Occupational adjustment of the prospective payment system wage index

In this article, the bias in the Medicare prospective payment system (PPS) hospital wage index that results from its failure to hold hospital occupation mix constant is examined. On average, the difference between the current PPS wage index and a fixed-occupation-mix Laspeyres index is small, approximately 2 percent. However, occupation-mix distortions are substantially larger for a small proportion of labor market areas, especially some in the South. Biases in the wage index resulting from its failure to appropriately account for labor substitution and intra-occupational worker characteristics are also analyzed but are not found to be significant.