All things considered, we can live with a little Medicare fraud. Photographer: Dave Cruz/Bloomberg News
All things considered, we can live with a little Medicare fraud. Photographer: Dave Cruz/Bloomberg News

According to the inspector general of the Department of Health and Human Services, Medicare is overpaying for office visits and other patient evaluations. Overpaying a lot: “The inspector general's report, released today, estimates that overpayments account for 21 percent of the $32.3 billion spent on evaluation and management services in 2010.”

Advocates of “Medicare for all” or some other version of single-payer health care tout Medicare’s lower administrative costs. And Medicare does legitimately have some lower costs. Its billing is done by the Internal Revenue Service, which is already collecting your taxes, generating efficiencies. It doesn't need to market the program, pre-qualify customers or worry about retention.

On the other hand, other expenses of the program are absorbed by different government agencies; Medicare doesn't have to run its own pension program or manage buildings to hold workers, but someone still has to do those things. And then there are some things Medicare doesn't do so much of, such as zealously policing provider billings, which maybe it should do.

I say “maybe” because -- and you are going to get mad when I say this -- the optimal amount of Medicare fraud is not zero.

Hold on, before you fire up the nastygrams: Medicare fraud is not OK. You shouldn’t do that, doctors, and if you are committing Medicare fraud, you should be very ashamed of yourself and stop.

But that doesn’t mean the folks who run Medicare should do everything in their power to stop you. Every organization should work hard to prevent malfeasance, but it should not go after every possible case of fraud ever. As the frauds get smaller or more sophisticated, the cost of preventing the fraud starts to exceed the cost of the fraud itself.

If you’re familiar with the retail industry, you know that virtually every retailer has a line item in the books for “shrinkage,” or “theft by employers and customers.” (Also inventory that just got misplaced somewhere. But theft is a major component of this.) It’s a big expense, and if you’re operating on tight margins, it can mean the difference between profit and loss.

Retailers could certainly do more to prevent this. They could, for example, lock up all the merchandise so that you can’t look at it without an associate standing there. People who sell small high-value items often do this, which is why a salesperson has to show you eyeglass frames. And many retailers put theft-prone items out of reach, which is why in many drugstores the electronics are locked up and the condoms and pregnancy tests and hemorrhoid creams are behind the counter. Or they attach theft-prevention devices to the merchandise, though this seems to have fallen out of favor at many of the clothing retailers that pioneered this technique.

But these techniques are aimed at “theft reduction,” not “theft prevention”; most stores still tolerate some shrinkage because it’s cheaper than the alternative. It wouldn’t pay Wal-Mart Stores Inc. to lock everything away so that you have to ask an associate to be shown something in a No. 2 pencil; the labor costs would outweigh what the business would save by preventing theft. Labor costs would also be a problem if Wal-Mart decided to search every customer at the exit, though not its biggest problem. And even that wouldn’t totally stop shrinkage, because how can I prove you didn’t buy those pencils here last week and bring them into the store in your bag?

The same is true of Medicare. Catching big, theatrical frauds -- those folks who set up fake office fronts and bilk the system out of millions -- is a no-brainer. Catching doctors who are sloppy in their billing might well be too costly, which is what a Medicare representative says about the latest report.

Medicare doesn’t just count the costs in dollars, however. It also counts the costs of angering the American Medical Association and hundreds of thousands of other doctors who don’t belong to that august organization. If it angers the AMA, it gets angry letters from congressmen. If it makes too many overpayments, it gets an inspector general report that no one except journalists reads. The bureaucratic calculus yields a pretty obvious answer.

So while the appropriate target for Medicare overpayments is probably not 0, I’m skeptical that it’s 21 percent. Maybe we could take a few percentage points off that and put it to better use in Medicare’s overhead.

To contact the writer of this article: Megan McArdle at mmcardle3@bloomberg.net.

To contact the author responsible for this article: James Gibney at jgibney5@bloomberg.net.