From the Cato Institute, Michael Cannon writes:

In response to growing concern over the quality of medical care,
private and public third-party payers are experimenting with financial
incentives, known as "pay-for-performance" (P4P), that reward health
care providers for recommended care. Although P4P has the potential to
improve quality in some instances, policymakers should take a cautious
approach to this new tool.

Creating and administering provider-focused P4P financial incentives
are immensely complex tasks that require making tradeoffs amid
considerable uncertainty. Provider-focused P4P incentives often improve
quality of care for some patients at the same time they reduce quality
of or access to care for others. In particular, provider-focused P4P
incentives can encourage inappropriate care or reduce access to care
for patients with multiple illnesses or low incomes.

Medicare, the federal health care program for the elderly and
disabled, has begun experimenting with provider-focused P4P incentives.
Yet Medicare faces additional challenges beyond those confronting
private third-party purchasers. Given Medicare's patient population,
size, and sensitivity to interest group lobbying, any harm that could
result from a P4P scheme would be more likely to occur within
traditional Medicare than elsewhere in the health care system.

Congress can realize the potential of providerfocused P4P
incentives, while reducing the likelihood of harm, by confining
provider-focused P4P to private Medicare Advantage plans and by
encouraging greater participation in those plans. Further, P4P
financial incentives can be targeted at patients as well as providers.
Patient-focused financial incentives would offer greater transparency
and allow patients and their doctors to deviate from treatment
guidelines when doing so is in the patient's interest.

I would raise a question in response to this: where did the information that the access could be reduced in low-income and/or complex medical patients come from?  He states: "In particular, provider-focused P4P
incentives can encourage inappropriate care or reduce access to care
for patients with multiple illnesses or low incomes."  The data seems to show otherwise.  With proper financial incentives, the care does improve and the overall cost to the system is reduced.

A recent article in the New England Journal of Medicine, there is a discussion of the implementation of P4P in the British Healthcare system, and they found this not to be true:

Because achievement was universally high, there was little variation between practices. It was not surprising, therefore, that socioeconomic and demographic factors, which profoundly affect population health and the use of health care facilities,^25,26 had relatively little influence on achievement. Although practices that served lower-income populations had worse overall population achievement, the effect was small, and they were no more likely to use exception reporting to exclude patients than were practices with more affluent populations. Deprivation-related health inequalities therefore appear unlikely to have been greatly increased by the introduction of the financial incentive program. Smaller practices performed marginally better overall than large ones, although there was much greater variation in the performance of small practices, and many smaller practices are believed to have merged in the face of the administrative pressures from the new contract.

They actually were able to acheive astonishing improvements to their quality numbers and improve physician incomes at the same time:

In the first year of the pay-for-performance program, English family practitioners performed extremely well with respect to the quality targets, attaining a median of 96.7 percent of the available points for clinical indicators. This greatly exceeded the 75 percent predicted when the scheme was negotiated, and consequently the cost to the taxpayers was considerably more than expected. Before the new contract was implemented, family practitioners typically earned from £70,000 to £75,000 ($122,000 to $131,000). The pay-for-performance program increased the gross income of the average family practitioner by £23,000 ($40,200), although the practitioners bore any additional nursing and administrative costs of meeting the targets. In 2005–2006, family-practitioner income will rise even more, since quality payments have been increased to £125 ($218) per point.

How does this translate to our system?  I think this article summed it up well:

Several lessons can be drawn from the U.K. experience. First, the U.K. program was costly and was funded with substantial additional monies rather than by restructuring existing payment systems. In addition to the payments for achieving quality targets, there were further costs, to both the practitioners and the government, of developing and implementing the information-technology systems required to monitor the program. Budget-neutral programs would face greater resistance from family practitioners. Second, a clear baseline is needed to avoid paying for improvements that have already occurred. Third, geographically staggered introduction would enable policymakers to better estimate the quality effects of the program. Fourth, introducing pay-for-performance incrementally reduces risks for providers and payers. Fifth, payers should allow for the possibility of higher-than-expected achievement. Sixth, the risk of inappropriate treatment can be decreased with the use of mechanisms such as exception reporting, but monitoring is required to prevent abuse.

The U.K. experience suggests that greater changes in professional practice can be achieved through pay-for-performance programs than previous research indicates.²¹ We do not know whether the size of the financial incentives made the difference in the United Kingdom, and if so, how big incentives need to be. Whatever the case, financial incentives should be aligned to physicians' professional values to avoid serious distortions of care.

Other studies have shown that the size of incentive does matter.  How would Medicare handle this?  Clearly it would have to be cost-neutral, but the cost of increasing preventive services could be taken from the higher reimbursement from procedures, etc (which is the place where the majority of cost resides).  As the number of hospitalizations decreases (hypothetically) with better prevention, the money would be recaptured and potentially save money. Bridges to Excellence estimates that for every $1 spent on incentives, there was a $4 return on savings.

A tip of the hat to The Healthcare Blog for pointing me to the Cato Institute article.