Performance-based budgeting in the public sector: an illustration from the VA health care system

This paper estimates frontier cost functions for US Department of Veterans Affairs (VA) hospitals in FY2000 that are consistent with economic theory and explicitly account for cost differences across patients' risk, level of access to care, quality of care, and hospital-specific characteristics. Results indicate that on average VA hospitals in FY2000 operate at efficiency levels of 94%, as compared to previous studies on US private sector hospitals that average closer to 90% efficient. Using these cost frontiers, management systems potentially could be implemented to enhance the equitable allocation of the VA medical care global budget and systematically distribute funds across hospitals and networks. The paper also provides recommendations to improve the efficiency of delivering health care services applicable to public sector organizations.