'Two-tier' charging, the practice of offering separate qualities of service at different prices, is a growing practice in public health facilities in many international contexts. The issue of 'pay-beds' provoked a heated debate in the UK NHS in the 1970s, and the issue of private patients continues to provoke debate there now. Similar strategies have been applied in countries as diverse as Indonesia and Israel and many low-income countries are now looking to this practice as a way of bridging the gap between available and needed finance, especially at hospital level. Advocates of the policy argue that it can be used to secure cross-subsidies from high-fee paying patients to the rest. Despite the extensive and long-running controversy, there has been no analytical model seeking to understand the implications of the strategy for cross-subsidy available. This paper models the incentives inherent in the policy under alternative assumptions about hospitals' objective functions (profit or public surplus, and revenue maximisation). It finds that whether or not two-tier charging will secure cross-subsidy from high-fee to ordinary patients depends on the own and cross-quality effects (the effects of both levels of quality on the demands for the two services) and other components of the demand functions for the two services, as well as on the assumed hospital objective functions. Under a range of assumptions, the policy will evoke cross-subsidy from ordinary to high-fee patients in place of the intended effects.
Journal of Health Economics (2007) 26 (3) 447-62 [doi:10.1016/j.jhealeco.2006.10.011]