From 1966 through 1991, Medicare paid physicians based on what they charged for services. The Omnibus Budget Reconciliation Act of 1989 (OBRA) required the establishment of a national Medicare physician fee schedule, which was implemented in 1992, replacing the charge-based system. Currently, the Medicare physician fee schedule includes more than 7,000 services together with their corresponding payment rates. In addition, each service on the fee schedule has three relative value units (RVU) that correspond to the three components of physician payment: Physician work—the financial value of physicians’ time, skill, and effort that are associated with providing the service. Practice expense—the costs incurred by physicians in employing office staff, renting office space, and buying supplies and equipment. Malpractice expense—the premiums paid by physicians for professional liability insurance. Each RVU measures the relative costliness of providing a particular service. For example, in 2007, for a mid-level office visit for an established patient, the three RVUs sum to 1.66. In contrast, total RVUs for a chemotherapy infusion procedure are 4.73, indicating that this procedure is almost three times as costly as a mid-level office visit. Medicare’s geographic adjustment for a particular physician payment locality is determined using three GPCIs that also correspond to the three components of a Medicare payment—physician work, practice expense, and malpractice expense. These GPCIs adjust physician fees for variations in physicians’ costs of providing care in different geographic areas. Other Medicare adjustments to physician fees address issues other than geographic variation in costs. For example, physicians practicing in designated health professional shortage areas receive a 10 percent bonus payment for Medicare services they provide, and physicians practicing in designated physician scarcity areas receive a 5 percent bonus payment for Medicare services they provide. The GPCIs are numerical factors expressed as the ratio of an area’s cost to the national average cost. For example, in 2007, the practice expense GPCI for Orlando, Florida, is 0.936, which means that the practice expense component of the fee for a service is 6.4 percent below the national average. Because the GPCIs measure physician costs relative to the national average costs, an increase in the GPCIs of one area will result in a decrease in the GPCIs of other areas. In general, GPCIs are higher in urban areas than in rural areas. To calculate the Medicare payment amount for a service in a particular payment locality, each of the three RVUs for a service is adjusted for geographic differences in resource costs and converted into dollars. This process has several steps. First, to adjust for differences in costs, each of the three RVUs is multiplied by the appropriate GPCI. Second, these adjusted RVUs are added together. Third, that sum is converted into dollars using a conversion factor—a dollar amount CMS calculates that translates each service’s RVUs into a payment amount. The result equals the Medicare payment for that service in that payment locality. For example, to determine the Medicare payment for a mid-level office visit in South Carolina in 2007, first, the three RVUs—work, practice expense, and malpractice expense—are multiplied by the appropriate GPCI (see fig. 1). Second, these adjusted RVUs are summed together to total 1.57. Third, this sum is multiplied by the conversion factor ($37.8975), resulting in a Medicare payment of $59.50 for this service. In the District of Columbia, total adjusted RVUs for a mid-level office visit sum to 1.88, which the conversion factor translates into a payment of $71.25. Physicians practicing in the District of Columbia payment locality receive a higher overall payment for the same service because of the higher costs of operating a private medical practice compared with physicians practicing in the South Carolina payment locality. Since the work, practice expense, and malpractice expense RVUs for a single service are the same in every payment locality, the geographic variation in the Medicare payment for a service mirrors the variation in the GPCIs across payment localities. CMS is required to review the GPCIs at least every 3 years and, based on that review, may revise them using the most recent data available. The agency last updated the GPCIs in 2005 and is scheduled to review and, if necessary, update them again in 2008. The data used for the different GPCIs are updated on different intervals. Specifically, the decennial census, which is the major data source used in calculating the GPCIs, provides new data once every 10 years. These data are used in calculating the work and practice expense GPCI. HUD data, which are also used in calculating the practice expense GPCI, are updated annually. CMS collects state insurance department and private insurer data, which are used in calculating the malpractice expense GPCI, when the GPCIs are reviewed every 3 years. In addition, CMS is required to review the RVUs at least every 5 years and last updated them in 2007. GPCIs can be summarized by the GAF, which broadly illustrates differences in costs across physician payment localities. The GAF is an average of the GPCIs, with each of the three GPCIs weighted by the percentage of costs accounted for by its corresponding RVU. Specifically, on average, across all services, work represents 52.5 percent of costs, practice expense represents 43.7 percent, and malpractice expense represents 3.9 percent. For example, to calculate the GAF for the statewide South Carolina payment locality in 2007, the work, practice expense, and malpractice expense GPCIs for South Carolina are weighted and then summed to equal a GAF of 0.931 (see fig. 2). For the District of Columbia payment locality in 2007, the GPCIs are weighted and summed to equal a GAF of 1.133. The current 89 physician payment localities are primarily consolidations of the payment localities that Medicare carriers first defined in 1966. CMS has since revised them over two different time periods using three approaches that were not uniformly applied (see fig. 3). In 1966, Medicare carriers established 240 payment localities, including 16 statewide localities, using their knowledge of local medical practice and economic patterns at the time. These payment localities varied in size, ranging from a single zip code to statewide. For example, California had 28 payment localities, including 8 zip-code-based localities within the county of Los Angeles, whereas New Mexico was a statewide payment locality. According to CMS, the payment locality boundaries were relatively stable for the next 26 years. In 1989, OBRA required the establishment of a national Medicare physician fee schedule, replacing the charge-based payment system. Under the law, the new fee schedule was phased in over a 4-year period, from 1992 through 1995. To facilitate this transition, CMS continued to use the 240 carrier-defined payment localities, but permitted state medical associations to petition to consolidate their state into one statewide payment locality. Under this approach, from 1992 through 1995, CMS consolidated six states into statewide localities, reducing the number of payment localities to 210, including 22 statewide localities and 28 multiple- locality states. Consolidation into a statewide payment locality would have generally resulted in urban physicians experiencing a decrease in payment and rural physicians experiencing an increase in payment. Citing this fact, CMS stated it would consider a petition for consolidation from a state medical association that could demonstrate that it had the “overwhelming support” of both groups of physicians. The agency declined to set a numerical level of support that it would consider “overwhelming,” but did enumerate several elements it would require, at a minimum, for state medical associations to demonstrate overwhelming support. CMS assessed the level of physician support by reviewing both the petition from the state medical association and the comments regarding the change that the agency received directly from physicians. For example, in 1995, CMS consolidated Iowa to a statewide payment locality when the state medical association, which represented 75 percent of Iowa physicians, submitted a resolution in favor of consolidation, and 98 percent of the comments CMS received, including 94 percent of comments from physicians who would experience a payment decrease, also supported the transition. CMS has not required medical associations in the states that it consolidated to continue to demonstrate that there is overwhelming support from the physician community for a statewide payment locality. In 1996, CMS cited a lack of consistency among the carrier-defined payment localities and, in 1997, revised the 28 multiple-locality states. As a result of these revisions, the total number of payment localities was reduced from 210 to the current total of 89. Thirty-four states have statewide payment localities and 16 states have multiple payment localities. In revising the payment localities in 1997, CMS used two different approaches. Specifically, in 25 of the multiple-locality states, CMS revised the carrier-defined payment localities using a methodology designed to consolidate them. As a result, the agency converted 12 states to statewide payment localities, while it retained multiple payment localities in 13 states. In the remaining 3 multiple-locality states, CMS concluded that its consolidation methodology would have yielded inaccurate localities and therefore created entirely new payment localities. When making these revisions, the agency did not examine any of the 22 then-existing statewide payment localities that had been set using carrier definitions and the overwhelming support policy; therefore, these payment localities have not been examined since they were created, which in most cases was over 40 years ago. In 25 of the 28 multiple-locality states, CMS applied a methodology that was designed to consolidate the carrier-defined payment localities: new localities could not be created. The agency did not examine the geographic boundaries of the carrier-defined payment localities before consolidating them, even though in 1993, it had stated that the existing payment localities had not been established on “any consistent basis.” Specifically, within the 25 states, CMS ranked the carrier-defined payment localities from highest to lowest cost, as measured by the locality GAF.