P aying F or J oint C osts in H ealth C are

The paper analyzes a regulatory game between a public and a private payer to finance hospital joint costs (mainly capital and technology expenses). The public payer (inspired by the federal Medicare program) may both directly reimburse for joint costs (“pass‐through” payments) and add a margin over variable costs paid per discharge, while the private payer can only use a margin policy. The hospital chooses joint costs in response to payers' overall payment incentives. Without pass‐through payments, under provision of joint costs results front free‐riding behavior of payers and the first‐mover advantage of the public payer. Using pass‐through policy in its self‐interest, the public payer actually may moderate the under provision of joint costs; under some conditions, the equilibrium allocation may be socially efficient. Our results bear directly on directly Medicare policy, which is phasing out pass‐through payments.