	rate 	of 	0.33 	percent 	per 	year. 	For 	the
population 	as 	a 	whole, 	the 	rate 	of 	decline 	was 	1.98 	percent.
Between 	1980 	and 	1983, 	the 	rate 	of 	decline 	was 	0.77 	percent 	per
year 	for 	seniors 	and 	2.05 	percent 	for 	the 	population 	as 	a 	whole.
(Based on data 	in Health, 	United 	States, 	1978, 	table 	101, 	p. 	308,
and 	Health, 	United 	States, 	1987, 	table 	63, 	p. 	109.)
- 	11 	-

As 	consumers 	and 	health 	insurers 	become 	more 	cost-conscious,
hospitals 	with 	inflated 	costs 	and 	prices 	will 	increasingly 	risk
losing 	business. 	This 	is 	particularly 	true 	where 	HMOs 	and 	PPOs
can 	direct 	their 	large 	numbers 	of 	patients 	to 	hospitals 	that
charge 	lower 	fees. 	Thus, 	the 	growing 	cost 	sensitivity 	of
consumers 	and 	health 	insurers 	should 	increase 	incentives 	for
hospitals 	to 	provide 	quality 	service 	at 	the 	lowest 	possible
price.
D. 	Conclusion.
In conclusion, 	the 	available 	economic 	evidence 	suggests 	that
CON 	regulation 	has 	not 	been 	successful 	in controlling health care
costs. 	CON may 	have 	anti-competitive 	effects. 	Recent 	changes 	in
health 	care 	markets 	should 	be 	increasing 	the 	ability 	of 	health
care markets 	to 	function 	effectively and 	efficiently.
This 	completes 	my 	statement. 	I 	would 	be 	pleased 	to 	attempt
to 	answer 	any 	questions 	you may 	have.
# 	# 	# 	# 	#
- 	12 	-

V890'J28
COMMISSION AUTHORIZED
Certificate of Need Regulation of Health Care Facilities
Prepared Statement of
Keith B. Anderson
Special Assistant to the Director
Bureau of Economics
Federal Trade Commission
Before
North Carolina State Goals and Policy Board
March 6, 1989

It 	is 	a pleasure 	to be here 	today to discuss 	the available evidence on
the need for and effectiveness of Certificate of Need, or CON, regulation. l
My name is Keith Anderson. 	I am Special Assistant to the Director of the
Bureau 	of 	Economics 	of 	the 	Federal 	Trade Commission. 	For 	the 	last 	ten
years, 	much 	of 	my 	professional 	work 	has 	focused 	on 	the 	effects 	of
government regulation on the functioning of markets. 2 	I am a coauthor of
one of the three studies the Bureau of Economics has published in the last
three years dealing with Certificate of Need regulation. s
To 	promote 	competition 	in 	health 	care 	markets, 	the 	Federal 	Trade
Commission and its staff have been active both in antitrust law enforcement
and 	in 	advocacy of 	regulatory 	reforms, including advocating the 	repeal of
Certificat.e of Need regulation in several other states.· 	In addition, many of
the 	Commission's antitrust 	investigations 	in 	the 	health care 	field 	focus 	on
competitive 	problems 	tilat 	would 	be 	less 	severe 	if 	there 	were 	no 	CON
regula tions.5
In these comments, I would like to do four things. 	First, I would like
to 	review 	the 	economic 	evidence 	concerning 	the 	effectiveness 	of 	CON
1 These 	comments 	represent 	the 	views 	of 	the 	staff 	of 	the 	Federal
Trade Commission's Bureau of Economics, and not necessarily those of the
Commission itself or any individual Commissioner.
2 A copy of my vita is attached.
S Keith 	B. 	Ander50n 	and 	David 	I. 	Kass 	(1986), 	Certificate 	of 	Need
Regulation 	of 	Entry 	into 	Home 	Health 	Care: 	A 	Multi-product 	Cost 	Function
Analysis, Bureau of Economics Staff Report to the Federal Trade Commission.
The 	other studies are 	Monica 	Noether 	(1987), Competition 	Among Hospitals,
Federal Trade Commission, 	Bureau of Economics Staff Report; 	and 	Daniel
Sherman 	(1988), 	The 	Effect 	of 	State 	Certificate-of-Need 	Laws 	on 	Hospital
Costs: 	An 	Economic 	Policy 	Analysis, 	Bureau 	of 	Economics, 	Federal 	Trade
Commission.
• See, e.g., 	Letter 	to Maston 	T. Jacks, 	ESQ., Chairman, Commission on
Medical Facilities and Certificate of Public Need, Commonwealth of Virginia,
from Jeffrey 1. Zuckerman, Director Bureau of Competition, Federal Trade
Commission, dated August 6, 1987; Letter to The Honorable John F. Pressman
and 	The 	Honorable 	Donald 	W. Snyder, 	Pennsylvania 	State 	Representatives,
from 	John 	M 	Mendenhall, 	Acting 	Director, 	Cleveland 	Regional 	Office,
Federal Trade Commission, dated 	March 	30, 	1988; Letter to The 	Honorable
Culver 	Kidd, Georgia State Senator, from 	Paul 	K. Davis, 	Director, Atlanta
Regional 	Office, 	Feder'll 	Trade 	Commission, 	dated 	February 	6, 	1989; 	and
Letter 	to 	The 	Honora;);e 	Bernice 	Labedz, 	Nebraska 	State 	Senator, 	from
Jeffrey 	1. 	Zuckerman, 	Director 	Bureau 	of 	Competition, 	Federal 	Trade
Commission, dated February 22, 1988.
5 See, e.g., Hospital Corporation of America [Chattanooga acquisitions],
106 F.T.C. 361, 489·496 (1985), affirmed 807 F.2d 1381 (7th Cir. 1986), cert.
denied, 	107 	S.Ct. 	1975 	(1987); 	Hospital 	Corporation 	of 	America 	[Forum
acquisitions], 	106 	F.T.C. 	298 	(1985) 	(consent 	order); 	and 	American 	Medical
International, 104 F.T.C. 1 (1984).

In these comments, I would like to do four things. 	First, I would like
to 	review 	the 	economic 	evidence 	concerning 	the 	effectiveness 	of 	CON
regulation 	in 	controlling 	health 	care 	costs. 	Second, 	I 	will 	consider 	the
effects of CON regulation in limiting competition and innovation in health
care 	markets. 	Third, 	I will discuss changes in 	health care in 	recent years
that 	have 	increased 	the 	ability 	of 	health 	care 	markets 	to 	function 	in 	an
unregulated, competitive way. 	Finally, I will 	briefly consider some of the
rationales for CON regulation.
To jump ahead and provide a preview of my conclusions, almost all of
the available empirical evidence suggests that CON regulation does not help
control 	the 	costs 	of 	health 	care. 	Further, 	the staff of 	the 	Federal Trade
Commission's 	Bureau 	of 	Economics 	find 	nothing 	in 	the 	issues 	that 	I 	will
discuss 	that 	leads 	us 	t'o 	believe 	that 	Certificate 	of 	Need 	regulation 	is
necessary to achieve any of the rationales advanced for it. 	Consumers would
most likely be better served if CON regulation were removed.
A. 	The Available EcoDomic EvideDce StroD&ly Suuests That Certificate of
Need 	RelulatioD 	Has 	Not 	BeeD 	Effective· iD 	ReduciDI 	the 	Costs 	of
Health Care.
As 	I 	noted. 	in 	the 	past 	three 	years, 	the 	Bureau 	of 	Economics 	has
published 	three studies that. in whole or in 	part, look at the effectiveness
of Certificate of Need regulation 	in reducing the cost of providing health
care 	services. 	(I 	believe cost 	reduction 	is 	the 	primary 	objective 	of 	those
advocating CON regulation.) 	These studies are only three of at least sixteen
studies 	on 	the 	effects 	of 	CON 	regulation 	that 	have 	appeared 	in 	the
economics 	literature 	in 	the 	last 	fifteen 	years. 6 	Of 	these 	i6 	studies, 	II
6 In addition to the three Bureau of Economics' studies, the following
studies 	have 	been 	done: 	(I) 	David 	S. Salkever 	and 	T.W. 	Bice 	(1976), "The
Impact 	of 	Certificate 	of 	Need 	Controls 	on 	Hospital 	Investment," 	Milbank
Memorial 	Fund 	Quarterly, 	54 	(Spring), 	pp. 	185-214; 	and 	(1979) 	Hospital
Certificate 	of 	Need 	Controls: 	Impact 	on 	Investme1ll, 	Costs, 	and 	Use,
American 	Enterprise 	Institute; 	(2) 	F.J. 	Hellinger 	(1976), 	"The 	Effect 	of
Certificate-of-Need 	Legislation 	on 	Hospital 	Investment," 	Inquiry, 	13 	(June),
pp. 	187-193; 	(3) 	Frank 	A. 	Sloan 	and 	Bruce 	Steinwald 	(I 980a), 	"Effects 	of
Regulation on Hospital Costs and Input Use," Journal of Law and Economics,
23 	(April), 	pp. 	8I-I09;and (l980b) 	Insurance, 	Regulation, and 	Hospital Costs,
Lexington 	Books; 	(4) 	D.R. 	Cohodes 	(1980), 	Institutional 	Response 	to
Regulation: Certificate of Need and Hospitals, Unpublished PhD Dissertation,
Harvard 	University 'School 	of 	Public 	Health, 	January; 	(5) 	Policy 	Analysis,
Inc .• and Urban Systems Research and Engineering, Inc. (1980), Evaluation of
the Effects of Certificate of Need Programs, HRA #231-77-0144, Department
of Health and Human Services; (6) Craig Coelen and Daniel Sullivan (1981),
"An 	Analysis 	of 	the 	Effects 	of 	Prospective 	Reimbursement 	Programs 	on
Hospital 	Expenditures," 	Health 	Care 	Financing 	Review, 	2 (Winter), 	pp. 	1-40;
(7) 	Paul 	L. Joskow (l9l:0), "The 	Effects of Competition and 	Regulation on
Hospital 	Bed Supply and the Reservation Quality of the Hospital," The Bell
( continued ... )
2

examine the effect of CON on the cost of health care, while seven examine
the 	effect 	of 	these 	r:gulations 	on 	hospital 	investment. 7 	Rather 	than
examine the Bureau of Economics' studies alone, I would like to summarize
the conclusions that follow from all of the studies.
In their 1981 review of five studies of CON regulation, Bruce Steinwald
and Frank Sloan, two Vanderbilt University health economists, wrote:
Research on [certificate of need] hospital regulation has produced
remarkably 	consistent 	results. 	The 	empirical 	evidence 	indicates
that 	certificate-of-need 	laws 	have 	not 	been 	successful 	in
restraining per diem, per case, or per capita hospital costs. 8
There 	has 	been 	little 	evidence 	in 	the 	10 	or 	so 	studies 	that 	have
appeared 	since 	the 	Steinwald 	~nd 	Sloan 	review 	to 	alter 	the 	conclusions
drawn at that time. 	There is near total agreement among health economists
that Certificate of Need regulation does not achieve the goal of lowering the
costs 	of 	health 	care: some studies 	find 	costs are 	the same 	whether or 	not
CON 	regulations 	are 	present, 	others 	find 	that 	costs 	are 	actually 	higher
where 	there 	is 	CON.9 	'The 	majority 	of 	these 	studies 	have 	examined 	the
6(... continued )
Journal 01 Economics, 	11 	(Autumn), pp. 421-447; (8) Frank 	A. Sloan (1981),
"Regulation and the Rising Cost of Hospital Care," Review 01 Economics and
Statistics, 	(November), 	pp. 	479-487; 	(9) 	Paul 	L. 	Joskow 	(1981), 	Controlling
Hospital 	Costs: 	The 	Role 	01 Government 	Regulation, 	MIT 	Press; 	(IO) 	Steven
Eastaugh (l982), "The Effectiveness of Community-based 	Hospital 	Planning:
Some Recent Evidence," Applied Economics, 14 (October), pp. 475-490; (11) A.
Lee, 	H. 	Birnbaum, and 	C. 	Bishop (1983), "How 	Nursing 	Homes 	Behave: 	A
Multi-Equation 	Model 	of 	Nursing 	Home 	Behavior," 	Social 	Science 	and
Medicine, 	17, p. 	1897; (12) 	Dean 	E. 	Farley and Joyce 	V. 	Kelly (1985), The
Determinants 	01 	Hospitals' 	Financial 	Positions, 	National 	Center 	for 	Health
Services 	Research; 	and 	(13) 	John 	W. 	Mayo 	and 	Deborah 	A. 	McFarland
(1989), 	"Regulation, 	Market 	Structure, 	and 	Hospital 	Costs," 	Southern
Economic 	Journal, 	55 	(January), 	pp. 	559-569. (In 	some cases, essentially 	the
same 	study 	has 	been 	published 	in 	two 	different 	places. 	These 	are 	listed
together and are only counted as one study.)
7 Two 	of 	the 	studies 	-- 	Sloan 	and 	Stein wald 	(1980a 	and 	1980b) 	and
Policy 	Analysis, 	Inc., 	and 	Urban 	Systems 	Research 	and 	Engineering, 	Inc.
(1980) 	-- 	examine 	the 	effects 	of 	CON 	regulation 	on 	both 	the 	costs 	of
hospital care and on hospital investment behavior.
8 Bruce 	Steinwald 	and 	Frank 	A. 	Sloan, 	"Regulatory 	Approaches 	to
Hospital Cost Containment: A Synthesis of the Empirical Evidence," in A New
Approach 	to 	the 	Economics 	01 	Health 	Care, 	edited 	by 	Mancur 	Olson,
American Enterprise Institute, 1981, p. 285.
9 Supporters 	of 	CON 	regulation 	sometimes 	point 	to 	the 	number 	or
dollar amount of projects denied, withdrawn or modified as a result of the
(continued ... )
3

effect 	of 	CON 	on 	hospital 	services. 1o 	However, similar 	results 	have 	been
9(... continued)
CON 	process 	as 	an 	indication 	of 	the 	value 	of 	CON 	regulation. 	These
amounts, however, are not necessarily an accurate measure of the "excessive"
capital investment deterred because CON regulation may cause the filing of
applications 	for 	more 	projects 	than 	would 	actually 	be 	carried 	out 	in 	an
unregulated market .
. CON 	regulation 	may 	force 	firms 	to compete for a 	limited 	number of
project 	approvals. 	Because 	the 	projects 	are 	approved 	on 	a 	showing 	of
"need", applicants may assume that any CON granted reduces the likelihood
that a approval will be granted to another applicant with a similar project.
This 	generates 	pressure 	to 	file 	preemptively 	or 	defensively 	(particularly
under combined review, where applications for similar projects are required
to file at the same time). 	When several applicants seek approval of similar
projects in the same area, that does not mean that in the absence of CON
regulation all 	proposed projects would be carried out. 	The applicants may
realize 	that 	demand 	exists 	for 	only one 	project. 	Therefore, denial 	of all
applications 	but one 	would 	not 	represent actual savings resulting from 	the
regulations.
Moreover, some applicants may not be committed to carrying out their
proposed 	project 	even 	if 	selected. 	An 	applicant 	may 	be 	protecting 	its
perceived 	long-run 	interests or 	may 	simply 	be 	filing 	to 	delay or 	frustrate
other applications. 	Therefore, the number of applications denied, withdrawn,
or modified may substantially overstate actual deterrence.
The 	anticipation 	tliat 	projects 	will 	not 	be 	approved 	may 	also 	deter
firms from filing for projects they would actually construct in the absence
of CON regulation. 	In this case, the number of applications denied would
understate 	the 	effectiveness 	of 	the 	CON 	process. 	Since 	the 	number 	of
applications 	denied, 	withdrawn, 	or 	modified 	may 	either 	overstate 	or
understate the actual number of projects deterred, this is not a reliable way
to measure the effectiveness of the regulations.
10 Of the nine studies examining the effect of CON on hospital costs,
Coelen and Sullivan (1981), Sloan (1981), and Joskow (1981) find 	that CON
has no significant effect on costs. 	Farley and Kelly (1985), Noether (1987),
and 	Sherman 	(1988) 	all 	found 	that 	hospital 	costs 	were 	higher 	where 	there
was CON regulation. 	Sloan and Steinwald (1980a and 1980b) found that CON
regulation 	has 	no 	significant 	effect 	on 	costs 	where 	CON 	regulation 	is
comprehensive. 	However, 	costs 	were 	higher 	in 	states 	that 	only 	regulated
additions to beds than in states that had no CON regulation.
These 	studies 	use 	cost 	data 	for 	various 	years 	to 	examine differences
between states 	with 	CON 	regulation 	and states without 	it. 	Further, states
have 	enacted 	and 	revi3f;d 	their 	CON 	regulations 	at 	times. 	Two 	of 	the
studies, 	those 	of 	Coele:.1' and 	Sullivan 	and 	Sloan 	and 	Steinwald, 	look 	for
differences in the rate of change in costs between states that have CON and
those that do not. 	Sherman (1988) examines differences in costs associated
with different review thresholds -- i.e., with differences in the stringency of
the CON regulation. 	Only one of the studies -- Mayo and McFarland (1989)
.- finds 	that 	hospital 	costs 	are 	lower 	where 	CON 	regulation 	is 	more
(continued ... )
4

found in studies of nursing homes and of firms providing home health care
services. 11
In 	addition 	to 	the 	studies 	that 	empirically 	examine 	the 	effects 	of
Certificates of Need, one recent study has sought to establish the theoretical
relationship between hospital costs and the presence of CON regulation. 	The
author of this study found that, even at a theoretical level, it was not clear
that 	CON 	regulation 	could 	control 	costs. 	Whether a 	perfectly 	functioning
CON program would reduce hospital costs depends crucially on the way in
which' hospitals 	are 	reimbursed 	and 	on 	whether 	the 	main 	effect 	of CON
regulation is to limit expansion of existing hospitals or to keep new hospitals
from opening. 	According to the study, CON should be expected to lead to
lower 	costs 	per 	admission 	in 	some 	cases; 	in 	others 	it 	will 	lead 	to 	higher
costs. 	Interestingly, 	wh(~re hospitals 	are 	reimbursed 	on 	a 	per 	case 	basis--
the method Medicare now uses for hospital operating costs _. CON should be
expected to have no effect on costs. l2
In 	sum, 	the 	economic 	evidence 	concerning 	the 	effectiveness 	of 	CON
regulation 	still 	supports 	the 	1981 	conclusions 	of Steinwald 	and 	Sloan 	that
lo(... continued)
stringent. 	While no economic study is methodologically perfect, the problems
with 	this 	study, 	which 	are 	discussed 	in 	more 	detail 	in 	footnote 	13, seem
particularly great.
Several of the studies have examined the effect of Certificate of Need
regulation on investment in new hospital assets. 	Most of the studies appear
to find 	no significant reduction in hospital assets in states that have CON
regulation. (See 	Hellinger (1976), Cohodes (1980), 	Policy 	Analysis, Inc., and
Urban 	Systems 	Engineering, 	Inc. 	(1980), 	and 	Eastaugh 	(1982).) 	However,
some 	of 	the 	studies 	have 	found 	that 	Certificate 	of 	Need 	regulation 	has
limited investment in additional hospital beds. (Salkever and Bice (1976 and
1979) and Joskow (1980»· 	Others have found that CON has had no effect or
has 	even 	increased 	the 	number 	of 	beds. (Sloan 	and 	Steinwald 	(1980a 	and
1980b» 	Even 	if 	CON 	has 	reduced 	the 	growth 	in 	new 	hospital 	beds, 	it
appears 	that 	hospitals 	have 	increased 	their 	use 	of 	other 	inputs. 	Salkever
and Bice (1976 and 	1979) found a substitution toward unregulated forms of
capital. 	While 	Sloan 	and 	Steinwald 	(1980a 	and 	1980b) 	did 	not 	find 	a
substitution toward unregulated capital, they found 	that hospitals subject to
CON 	regulation 	tended 	to 	have 	higher employment 	levels 	than 	comparable
unregulated hospitals.
11 Lee, 	Birnbaum, 	and 	Bishop 	(1983) 	found 	that 	nursing 	home 	costs
were higher in states with CON regulation, while Anderson and Kass (1986)
found 	that 	Certificate 	of 	Need 	regulation 	did 	not 	appear 	to 	increase 	the
attainment of economies of scale in home health care services and also that
CON regulation was associated with higher per unit costs.
12 Peter C. Coyte, "Alternative Methods of Reimbursing Hospitals, and
the 	Impact 	of 	Certificate-of-Need 	and 	Rate 	Regulation 	for 	the 	Hospital
Sector," Southern Economic Journal, 53 (April 1987), pp. 853-873.
5

· .
"[C]ertificate-of-need controls ... may be regarded 	as a classic example of
regulatory failure."13
Why have Certificate of Need regulations been ineffective? 	To answer
this 	question 	we 	must 	understand 	that 	the 	key 	justification 	for 	CON
legislation 	was the 	belief that hospitals did not have the 	proper incentives
to control their costs. 	Patients did not directly pay for most of their health
care -- particularly hospital care. 	The costs were paid by private insurance
companies or by the government. 	In addition, in most cases, payment was
on 	a 	retrospective 	cost 	reimbursement 	basis: 	the 	amount 	the 	hospital
received 	was 	determined 	by 	the 	costs 	incurred 	in 	treating 	the 	particular
patient. 	As a result, proponents of planning argued, patients would not be
sufficiently sensitive to high prices; and competition among hospitals would
focus on 	patients' perceptions of quality and convenience. 	Further, it was
argued 	that 	hospitals 	would 	compete 	for 	patients 	by 	competing 	for
physicians, who would be attracted to the hospital that had the fanciest and
most modern facilities. 14
CON regulation may be ineffective because it does not change any of
these 	incentives. 	Hospitals are no more 	likely 	to compete on 	the 	basis of
price with CON regulation than without. 	CON regulation may affect quality
competition 	among 	hos~,jtals by foreclosing 	certain 	avenues 	hospitals could
13 Steinwald and Sloan (1981), p. 296. 	As noted before, only the Mayo
and 	McFarland 	(1989) 	study 	finds 	CON 	regulation 	has 	been 	effective 	in
reducing hospital costs. 	However, there are a number of problems with this
study 	which suggest that 	its findings 	are unreliable. 	First, because of the
way 	the 	authors 	model 	the 	effect of CON 	regulation, CON is 	assumed 	to
affect only the number of beds in a hospital. 	Their approach rules ou't the
possibility 	that other 	forms 	of equipment are substituted 	for 	beds or 	that
additional 	staff 	is 	substituted 	for 	capital 	equipment 	where 	there 	is 	CON
regulation. 	As noted 	in footnote 	10, several studies have found 	that these
kinds 	of substitutions occur. 	Second, as 	its 	measure 	of 	the 	stringency 	of
CON regulation the study uses a function of the percentage of applications
approved. 	As discussed in footnote 9, the number of applications approved
or 	denied 	is 	not 	an 	appropriate 	measure 	of 	the 	effectiveness 	of 	CON
regulation. 	Third, 	rather 	than 	compare 	costs 	in 	states 	with 	and 	without
CON 	regulation 	or 	across 	states 	with 	different 	cost 	thresholds, 	this 	study
examines costs 	in differc:nt parts of a single state -- Tennessee. 	However,
CON 	decisions 	are 	made 	at 	the 	state 	level. 	Thus, 	there 	are 	no 	real
differences in CON stringency in the data. 	Finally, the authors use data for
the period 	1980 through 	1984. 	During this period, hospital utilization rates
fell 	considerably, 	in 	part 	because 	Medicare 	introduced 	a 	prospective
reimbursement system (see pp. 12-13) 	The authors do not account for these
changes in an appropriate way in estimating the costs of hospital care.
14 See, 	e.g., 	Joskow 	(1981), 	pp. 	21-31. 	See 	also 	Health 	Planning and
Resources Development Amendments of 1979, Pub. L. No. 96-99, Section 103
(b), 	93 	Stat. 	592 	(1979), 	repealed, 	Publ. 	L. 	No. 	99-660, 	Section 	701 (a), 	100
Stat. 3799 (1986) and the Findings of Fact contained in the North Carolina
Certificate of Need Statute (N.C. Gen. Stat. Section 131£-175 (l».
6

use to achieve their goals. 	However, it does not eliminate any incentives to
be 	extravagant. 	In 	some 	cases, 	existing 	hospitals 	may 	have 	been 	able,
perhaps 	with a delay, to obtain approval 	for arguably uneconomic projects
even with CON regulation. 	Other hospitals were able, the evidence suggests,
to find 	new ways to compete. 	For example, if the CON law only required
approval 	for 	some 	kinds 	of 	capital 	investments 	-- 	e.g., 	new 	beds 	-- 	the
hospitals could add other kinds of fancy equipment. 	If all equipment was
covered, hospitals could compete by providing additional staff. 15 	Thus, CON
regulation 	did 	not 	~c wer 	costs 	by 	ending 	supposedly 	unnecessary
expenditures, it merely r:directed such expenditures into other areas.
B. 	CON Regulation Interferes with Competition and Innovation In Health
Care Markets.
The 	foregoing 	discussion 	suggests 	that 	CON 	regulation 	has 	been
ineffective. 	But 	more 	than 	that, 	these 	regulations 	have 	probably 	been
harmful. 	The CON regulatory process may increase prices to consumers by
protecting health care providers from competition by new entrants. 16 	CON
also reduces the possibility of entry by firms that could provide services of
higher 	Quality 	or 	lower 	cost 	than 	existing 	firms, 	and 	that 	could 	perhaps
replace providers that are not effectively meeting consumer needs. 	This may
explain 	why several of the studies I reviewed 	today found 	that costs were
higher in states with CON regulation.
Because Certificate of 	Need 	regulation delays or 	reduces the prospect
of new entry and expansion,11 it increases the likelihood that providers will
15 Salkever 	and 	Bice 	(1976 	and 	1979) 	found 	a 	substitution 	toward
unregulated forms of capital. 	While Sloan and Steinwald (1980a and 1980b)
did 	not 	find 	a 	substitution 	toward 	unregulated 	capital, 	they 	found 	that
hospitals subject to CON regulation tended to have higher employment levels
than comparable unregulated hospitals.
16 Richard 	A. 	Posner 	(1974), 	"Certificates 	of 	Need 	for 	Health 	Care
Facilities: 	A 	Dissenting 	View," 	in 	Regulating 	Health 	Facilities 	Construction,
edi ted by Clark Ha vigh urst, American Enterprise Insti tu te, pp. 113-117.
11 The 	CON 	process 	generally 	places 	the 	burden 	on 	the 	applicant 	to
demonstrate 	that 	a 	need 	is 	not 	being 	served 	by 	those 	currently 	in 	the
market. 	For 	example, 	N.C. 	Gen. 	Stat. Section 	131E-183 	(a)(3) 	states: 	"The
applicant shall identify the population to be served by the proposed project,
and 	shall 	demonstrate 	the 	~ 	that 	this 	population 	has 	for 	the 	services
proposed .... " (emphasis added) 	Similarly, N.C. Gen. Stat. Section 	13IE-
183 (a)(6) states: "-The applicant shall demonstra te that the proposed project
will 	not 	result 	in 	unnecessary 	duplication 	of 	existing 	or 	approved 	health
service capabilities or facilities."
The 	process 	of 	preparing 	and 	defending 	a 	CON 	application 	is 	often
costly and time-consuming, particularly if the application is opposed by firms
already in the market. 	For example, an evaluation of the CON program in
(continued ... )
7

exploit 	whatever 	market 	power 	they 	have, 	individually 	or 	collectively, 	to
raise 	prices above, or reduce quality 	below, the competitive level. 	That is
why 	the 	Federal Trade Commission 	has cited 	the entry 	barrier created 	by
CON 	regulation 	as 	a 	factor 	significantly contributing 	to 	the 	potential 	for
anticompetitive effects from hospital mergers. 18
To 	the 	extent 	that 	CON 	regulation 	reduces 	the 	supply 	of 	particular
health 	services 	below 	competitive 	levels, 	prices 	for 	these 	services 	can 	be
expected 	to 	be 	higher 	than 	they 	would 	be 	in 	an 	unregulated 	market. 19
17( .•. continued)
Michigan found 	that the number and complexity of CON appeals increased
dramatically from 	1979 to 	1986, and comparative reviews were particularly
protracted. 	(Michigan Statewide Health Coordinating Council, An Evaluation
of 	the 	Certificate 	of 	Need 	Program, 	March 	1987, 	pp. 	29-34) 	See 	also,
Hospital 	Corporation 	of 	America 	[Chattanooga 	acquisitions], 	160 	F.T.C. 	at
490-92. 	CON regulation may also create opportunities for existing firms to
abuse 	the 	regulatory 	process 	to 	prevent 	or 	delay 	new 	competition. 	(Terry
Calvani 	and 	Neil 	Averitt 	(1987), 	"The 	Federal 	Trade 	Commission 	and
Competition in the Delivery of Health Care," Cumberland Law Review, 17, p.
283 (discussing potential for health providers to use CON process for "non-
price 	predation"); St. Joseph's 	Hospital v. Hospital Corporation of America,
795 	F.2d 	948, 	959 (1Ith 	Cir. 	1986) (defendants' 	misrepresentations 	to state
health 	planning 	body 	concerning 	plaintiff's CON application 	not 	protected
from 	antitrust 	scrutiny); 	Hospital 	Corporation 	of 	America 	[Chattanooga
acquisitions], 106 F.T.C. at 492.)
18 American 	Medical 	International, 	104 	F.T.C. 	at 	200-201 	(1984);
Hospital 	Corporation 	of 	America 	[Chattanooga 	acquisitions], 	106 	F.T.C. 	at
489-496. 	In affirming the Commission's decision in Hospital Corporation of
America, Judge Posner agreed 	that CON regulation can create a 	barrier to
entry. 	(Hospital 	Corporation of 	America 	v. 	Federal Trade Commission, 807
F.2d. 1381, 1387 (7th Cir:nit, 1987»
Some 	shared 	service 	arrangements, 	consolidations, 	and 	other 	joint-
provider 	activities 	could 	significantly 	threaten 	competition, 	unless 	the
prospect 	of 	new 	entry 	would 	keep 	the 	market competitive 	by 	making any
significant, sustained price increases unprofitable. 	CON regulation can thus
conflict 	with 	cost-containment 	by 	limiting 	providers' 	freedom 	to 	pursue
efficiencies 	without 	also 	creating 	unacceptable 	risks 	of 	anti-competitive
effects.
19 Where 	prices are 	regulated, 	the "price increase" may 	take 	the 	form
of reductions in service quality, so that consumers receive services of lesser
value 	for 	the 	same 	price, 	instead 	of 	paying 	more 	money 	for 	the 	same
services.
Severe shortages of capacity can protect firms that provide substandard
service, 	not 	only 	from 	competitive 	pressures 	to 	upgrade 	performance, 	but
also 	from 	regulatory 	pressures 	to 	adhere 	to 	licensure 	requirements. 	For
example, a state agency may be reluctant to close a nursing home for major
violations 	of 	licensure 	requirements 	if 	the 	patients 	cannot 	be 	placed
(continued ... )
8

Curtailing services or facilities may force some consumers to resort to more
expensive 	or 	less-desirable substitutes, 	thus 	increasing costs 	for 	third-party
payers or patients. 	For example, if nursing home beds are not available, the
discharge of patients from more expensive hospital beds may be deiayed 20 or
patients may be forced to use nursing homes far from home.
CON 	regulation 	may 	also 	interfere 	with 	competition 	by 	delaying 	the
introduction 	and 	acceptance 	of 	innovative 	alternatives 	to 	costly 	treatment
methods. 	Regulators may lack the information to determine how many such
facilities are 	needed, or they 	may not respond 	rapidly enough 	to changing
market 	conditions. 	It 	is 	difficult 	to 	predict 	demand 	for 	innovations 	in
medical practice. 21 	Providers have strong financial incentives, which health-
planning agencies 	lack, 	to 	gather 	information 	and 	to adjust 	to 	unexpected
changes 	in 	costs 	or demand. 	Thus, reliance on 	market 	forces 	is likely 	to
provide more rapid and desirable responses to changing conditions than CON
regulation.
C. 	Healtb 	Care 	Markets 	Are 	Now 	More 	Able 	to 	Function 	Effectively
Without Certificate of Need Regulation.
As I noted, CON regulation was imposed in the 	belief that consumers
lacked 	strong 	incentives 	to 	seek 	out 	lower 	cost 	health 	care 	and 	that
providers, 	therefore, did 	not 	have 	sufficient incentives 	to keep 	their costs
down. 	But, CON 	regulation 	has not successfully reduced 	health care costs
because 	it 	does 	not 	aff ~ct those 	incentives. 	However, 	recent 	changes 	in
health 	care 	markets 	that do alter incentives shculd 	increase 	the 	likelihood
that unregulated competition will provide health care services efficiently.
Private and public insurance still pays for the vast majority of health
19( ... continued)
elsewhere. (See J. Feder and W. Scanlon (1980), "Regulating the Bed Supply
in Nursing Homes," Milbank Memorial Fund Quarterly, 58, p. 76.)
20 U.S. 	General 	Accounting 	Office 	(1985), 	Constraining 	Health 	Care
Expenditures. Achieving Quality Care at Affordable Cost, pp. 93-94.
21 	Freestanding 	ambulatory 	surgical 	centers 	(FASCs) 	offer 	an
innovative, 	less 	costly 	alternative 	to 	hospital 	surgical 	facilities. 	However,
evidence suggests that the growth of FASCs generally has been hampered by
the CON process. 	(Dan 'Ermann and Jon Gabel (1985), "The Changing Face
of American Health Ca:~," Medical Care, p. 407) 	In addition, action on all
CON applications for FASCs in Pennsylvania was delayed by six months while
a 	CON 	task 	force 	reviewed 	the 	need 	for 	these 	facilities. 	(Budget 	and
Finance 	Committee 	of 	the 	Pennsylvania 	Legislature, 	Report on 	a 	Study 	of
Pennsylvania's Certificate of Need Program, February 1987, p. 14.)
9

care.22 	This is 	particularly 	true of 	hospitalization, 	where only 9.4 	percent
of costs were paid directly by consumers in 1986.23 	However, consumers and
employers have become more sensitive to the costs of health 	insurance and
have therefore sought ways to increase incentives for 	health care providers
to behave efficiently.
One indication of this increased attention to cost control is the growth
in 	health 	maintenance 	organizations 	(HMOs) 	and 	preferred 	provider
organiza tions 	(PPOs). 	By 	1988, 	HMO 	enroll men twas 	31.4 million. 24 	This
represented more than a five-fold increase from the 6.0 million enrolled in
1976. 25 	Today, an estimated total of 45 to 50 million people have the option
of 	using a 	preferred 	provider.26 	In December 	1984, only 	1.3 	million 	were
enrolled in plans with a PPO option. 27
Another recent change in health insurance has been 	the tendency for
companies to self-insure. 	By 1987, about 60 percent of employers were self-
insuring 	in 	whole 	or 	in 	part.28 	According 	to one source, these employers
are increasingly interested in competitive alternatives to further reduce their
health costs.29
22 Direct 	payments 	by 	consumers 	accounted 	for 	28.7 	percent 	of 	total
personal 	health 	care 	expenditures 	in 	1986, 	the 	same 	level 	found 	in 	1980.
(Health. United States. 1987, table 102, p. 158)
23 Health. 	United 	States. 	1987, 	table 	103, 	p. 	159. 	This 	represents 	a
slight increase from 1977, when only 6 percent of hospital expenditures were
paid 	directly 	by consumers. 	(Paul Feldstein (1979), Health Care Economics,
John Wiley and Sons, p. 32.)
24 As 	of 	June 	19f:8, 	there 	were 	643 	HMOs 	in 	the 	United 	States.
(Telephone interview wi:1t David Glazer of InterStudy, February 10, 1989.)
25 Health. United States. 1987, table 112, p. 170.
26 There are currently 637 	PPOs in operation in 	the U.S. 	(Telephone
interview with Ed Pickens, American Medical Care and Review, February 10,
1989.)
27 Jon Gabel, Dan Ermann, Thomas Rice, and Gregory de Lissovoy, "The
Emergence and 	Future of PPOs," Journal of Health 	Politics. Policy and Law,
II (Summer), p. 306.
28 Based on data in Steven DiCarlo and Jon Gabel (1988), "Conventional
Health 	Plans: 	A 	Decade 	Later," 	Research 	Bulletin, 	Health 	Insurance
Association of America, p. 	II. 	Before 	1975, less than 	10 percent of health
insurance 	premiums 	went 	into 	self-insured 	plans. 	(Jeff 	Goldsmith 	(1984),
"Death 	of 	a 	Paradigm: 	The 	Challenge 	of 	Competition, 	Health 	Affairs, 	3
(Fall), p. 9)
29 Goldsmith (19841,' pp. 9-10.
10

The percentage of firms requiring reviews before a patient is admitted
to 	a 	hospital 	and 	requiring 	second 	opinions 	prior 	to 	surgery 	has 	also
increased. 	By 	1987, 	preadmission 	certification 	was 	required 	by 	over one-
third of company-offered health plans,so compared with 2 percent in 1982. 31
In 	1987, more than 40 percent of employee health plans mandated a second
opinion prior to surgery,32 while only 28 percent of plans did so in 	1984. 33
Finally, 	the 	use of copayments and deductibles in 	private health 	insurance
plans 	has 	increased. 34 	These changes 	increase 	incen ti ves 	for 	consumers 	to
purchase less expensive health care and forego unnecessary treatments. 3ri
Government-funded 	programs 	have 	also 	introduced 	changes. 	The
Medicare 	system 	has 	converted 	payment 	of 	hospital 	operating 	costs 	to 	a
prospective payment approach, in which standardized payments are based on
the patient's diagnosis, rather than on the costs incurred in each individual
case. 36 	In 	addition, 	many 	states 	have 	been 	experimenting 	with 	cost
so DiCarlo Gabel (1988), p. 11.
31 Goldsmith (1984;" 	p. 14.
S2 DiCarlo and Gabel (1988), p. II. 	Moreover, an additional 10 percent
required a second opinion in some cases.
ss Goldsmith (1984), p. 14.
S4 Between 1982 ar:d 1984, the percentage of insurance plans paying 100
percent of hospital charges for 	the first days of hospital care fell from 67
percent to 42 percent. 	The percentage paying 	100 percent of surgical fees
fell 	from 	42 	percent 	to 	26 	percent. 	In 	1982, 	only 	4 	percent 	of 	'plans
required an annual deductible of $200 or more per family. (Goldsmith (1984),
p. 	12) 	By 	1987,· the average plan 	had an deductible of $330. (Computed
from figures in DiCarlo and Gabel (1988), p. 14.)
Sri A 	recent 	Rand 	Corporation 	study 	funded 	by 	the 	Department 	of
Health and Human Services demonstrated that consumers demand less health
care 	when 	they 	have 	to 	pay 	a 	higher 	portion 	of 	the 	cost 	of 	that 	care.
(Willard G. Manning, Joseph P. Newhouse, Naihua Duan, Emmett B. Keeler,
Arleen 	Leibowitz, and M_ Susan Marquis (1987), "Health Insurance and 	the
Demand 	for 	Medical 	Care: 	Evidence 	from 	a· Randomized 	Experiment,"
American Economic Review, 77 (June), pp. 251-277)
S6 In 	contrast 	to 	operating 	cost 	reimbursement, 	prospective
reimbursement for 	the capital costs of hospital care has been delayed until
at least 1991. 	(See Omnibus Budget Reconciliation Act of 1987, Pub. L. No.
100-203, Section 4006 (b)(I), 	101 	Stat. 	1330-52 (1987) (amending 42 U.S.C.A.
1395ww; 	delays 	implementation 	of 	prospective 	reimbursement 	for 	capital-
related costs until 1991.) 	As a result, it is difficult to predict the effect of
Medicare 	prospective 	reimbursement 	on 	hospital 	investment 	activity.
However, 	there 	are 	several 	reasons 	to 	believe 	that 	changes 	in 	Medicare
reimbursement 	already 	made 	and 	those 	proposed 	will 	pressure 	hospitals 	to
(continued ... )
II

containment 	strategies 	for 	their 	Medicaid 	programs. 	Several 	states 	have
begun 	using 	HMOs 	or 	other 	capitation 	and 	case-management 	strategies 	to
provide 	care 	to 	Medicaid 	patients. 37 	In 	addition, 	some 	states 	have 	used
prospective reimbursement plans to pay for nursing home costs.38
These changes have 	had substantial effects on 	the demand 	for 	health
care. 	Between 	1975 and 	1986, hospital usage rates declined more than one-
36(••• continued)
reduce 	any 	unnecessary 	investment 	even 	today. 	First, 	the 	costs 	of 	any
major capital investment programs undertaken now will have to be recovered
in hospital charges long past 1991. 	Therefore, current investment plans will
be substantially 	affecteli 	by any anticipated 	changes in 	reimbursement 	for
capital 	costs 	in 	1991. 	Second, some studies 	ha ve 	found 	tha t 	increases 	in
hospital capital investment result in increases in hospital operating expenses.
(See Gerard Anderson and Paul B. Ginsberg (1984), "Medicare Payment and
Hospital 	Capital: 	Future 	Policy 	Options," 	Health 	Allairs, 	3 	(Fall), 	p. 	37,
citing a 1982 study by Arthur D. Little, Co., "Development of an Evaluation
Methodology for Use in Assessing Data Available to the Certificate of Need
(CON) and Health Planning Problems," Office of the Assistant Secretary for
Health, Department of Health and Human Services, Contract No. 233-79-4003)
Thus, 	existing 	restraints 	on 	operating 	expense 	reimbursement 	may 	restrain
capital 	spending 	as 	well. 	Finally, 	there 	have 	been substantial 	declines 	in
hospital 	admissions and average 	length 	of stay for Medicare patients since
the 	prospective 	reimburst:ment 	system 	was 	put 	in 	place. 	During 	the 	first
three years of the progr3m, total Medicare admissions fell 	by 	11.3 percent,
and admissions per Medicare enrollee fell by 15.9 percent. 	During the same
period, 	the 	average 	length 	of 	stay 	for 	Medicare 	enrollee 	fell 	17 	percent
(Stuart 	Guterman, 	Paul 	W. 	Eggers, 	Gerald 	Riley, 	Timothy 	F. 	Greene, 	and
Sherry 	A. 	Terrell 	(1988), 	"The 	First 	3 	Years 	of 	Medicare 	Prospective
Payment: 	An 	Overview," 	Health 	Care 	Financing 	Review, 	9 (Spring), 	pp. 	68-
69). 	Such a significant reduction in hospital utilization is likely to make it
more difficult for hospitals to justify new capital expenditures.
37 Under 	a 	capitation 	plan, 	a 	provider 	receives 	a 	fixed 	payment 	per
month 	which 	depends 	on 	the 	number 	of 	covered 	patients 	who 	select 	that
firm 	or 	individual 	as 	their 	primary 	care 	provider. 	This 	payment 	is
independent of the costs of any care provided to any particular patient. 	In
some 	cases, 	states 	have 	used 	partial 	capitation 	plans 	where 	the 	provider
receives 	a 	fixed 	fee 	to 	cover 	some 	set 	of 	basic 	services. 	However,
additional 	payments are 	made 	if the 	patient needs care 	not covered 	under
the capitation agreement. 	(Deborah A. Freund and Edward Neuschler (1986),
"Overview of Medicaid Capitation and Case-Management Initiatives," Health
Care Financing Review, (A .1nual Supplement), pp. 21-30)
38 James 	H. 	Swan, 	Charlene 	Harrington, 	and 	Leslie 	A. 	Grant 	(1988),
"State 	Medicaid 	Reimbursement 	of 	Nursing 	Homes, 	1978-86," 	Health 	Care
Financing Review, 9 (Spring), pp. 33-50.
12

third. S9 	While some of this decline was probably the result of technological
change 	in 	health 	care, economic 	incentives also 	appear 	to 	have 	played 	an
important 	role. 	Before 	Medicare 	introduced 	its 	prospective 	reimbursement
system, 	hospitalization 	rates 	declined 	more 	slowly 	for 	senior 	citizens 	than
for 	younger 	patients. 	Since 	1983, 	when 	prospective 	reimbursement 	was
introduced, 	senior 	citizen 	usage 	has 	declined 	at 	8.3 	percent 	per 	year, 	the
same rate as for the population at large.40
As consumers and health insurers become more cost-conscious, hospitals
with inflated costs and prices will increasingly risk losing business. 	This is
particularly 	true where HMOs and PPOs can direct their large numbers of
patients 	to 	hospitals 	that 	charge 	lower 	fees. 	Thus, 	the 	growing 	cost
sensitivity of consumers and 	health 	insurers should 	increase 	incentives for
hospitals to provide quality service at the lowest possible price.
D. 	Other 	Arguments 	'n 	Favor or 	Certificate or 	Need 	Regulation 	Do Not
Support Such Interference With the Competitive Market.
Several other rationales for Certificate of Need frequently crop up. 	I
would briefly like to comment on three: (l) that CON regulation is necessary
to assure quality health care; (2) that state taxpayers will face higher costs
to provide hospital care for the poor if CON regulation is eliminated; and (3)
that the State's Medicaid costs for nursing home care will increase if CON
regulation is ended.
1. 	CON 	regulation 	is not necessary to assure Quality in the provision of
health care.
States often 	suggest 	that 	assuring 	quality 	is 	one 	of 	their 	reasons 	for
enacting Certificate of Need legislation.n 	However, CON does not appear to
be effective in assuring quality. 	A Certificate of Need review occurs only
when a hospital or other health care facility wishes to make an investment
SQ In 1975, the rate of hospital utilization was 1,254.9 days of care per
1,000 	persons. 	(National 	Cen ter 	for 	Health 	Statistics, 	Health. 	United 	States.
1978, 	DHEW 	Publication 	No. 	(PHS) 	78-1232, 	Public 	Health 	Service, 	U.S.
Government Printing Office, 1978, table 	101, p. 308) 	In 1986, the rate was
only 833.1 	days of care per 1,000 persons. (Health. United States. 1987, table
63, p. 109.
40 Between 	1975 and 	1980, hospital use by persons aged 65 and above
declined at a rate of 0.33 percent per year. 	For the population as a whole,
the 	rate of decline was 	1.98 percent. 	Between 	1980 and 	1983, the rate of
decline 	was 	0.77 	percent 	per 	year 	for 	seniors 	and 	2.05 	percent 	for 	the
population as 	a 	whole. (Based on data 	in Health. 	United 	States. 	1978, table
101, p. 308, and Health. United Slates. 1987, table 63, p. 109.)
41 See, 	e.g., 	James 	B. 	Simpson 	(1986), 	"Full 	Circle: 	The 	Return 	of
Certificate of Need Regulation of Health Facilities to State Control," Indiana
Law Review, 19, pp. 1028·)030.
13

that 	requires 	CON 	approval. 	Thus, 	the 	CON 	process 	cannot 	be 	used 	to
discipline 	an 	institution 	that 	is 	providing an 	unacceptable 	quality 	of care
unless 	the 	institution 	is 	regularly applying 	for 	new 	project approvals. 	On
the other hand, periodic accreditation and licensing reviews provide a way to
monitor 	quality 	on 	an 	ongoing 	basis. 	These 	mechanisms 	are 	probably
sufficient to ensure quality. 	CON regulation appears both unnecessary and
largely ineffective as a means of quality control. 4:Z
2. 	Eliminating 	CON 	regulation 	wjll 	not 	increase 	the 	costs 	of 	providing
hospital care to the poor.
While 	the 	cost 	of 	indigent 	care 	is 	frequently 	cited 	in 	debates 	on
Certificate 	of 	Need,43 	the 	relation 	to 	CON 	regulation 	is 	unclear. 	One
possibility 	is 	that, absent competition, 	hospitals can charge 	paying patients
rates high enough to cover the unreimbursed costs of indigent care. 4•
If this is occurring, several observations would appear to be in order.
First, such a system may not be able to survive, even with CON regulation,
as 	cost-conscious 	private 	insurers 	and 	governments 	pressure 	providers 	to
operate more efficiently. 	For example, hospitals not subsidizing care for the
poor 	with 	higher 	rates 	to 	paying 	patients 	will 	be 	more 	successful 	in
competing for patients.
Second, 	hospital 	rates 	that cover the cost 	of subsidizing care for 	the
poor constitute an indirect tax on paying users of hospital services and on
all holders of private health insurance. 	While this "tax" is not paid directly
to 	the 	government, 	in 	its effect, 	it 	is as 	much 	a 	tax 	as a 	direct 	levy on
4: The CON quality assurance role is sometimes justified by pointing to
epidemiological 	studies 	that 	show 	that 	hospitals 	that 	perform 	certain
operations more frequently have lower mortality rates from those operations.
(See, 	e.g., 	Simpson 	(1986), 	p. 	1030.) 	However, 	accreditation 	and 	licensing
should be able to assure that adequate levels of quality are maintained here
as 	well. 	If 	a 	certain 	volume 	is 	necessary 	to 	assure 	quality 	in 	certain
surgical procedures, a hospital could be granted only a provisional license or
accreditation to perform that operation. 	To be fully-licensed or accredited,
the 	hospital 	would 	have 	to 	demonstrate 	that 	it 	is 	generating 	enough 	of
patients to assure quality. 	If, after some period of time, the hospital is not
meeting this requirement, the license or accreditation to perform that service
would be withdrawn. 	('lie advantage such an approach would have over the
CON 	process 	is 	that 	a 	hospital 	which 	can 	offer 	the 	service 	at 	a 	higher
quality 	level 	or 	a 	lower 	cost 	would 	be 	able 	to 	enter 	and 	compete 	with
existing providers. 	This is much more difficult, if it is possible at all, with
a CON process.
43 See, e.g., 	M 	Le"ner, 	et 	al. 	(1987), 	Investigation 	of Certain 	Issues 	in
Connection 	With 	the 	Virginia 	Certificate 	of Need 	Law, 	in 	which 	one 	of 	the
questions asked 	of all 	parties expressing opinions on CON 	repeal 	was 	how
repeal would affect the provision of medical care for the indigent.
44 This argument is suggested in Lerner, et al. (1987), p. YII.22.
14

hospital 	services 	or 	health 	insurance 	premiums.45 	In 	either 	case, 	the
consumer -- i.e., the taxpayer -- pays a price that exceeds the 	value of the
service provided. 	Furthermore, the costs of the current system are probably
greater than would be necessary if an alternative tax was imposed to pay for
indigent care.46
Third, any such indirect tax is highly regressive. 	The costs of health
care 	and 	of 	health 	insurance 	are 	no 	lower 	for 	low 	income 	families 	and
individuals 	than 	for 	the 	well-to-do. 41 	Thus, 	low 	income 	families 	spend 	a
higher percentage of thetr income on health insurance and health care.48
45 Several states, including Florida, Wisconsin, South Carolina, and New
York have developed procedures under which funding for indigent health care
is financed from taxes on hospital revenues. (See M Lerner, et aI., (I987), p.
VII.24, n.·) 	We take no position on whether a tax on hospital revenues or
on 	health 	insurance 	premiums 	is 	superior 	to 	other 	alternatives 	such 	as
funding indigent care from general tax revenues.
46 There 	are 	two 	reasons 	for 	this. 	First, 	as 	noted 	above, 	the 	CON.
process probably inhibits competition and slows innovation. 	This is apt to
result in higher costs, lower quality, or both. 	This inefficient provision of
services would be eliminated if CON was repealed and an alternative means
found to fund indigent care. 	Second, if CON regulation limits entry of new
health facilities for the purpose of guaranteeing prices high enough to cover
the 	costs 	of 	indigent 	care, 	the 	actual 	payments 	to 	health 	facilities, 	in
aggregate, 	are 	likely 	to 	be 	more 	than 	is 	necessary 	to 	do so - even 	if the
facilities behave competitively in pricing their health services. 	This occurs
when existing facilities differ in their burden of indigent care. 	If prices are
high 	enough 	to 	cover 	the 	costs 	of 	indigent 	care 	at 	a 	facility 	with 	the
highest 	percentage of 	indigent 	patients, the same prices will 	be 	more than
adequate 	to 	cover 	indigent 	care 	costs 	at 	the 	facility 	with 	the 	lowest
percentage 	of 	indigent 	patients. 	Thus, 	while 	indigent 	care 	costs 	are
"covered" 	at 	all 	facilities, 	the 	aggregate 	of 	payments 	by 	non-indigent
patients will be in exc~ss of the minimum necessary to cover indigent care
needs. 	In 	this 	case, 	use of 	tax 	money 	to subsidize indigent care, coupled
with the competitive benefits of eliminating CON limitations on entry, may
result in lower costs of subsidizing indigent care.
41 If anything, 	families 	with 	lower incomes tend 	to need 	more health
care. 	In 	1986, families 	with incomes below $10,000 had an average of 6.6
visits 	to 	a 	physician. 	For 	all 	income 	classes 	above 	$10,000, 	the 	average
number of visits was either 5.3 or 5.4 (Health. United States. 	/987, table 57,
p. 	103) 	Hospital 	care 	is 	even 	more 	strongly 	related 	to 	income: 	In 	1986,
families 	with incomes less than $10,000 had 	1,445.9 days of hospitalization
per 	1,000 population. 	The hospitalization rate fell steadily as income rose.
For families 	with incomes above $35,000, the hospitalization rate was 773.8
days of per 1,000 population. 	(Health. United States. /987, table 62, p. 108.)
48 See, e.g., Alain En thoven and Richard Kronick (1989), "A ('onsumer-
Choice 	Health 	Plan 	for 	the 	1990s: Universal 	Health 	Insurance 	ina 	System
(Cl\lll in ued ... )
15

3. 	Eliminating CON regulation need not lead to increases in expenditures
for nursing home beds under the State's Medicaid program.
Turning 	now 	to 	the 	third 	argument, 	states 	also 	appear 	to 	have 	used
CON to control the number of nursing home beds for which they must pay
under the Medicaid program. 49 	Thus, it is feared that CON repeal will be
accompanied 	by 	large, 	uncontrollable 	increases 	in 	the 	Medicaid 	budget. so
The concern appears to be, not with the cost per bed, but rather with the
absolute number of beds. 51
48(".con tinued)
Designed 	to 	Promote 	Quality 	and 	Economy," 	The 	New 	England 	Journal 	oj
Medicine, 320 (January 12), p. 95.
49 See, e.g., Simpson (1986), p. 1032.
50 M Lerner, et al. (1987), VII.24.
51 As 	I 	noted 	above, 	the 	one study 	that 	has examined 	the effect of
CON regulation on the cost of nursing home care found that per unit costs
were 	higher 	in 	states 	with 	CON 	regulation. 	(Lee, 	Birnbaum, 	and 	Bishop
(1983»
The experience in two of the states that first ended CON regulation of
new nursing home bed construction would appear to provide some support for
this expectation: in both Arizona and Utah, deregulation was accompanied by
large 	increases in 	the number of nursing home beds. 	Arizona repealed its
CON regulation of new nursing home bed construction in July 1982, 	(Lerner,
et 	al. 	(1987), 	p. 	VI.12) 	The 	number 	of 	skilled 	nursing 	facility 	and
intermediate care facility beds in Arizona grew from 7,148 in 1982 to 13,734
in 1986 -- an annual rate of growth of 16.3 percent. 	(Charlene Harrington,
James H. Swan, and Le~lie A. Grant (1988), "Nursing Home Bed Capacity in
the 	States, 	1978-1986," 	Health 	Care 	Financing 	Review, 	9 	(Summer), 	p. 	87)
Utah repealed all of its CON requirements in December 1984. (Lerner, et al.
(1987), 	p. 	VI.12) 	In 	1984, 	there 	were 	5,425 	nursing 	home 	beds 	in 	Utah.
(Harrington, 	Swan, 	and 	Grant 	(1988), 	p. 	87) 	By 	1988, 	the 	number 	had
increased 	to 	6,906 	-- 	a 	27.3 	percent 	increase 	over 	four 	years. 	(Telephone
interview 	with 	John 	Williams, 	Office 	of 	Health 	Facilities 	and 	Licensure,
Department of Health, State of Utah, January 27, 1989)
However, 	on 	closer 	inspection, 	it 	is 	not 	clear 	that 	the 	experience 	in
Utah and Arizona would be repeated in other states. 	Prior to deregulation,
both 	states 	had 	a 	ratio 	of 	nursing 	home 	beds 	to 	population 	aged 	65 	and
above that was below the average for the nation as a whole. 	Arizona, with
21 	beds per 1,000 aged citizens, had the lowest bed rate of any state in the
nation. 	By 	1986, 	the 	ratio 	in 	Arizona 	had ·only 	risen 	to 	33.5, 	the 	fifth
lowest ratio among the states. 	Utah had 42.4 beds per 	1000 aged in 	1984,
compared with a national average of 51.9 beds per 1000 aged. 	(Harrington,
Swan, and Grant (I988), p. 89) 	Thus, it is possible that the construction of
new beds in Arizona and Utah merely represented a catching up with demand
that would not be repeated in other states.
16

States 	may 	well 	be 	interested 	in 	limiting 	their 	Medicaid 	expenditures
and 	may, 	therefore, 	conclude 	that 	they 	will 	limit 	the 	number 	of 	nursing
home 	beds 	for 	which 	state 	Medicaid 	funds 	will 	pay. 	The 	Federal 	Trade
Commission's Bureau of Economics has no expertise here; and 	therefore we
cannot 	advise 	the 	State 	of 	North 	Carolina 	on 	how 	many 	beds 	should 	be
available 	for 	Medicaid 	patients. 	However, 	if 	the 	state 	chooses 	to 	impose
such a limit, we would point out that Certificate of Need regulation would
not appear to be the best way of doing so. 	.
If CON regulation is used, the number of nursing home beds available
to everyone is restricted.. 	As a result, citizens paying for their own use of
nursing 	homes, 	or 	those 	having 	private 	nursing 	home 	insurance, 	may 	have
more difficulty finding the service and quality levels they desire.52 	Further,
as 	a 	result of CON entry 	restrictions, such patients will 	likely pay higher
prices 	than 	they 	would 	if 	the 	market 	were 	allowed 	to 	function
competitively.53
Moreover, if CON regulation 	is used to limit the number of beds for
which Medicaid must pay, it is not clear that the state will pay the lowest
possible cost 	for 	the 	use 	of 	those 	beds. 	Indeed, 	the one study examining
nursing home costs and Certificate of Need found that costs were higher in
regulated states. 54
There 	are alternative 	mechanisms 	for 	limiting 	the 	number of nursing
home 	beds 	for 	which 	Medicaid 	reimburses. 	One 	approach 	would 	be 	to
control the maximum rate the state pays nursing homes for care of Medicaid
patients. 55 	Another approach would be to directly limit the number of beds
52 In 	1987, 	51 	pel cent 	of 	nursing 	home 	care 	was 	paid 	for 	by 	those
receiving the care or their families. 	Private health insurance paid for 0.8
percent 	of 	care, 	while 	government 	programs, 	including 	Medicare 	and
Medicaid, 	paid 	for 	47.5 	percent of care. 	(The remainder 	apparently came
from 	philanthropy 	or 	care 	for 	which 	the 	provider 	received 	no
reimbursement.) 	(Health. United States. 1987, table 103, p. 159)
53 Nursing 	home 	costs 	have 	been 	found 	to 	be 	higher 	in 	states 	with
CON regulation. 	(Lee, Birnbaum, and Bishop (1983), p. 1903) 	In addition,
the 	rates 	charged 	private-pay 	patients 	may 	well 	be 	higher 	in 	states 	with
CON regulation, either because the regulations reduce competitive supply or
because nursing homes will 	be able to exercise market power because CON
regulation reduces the lik :lihood of entry.
54 Lee, Birnbaum, and Bishop (1983), p. 1903.
55 North 	Carolina 	currently 	uses 	a 	prospective 	reimbursement 	scheme
for Medicaid nursing home beds under which each home is reimbursed at an
individually-determined rate -- provided that rate is not above an industry-
wide maximum rate. 	(Telephone interview with Jim Barnhill, North Carolina
Division of Medical 	Assistance, February 	16, 1989.) 	One 	way 	to limit the
number of nursing home beds filled 	by Medicaid patients would be to keep
the industry maximum reimbursement rate low.
17

covered 	by 	Medicaid. 	A third 	alternative 	would 	be 	to 	rely 	on 	utilization
reviews 	to 	limit 	nursing 	home 	care 	to 	those 	Medicaid 	patients 	who 	truly
need care. 56
In 	short, 	the 	state 	may 	choose 	to 	impose 	some 	form 	of 	regulation
affecting 	Medicaid 	patients. 	However, 	CON 	regulation 	does 	not 	appear
necessary 	to 	any 	effort 	to 	limit 	Medicaid 	expenditures. 	Further, 	CON
regulation is undesirable because it is likely to limit access for self -paying
and privately insured patients, as well as for those on Medicaid.
E. 	Conclusion
In 	conclusion, 	the 	available 	economic 	evidence 	does 	not 	support 	the
view 	that 	Certificate 	of 	Need 	regulation 	reduces 	the 	costs 	of 	providing
health 	care 	services. 	Indeed, 	it 	seems 	more 	likely 	that 	CON 	regulation
increases costs by inhibiting competition and the entry of more efficient or
innovative health care providers. 	In addition, changes in the organization of
health care and in health insurance have improved the ability of health care
markets 	to 	function 	in 	an 	unregulated, 	competitive 	environment. 	Finally,
CON regulation does not appear to be an efficient way to ensure the Quality
of 	health 	care 	services, 	to 	assure 	that 	health 	care 	is 	available 	to 	the
indigent, or to control Medicaid expenditures for nursing home beds.
This completes my prepared comments. 	I thank you for your time and
would be happy to attempt to answer any Questions you may have.
56 Under 	federal 	regulations, 	there 	must 	be 	a 	utilization 	review 	of
patients in skilled 	nursing 	facilities 	at 	the 	first 	scheduled 	meeting after a
patient is admitted. 	That patient must then be reviewed after 30 days and
after 	an 	additional 	60 days. 	After that 	there 	is a 	review 	every 90 days.
For patients in 	intermediate care facilities, 	reviews are required every 	180
days. 	While 	a 	utilization 	review 	is 	not 	required 	at 	admission, 	in 	North
Carolina, there is a review of the patient's need for that type of care prior
to admission. 	(Telephone interview with Olivia Hill, North Carolina Division
of Medical Assistance, F~bruary 15, 1989)
18

February 1989
VITA
NAME: 	Keith B. Anderson
ADDRESS: 	1648 N. Randolph Street
Arlin~ton, VA 	22207
DATE OF BIRTH: 	December 5, 1945
PLACE OF BIRTH: LaJolla, California
EDUCATION: B.A. (Economics) 1968, Washington State University
M.A. (Economics), 1971, Cornell University
A.B.D. (Economics), 1972, Cornell University
Member of American Economic Association
EMPLOYMENT
EXPERIENCE: 	Special Assistant to the Director
Bureau of Economics
Federal Trade Commission
Washington, D.C. 20580
(September 1986 to present)
Resprnsibilities: 	Conduct research into the effects of
government regulations on the functioning of competitive
markets; review studies prepared by others; and perform
other special projects as requested by the Bureau
Director.
Assistant Director for Regulatory Analysis
Bureau of Economics
Federal Trade Commission
(February 1982 to September 1986)
Responsibilities: 	Supervise a staff of between 10 and 15
economists conducting economic analysis on the impact of
government regulation and providing the economic input
for the Commission's Competition and Consumer Advocacy
Program. 	Issues covered include sales of airport landing
rights, restrictions on international trade, and energy
policy.
Assistant Director for Industry Analysis
Bureau of Economics
Federal Trade Commission
(February 1981 to April 1982)
Responsibilities: 	Supervise a staff of 10 to 15 economists
involved in economic research on microeconomic issues of
interest to the Federal Trade Commission.

VITA - Keith B. Anderson
Assistant to the Director
Bureau of Economics
Federal Trade Commission
(June 1977 to February 1981)
Economist
National Highway Traffic Administration
U.S. Department of Transportation
(May to July 1977 - on detail)
Economist
Division of Industry Analysis
Bureau of Economics
Federal Trade Commission
(September 1972 to June 1977)
Teaching Assistant
Department of Economics
Cornell University
(January 1970 to June 1971)
Research Assistant
Department of Economics
Cornell University
(Summers 1969, 1970)
RESEARCH
PRODUCTS: 	"Do Government-Imposed Ownership Restrictions Inhibit
Efficiency?: The Case of the FCC's Duopoly Rule,"
Working Paper No. 169, Bureau of Economics, Federal
Trade Commission, December 1988 (with John R.
Woodbury)
A Co'Wcal Evaluation of Petroleum Import Tariffs:
Analytical and Historical Perspectives, An Economic
Policy Analysis, Bureau of Economics Staff Report to the
Federal Trade Commission, April 1987 (with Michael R.
Metzger)
Certificate of Need Regulation of Entry Into Home Health
Care: A Multi-Product Cost Function Analysis, Bureau of
Economics Staff Report to the Federal Trade Commission,
January 1986 (with David I. Kass)
"Utilities and Energy Conservation: 	Competition and
Consumer Protection Issues" in Challenges for Public
Utility Regulation in the 1980's, Harry M 	Trebing,
editor, Michigan State University, 1981.
2