Abstract
Medicare could become an innovative leader in using financial incentives to reward health care providers for providing excellent and efficient care throughout a patient's illness. This article examines the variations in cost and quality in the provision of episodes of care and describes how a pay-for-performance payment system could be designed to narrow those variations and serve as a transition to a new Medicare payment policy that would align physicians' incentives with improvements in both quality and efficiency. In particular, Medicare could stimulate greater efficiency by developing new payment methods that are neither pure fee-for-service nor pure capitation, beginning with a pay-for-performance payment system that rewards quality and efficiency and moving to a blended fee-for-service and case-rate system.