The Costs and Benefits of Monitoring Providers : Evidence from Medicare Audits

This paper examines the extent to which government programs should monitor for wasteful expenditure when outsourcing to third parties, taking into account the costs and savings associated with monitoring. I use novel administrative data to study the largest Medicare monitoring program aimed at identifying and reclaiming payments for unnecessary inpatient admissions. I exploit plausibly exogenous variation across hospitals and across patients, and find that the majority of savings are due to the deterrence of future admissions. I do not find evidence that the marginal patient denied admission is harmed, suggesting that hospitals fine-tune their response to target unnecessary care. But in doing so, they incur compliance costs and adopt technology specifically aimed at assessing the medical necessity of care. For every $1,000 in savings to Medicare, hospitals incur $216 in compliance costs. My welfare calculations imply that despite the costs, increasing monitoring improves welfare