Price Cap vs. Per-Unit Subsidies: Selection, Pricing, and Cross Subsidization

TL;DR

This paper compares price cap and ad valorem subsidy mechanisms in the FCC's Rural Health Care program, analyzing their effects on spending, incentives, and cross-subsidization using theoretical models and empirical data.

Contribution

It introduces a theoretical framework and empirical analysis to evaluate how different subsidy mechanisms influence provider behavior and program costs.

Findings

Ad valorem mechanism reduces program spending compared to price cap.

Consortium applications significantly increase program costs.

Cross-subsidization intensity relates non-linearly to ineligible member share.

Abstract

We evaluate subsidy mechanisms in the FCC's Rural Health Care program using administrative data covering the full population of participants. The original price-cap mechanism removes cost-containment incentives for health care providers. An ad valorem mechanism introduced in 2014 addresses this flaw by making providers bear 35% of costs. However, allowing consortium applications creates a new distortion: cross-subsidization from eligible to ineligible members. We develop theoretical models predicting these effects and estimate treatment effects using an extension of the two-way fixed effects framework with continuous treatments. We find that the ad valorem mechanism substantially reduces program spending relative to the price cap, while the consortium option significantly inflates it. Enforcement records and an inverted U-shaped relationship between cross-subsidization intensity and ineligible member share corroborate the findings.