Abstract
The growth in Medicare spending for inpatient hospital services slowed following the implementation of the prospective payment system (PPS) due to a decline in admission rates and limits on payment increases. Hospital costs, however, have increased faster than payments. Rather than reducing costs further, hospitals responded by charging privately insured patients more than the costs of their care and developing new revenue sources. PPS also redistributed Medicare payments across hospitals and was associated with increased spending in other settings. The PPS experience leaves policymakers with some immediate challenges and provides insights for the development of health care reform initiatives.