Cost sharing and cost shifting mechanisms are of vital importance in a prospective payment system. This paper employed the difference-in-differences method to estimate the impacts of a per diem system with inverted-U-shape rates on medical costs and the length of stay based on data from a health insurance institution. The supply side cost sharing mechanism worked so that the new payment system significantly reduced medical costs by 17.59 percent while the average length of stay varied little. After further analyzing the mechanism, we found that heterogeneous effects emerged mainly due to the special rates design. The reform decreased the cases that incurred relatively high medical costs and lengths of stay. However, cost shifting existed so that physicians could be motivated to provide unnecessary services to the patients who should have been discharged before the average length of stay. Therefore, payment rates in the per diem system require a sophisticated design to constrain its distortion to medical service provision even though medical expenditures were successfully contained.
Keywords: cost shifting; per diem payment; supply-side cost sharing.