Dr. William C. Padgett is a retired optometrist who has been trying to bring an elderly care facility to Beaufort County, North Carolina, for over a decade. “Our senior citizens,” he laments, “are finding that it is difficult and in many cases impossible to find an appropriate long-term care facility locally.” Though he has received several commitments from premiere assisted living companies to open facilities in the county, he cannot procure the Certificate of Need (CON) permit necessary to break ground.
Thirty-six states and the District of Columbia require health care providers to obtain CON permits from their state health planning agencies before they can offer or expand services. As the name suggests, a CON will only be issued if the agency finds that a genuine need for the service exists in a given community.
Though they might sound like something out of Cuba, or the pages of Atlas Shrugged, CONs have a long history in the land of the free. For the most part, state CON laws grew out of the 1974 National Health Planning Resources and Development Act , which—in a misguided attribution of spiraling health care costs to a “maldistribution” of health care resources—required states to set up health planning agencies to control future health care expansion based on need.
Twelve years later, in 1986, the law was unceremoniously repealed for the simple reason that it had failed in it was intended to do—that is, reduce health care costs. Fourteen states subsequently repealed their CON laws, either because they agreed with the federal analysis that CON didn’t work or because they lost federal funding with the repeal. On the other hand, 36 states chose to double down on their CON laws under the by-then discredited premise that health care costs were being driven up by a maldistribution of resources.
Excess Supply Causes Prices to Rise?
CON backers claim that permits based on need restrain costs by eliminating excess capacity that would otherwise lead providers to charge higher fees to the patient. “The basic assumption underlying CON regulation,” according to the bipartisan National Conference of State Legislatures, “is that excess capacity (in the form of facility overbuilding) directly results in health care price inflation. … [On this basis] CON supporters say it makes sense to limit facilities to building only enough capacity to meet actual needs.” Advocates believe that if a facility is unable to recoup its fixed costs—from adding another 50 beds that might sit empty, for example—it will hike up its existing patient prices on services related to its variable costs to compensate. This is like saying that movie theater expansion should be limited to community need lest existing moviegoers be overcharged should new seats sit empty.
In the economic reality distortion field of health care, increased supply drives prices up—and high barriers to entry, like CONs, control costs. In other words, the economic laws governing health care, CON backers imply, are exactly the opposite of the ones that govern every other industry. As economist Dr. Roy Cordato, writing about CONs for the Alabama Policy Institute, put it, “There is possibly no proposition in economics that is more accepted than the idea that if you want to reduce the cost of something, you foster an environment that encourages open competition and entrepreneurship and discourages monopoly.”
Nevertheless, this reality-distorting brand of economics is evidenced time and again in the CON permitting process. For example, in 2008 Michigan refused to grant CONs to several hospitals looking to expand their radiation therapy capabilities by offering proton therapy, which can more precisely focus radiation on cancerous tissue than can other types of external beam therapy. The New York Times reported that the State’s CON Commission denied the request because “The costs of multiple centers, each having the most expensive medical equipment yet developed, would be tremendous.” Larry Horwitz, president of the Economic Alliance for Michigan, provided some intellectual cover for this ruling, saying, “We need to constrain health care costs … We certainly don’t need a mammoth escalation in health care costs, especially if it’s duplicative spending in an area that has not been medically validated.”
The story of dialysis centers in Washington State, however, seems to contradict Horwitz’s contention that expansion of health care services drives up costs. In response to rising rates of type 2 diabetes, which can lead to kidney failure, Washington’s health care providers sought several years ago to open new and expand existing dialysis centers. Their requests for CONs were denied because they did not meet the state planning board’s need requirement. Palmer Pollock, an administrator at Northwest Kidney Centers, says that as a result of this decision, dialysis prices in Washington State have skyrocketed: “Private carriers used to pay $200 or $300 per treatment … now it’s more than $1,000.”
Health Care Costs in CON States Are 11% Higher Than in Those Without
Across the board, the data show that CON laws not only fail to control health care costs but also that they may even contribute to increasing them. Health care costs are greater in states with CON laws than in states without. As these tables below show, average annual per capita health care costs in states with CON laws are $7,230, 11 percent higher than the $6,526 average in states without CON laws.
Average Health Care Costs Per Capita – CON States vs. Non-CON States
Further, the data suggest that states with more services subject to CON approval have higher average health care costs than do states with fewer services subject to CON approval. The severity of states’ CON requirements vary widely , from Vermont, which requires CONs for 30 services, at one extreme to Ohio, which requires CONs for only one service—the introduction of additional long-term care beds—at the other. States requiring CONs on 10 or more services have average per capita health care costs of $7,396, eight percent higher than the $6,837 average for states requiring a CON for fewer than 10 services. The chart below illustrates the positive relationship between CONs and average per capita health care costs.
Average Health Care Costs Per Capita – Non-CON States vs. CON States – less than 10 restrictions vs. CON States – 10 or more restrictions
Lack of Government or Scholarly Support
In addition to the economic logic and empirics demonstrating that they do not bring down health care costs, CON laws have some powerful opponents within the government itself. In 2004, the Federal Trade Commission (FTC) and the Department of Justice (DOJ) submitted a comprehensive joint report calling for the end of CON laws:
The Agencies’ experience and expertise has taught us that Certificate-of-Need laws impede the efficient performance of health care markets. By their very nature, CON laws create barriers to entry and expansion to the detriment of health care competition and consumers. They undercut consumer choice, stifle innovation, and weaken markets’ ability to contain health care costs. Together, we support the repeal of such laws, as well as steps that reduce their scope.
According to the report, “the best empirical evidence shows that ‘on balance … CON has no effect or actually increases both hospital spending per capita and total spending per capita.”
Furthermore, there is little support for CON to be found in scholarly journals. One high profile Duke University study in the Journal of Health Politics, Policy, and Law, claimed that CON laws lead to higher, not lower, health care costs: CON laws caused a two-percent reduction in bed supply and “higher costs per day and per admission, along with higher hospital profits.” An earlier study in the Journal of Regulatory Economics found that CON was responsible for a 13.6 percent increase in per capita health care costs. Florida lawyer and CON expert, Patrick John McGinley, writing in the Florida State University Law Review, summarizes the scholarship on CON laws: “In searching scholarly journals, one cannot find a single article that asserts that CON laws succeed in lowering health care costs. CON has elicited a remarkable evaluative consensus—that it does not work.”
Bootleggers, Baptists, Rent-seekers, and Cronies
So with economics, empirics, academic journals, and many arms of the government lining up against them, why do CON laws still exist? One reason could be that CON laws find support from a classic Bootleggers and Baptists coalition. The Bootleggers and Baptists story has its origins in the days of prohibition, when two very powerful yet very different groups, the bootleggers and the Baptists, unwittingly teamed up to keep alcohol illegal. The Baptists favored prohibition for moral reasons while the bootleggers favored it for profiteering reasons. Their joint support for the alcohol ban helped keep prohibition alive. Many of today’s policies are similarly backed by unexpected coalitions, with CON laws being prime examples. CON laws are helped kept alive by a coalition of misguided moralists supportive of any well-intended policy purporting to keep health care costs down and opportunistic cronies looking to use state power to shut out new competitors who might eat into their profits.
State health planning boards are often directly or indirectly under the influence of existing health care establishments whose officials are generally responsible for ensuring a profitable bottom line. McGinley has said that existing hospitals can regulate supply through influence on CON procurement and in this sense their activities are “indistinguishable from the activities of a cartel.” It is therefore unsurprising that the American Hospital Association was an early supporter of CON laws, engaging in a nationwide lobbying effort to pass them at the state level and drafting a model state law in 1972. The FTC and DOJ report highlights this side effect of the misaligned incentives of existing hospital administrators and CON procurement:
In some instances, existing competitors have exploited the CON process to thwart or delay new competition to protect their own supra-competitive revenues. Such behavior, commonly called “rent seeking,” is a well-recognized consequence of certain regulatory interventions in the market. … During our hearings, we gathered evidence of the widespread recognition that existing competitors use the CON process to forestall competitors from entering an incumbent’s market.”
In addition to encouraging a cottage industry of rent-seeking lobbyists and administrators, CON laws also encourage good, old-fashioned cronyism. Perhaps the most famous case of CON cronyism is the sordid 2004 affair of the procurement of a CON for the building of a new hospital in suburban Chicago, which resulted in fraud charges. According to the indictment , an official from the Illinois Health Facilities Planning Board, the contractor of a major construction company, a financier from a major investment bank, and the CEO of the proposed hospital, who was by this time wearing a wire for the FBI, conspired to operate a classic kickback scheme wherein the hospital would receive a CON on the condition that it be built by the aforementioned construction company. In return for granting the CON, the planning board member would receive a cut of the $100 million construction contract. Though this act was despicable, it should not be surprising that when people can’t use the price system to achieve their ends, they will resort to graft and cronyism instead.
Additionally, when market signals are not used, planning decisions often seem arbitrary and capricious. One notorious story comes out of Putnam County, Georgia, where the owners of a proudly locally owned and funded hospital sought to renovate, but not expand, their dilapidated facility. When the hospital owners took their renovation request to the Georgia State Health Agency, it was denied—unless the owners would agree to eliminate 10 beds at the same time.
What would it look like if the CON process were introduced to other sectors of the economy? This is the thought experiment that Georgia State Senator Tommie Williams, a restaurateur, took in his protest of state CON laws. He facetiously proposed the introduction of a CON process in the restaurant business to the Georgia State Legislature. Under his proposed legislation, a restaurateur could apply for a permit to open a new restaurant so long as he or she could prove that there was a need for it. Existing restaurants would be grandfathered in, but “if you make one change to that restaurant,” Williams explained, “if you buy a new grill, create more counter space, pave your parking lot, change the color of your building, you will have to apply for a Georgia Authority for Gastronomic Suppliers (GAG) permit.”