On today's Planet Money:
When the government created the Medicare system in 1965, they were so desperate to get doctors into it that they allowed them set their own fees. The fee for service system was good for doctors, but bad for the budget. Joseph Califano, was President Johnson's senior domestic policy aide at the time, and he says he and his colleagues simply didn't understand the economic structure of the health care system.
Ten years later, President Ford thought he had the solution to stem rising costs — cap the fees paid to doctors. Unfortunately this "fix," just caused another problem, overtreatment.
It wasn't until the late 1980's that an economist from Harvard, Professor William Hsiao, finally came up with method to determine competitive prices for doctor's care. Hsiao brought in doctors and asked them to rate every single thing they did based on how technically hard it was, how stressful, how much the supplies cost, etc. From this data, he developed the relative value scale. Medicare adopted the relative value scale in 1992, and it's still used today. However, the system has done little to cut rising costs — something Hsiao blames on special interest groups.
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