Payment by results has had a 'questionable' impact on driving up efficiency in the NHS, the Audit Commission has concluded.
But it found that the policy has not borne out fears that it would damage patient care by cutting costs.
In its third national report on payment by results, the commission said it had increased the number of patients treated as elective day cases but not had a noticeable impact on non-elective activity. It says this failure to drive efficiency is potentially a "serious issue", as the system was explicitly designed to incentivise this.
It says the lack of a stable tariff and reliable data have made it difficult for NHS organisations to respond to financial incentives. It highlights concerns about NHS Connecting for Health's secondary uses service, which collects data on patient care and commissioning but which is hampered by "unworkable deadlines and a perceived lack of national accountability".
Audit Commission chair Michael O'Higgins said: "Payment by results needs to develop so that it does what it says on the tin. In order to encourage a more efficient way of working, the NHS should set the price for procedures at the lower levels that some hospitals have shown can be achieved, rather than the average cost."
But the commission also argued that the Department of Health should consider reforming payment by results in order to take better account of the differing costs of capital and of specialist services at some trusts.
The payment by results tariff includes a 5.8 per cent allowance to cover the cost of capital investment such as technology. But some trusts that have used the private finance initiative face capital costs equivalent to more than 10 per cent of their turnover.
The DH is reviewing its capital policy. NHS Confederation policy director Nigel Edwards said it was important that an alternative solution was found.
"Most countries in Europe which have payment by results-style systems pay for capital separately. Payment through the tariff seems to be a particularly bad way of doing it. But there are problems with all of the alternatives you can come up with," he said.
The DH has already tried to reform the way it funds specialist top-ups - over and above the tariff - to hospitals performing treatments on the most complicated patients. But the commission warned that the new system introduced for 2008-09, under which trusts must be identified as eligible for top-ups at strategic health authority level, "allows very little notice for the organisations involved and has the potential to destabilise finances locally".
A Department of Health spokesman said it welcomed the report "which recognises the progress and benefits of payment by results". Lord Darzi's Next Stage review would include work on developing the system, he added.