Objective To examine whether decreases in Medicare outpatient payment rates under the Outpatient Prospective Payment System (OPPS) caused outpatient care to shift toward the inpatient setting. Data Sources/Study Setting Hospital inpatient and outpatient discharge files from the Florida Agency for Health Care Administration from 1997 through 2008. Study Design This study focuses on inguinal hernia repair surgery, one of the most commonly performed surgical procedures in the United States. We estimate multivariate regressions of inguinal hernia surgery counts in the outpatient setting and in the inpatient setting. The key explanatory variable is the time‐varying Medicare payment rate specific to the procedure and hospital. Control variables include time‐varying hospital and county characteristics and hospital and year‐fixed effects. Principal Findings Outpatient hernia surgeries fell in response to OPPS‐induced rate cuts. The volume of inpatient hernia repair surgeries did not increase in response to reductions in the outpatient reimbursement rate. Conclusions Potential substitution from the outpatient setting to the inpatient setting does not pose a serious threat to Medicare's efforts to contain hospital outpatient costs.