Certificate of Need: A Bad Idea with Political Staying Power

Every so often Virginia undergoes a spasm of skepticism regarding the Certificate of Need (CON) law that subjects proposals for hospital expansions and equipment purchases to regulatory approval. The law gives proof to the oft-heard claim that Virginia is “pro business” — state government protects existing businesses from the challenges of newcomers — and the lie to the idea that the Old Dominion is a champion of economic competition and innovation.

We’re seeing such a spasm right now. Op-ed pieces by free market-friendly writers have been published recently that highlight problems with the law. (For example, the Richmond Times-Dispatch’s Bart Hinkle tackled the subject in November, and the Thomas Jefferson Institute’s Mike Thompson did in late December.)

Both pieces raise excellent points. Hospitals use CON regulations to delay and block encroachment onto their turf. By limiting competition, the regulatory barrier creates capacity shortages that allow hospitals either to charge more or to maximize utilization, thus increasing profitability. Hinkle asks a logical question: If Virginia Republicans believe their own propaganda and really, truly support free market economics, which they invoke in their opposition to the expansion of Obamacare, why don’t they scrap Virginia’s COPN law?

The answer, of course, is that Virginia’s hospital lobby is extremely influential in Virginia. In the 2014-2015 reporting period, the health care industry (which includes hospitals, physicians and other health care providers) contributed $2.6 million to Virginia PACs and political candidates — surpassed only by the real estate and financial sectors, according to the Virginia Public Access Project. And the hospital industry, which serves the interest of existing industry players, not potential newcomers, fights to keep the law.

No one justifies the law anymore based upon its original pretext, which was that excessive spending on capital expansion drove up the cost of health care. Rather, they argue just the opposite: regulatory-induced scarcity helps prop up hospital profits. And profits need propping considering all the indigent patients that hospitals are expected to care for.

Indeed, the hospitals’ argument appears more potent than ever since General Assembly Republicans stymied Medicaid expansion in Virginia as part of their larger opposition to Obamacare. While blocking Medicaid is entirely justifiable on a number of grounds, it does create a problem for Virginia’s hospital industry. On the logic that Medicaid expansion would mean fewer indigent patients, Obamacare cuts federal payments to hospitals with indigent-care burdens.  Thus, Virginia hospitals are stuck with the indigent patients but get no federal support. The Virginia Hospital Association and Healthcare Association (VHHA) can plausibly argue that it needs CON more than ever.

If we’re going to advance the cause of scrapping CON in Virginia, it is insufficient to repeat old, familiar — and politically ineffective — arguments. We need to dig deeper.

Thomas Stratman and Jacob W. Russ with George Mason University’s Mercatus Center made an important contribution to the debate with their July 2014 paper, “Do Certificate-of-Need Laws Increase Indigent Care?” They directly tackled the argument that CON laws create a quid pro quo in which state agencies increase hospital profits in the expectation that hospitals will use the profits to support indigent care. After comparing

CON states with non-CON states, they concluded: “The effect of CON programs on indigent care shows no clear pattern using either direct or indirect measures of indigent care. However, consistent with the existing literature, our results suggest that CON programs restrict entry and limit the provision of regulated medical services. For example, CON states have about 13 percent fewer hospital beds per 100,000 persons than non-CON states.”

Of course, local CON defenders could argue that the Old Dominion is an exception to the national rule, so the Stratman-Russ findings do not end the debate. To overcome industry objections to scrapping the CON law, deregulation advocates need to demonstrate that:

CON as practiced here in Virginia leads to less hospital capacity and diagnostic equipment than the marketplace otherwise would support;

Virginia hospitals are more profitable as a result, either because they enjoy higher rates of utilization or they have the market power to charge higher rates; and

If deprived of protected profits, Virginia hospitals still would have the financial wherewithal to treat indigent patients.

I am fairly certain that the first two propositions are true but am less confident of the third. It’s fine to argue economic theory (I do it all the time), but without strong evidence to assure people that hospital finances won’t be brutalized by a repeal of CON, it will be very difficult to refute VHHA claims.

The other element missing from the CON debate in Virginia is a compelling vision of what a health care industry driven by competition and innovation would look like. For all intents, the debate over Obamacare is not a debate about how to deliver better health care at lower cost but about who pays. It’s a zero sum game. Some people pay more, others pay less. The number of losers offset the number of winners. What we need is a win-win vision in which the health care industry reaps the same level of gains in economic productivity seen in the rest of the economy. To achieve those gains, the hospitals need to evolve from generalized institutions that do all things to medical institutions that focus on doing a few things well — focused factories that excel in productivity and quality of outcomes. Insofar as CON protects the status quo, it is the enemy of focused factories, the enemy of innovation and the enemy of productivity and quality.

Unfortunately, it has been years since anyone has championed the causes of health care productivity and quality in Virginia. It’s a cause that Virginia Republicans could take up — but haven’t. Unless CON repeal is bundled into a larger vision of restructuring the healthcare industry along market- and innovation-driven lines, I doubt the little CON-deregulation boomlet will get anywhere… and probably doesn’t deserve to.

(This column first ran in Bacon’s Rebellion on January 5, 2015)