Screening Through Soft Spending Limits: Evidence from the Medicare Therapy Cap

Governments and firms often employ soft spending limits to restrict overspending while still allowing exceptions on a case-by-case basis. This paper studies a Medicare policy which capped per-patient physical therapy spending, with exceptions for patients with documented medical need. The cap reduced spending by 8 percent without harming patient health, with the targeting improvements driven by Medicare discretion in granting exceptions rather than improved provider screening. However, the documentation requirement also introduced horizontal inequity: conditional on need, lower-income and minority patients were more likely to be screened out, as they tended to see providers with poorer documentation practices.