Medicaid Reforms
Chris Edwards
May 1, 2018
Medicaid is a joint federal-state program that funds medical services and long-term care for people with moderate incomes. Medicaid spending is one of the largest and fastest-growing items in the federal budget, at almost $400 billion a year.
State governments administer Medicaid, but most of the funding comes from the federal government. The current funding structure — based on federal matching grants — encourages expansion and provides little incentive to control costs. At the same time, the top-down regulatory structure of Medicaid distorts health care markets.
The 2010 Affordable Care Act (ACA) increased Medicaid spending and did not fix the program's structural flaws. The ACA expanded eligibility, added to the health services covered, and increased the federal share of program costs. The federal costs of the ACA Medicaid expansion are more than $70 billion a year and rising.1
Policymakers should reverse course and restructure Medicaid to reduce costs. The program should be turned into a block grant, with the federal government providing a fixed amount of aid to each state. That was the successful approach taken for federal welfare reform in 1996. Fixed grants would encourage states to restrain Medicaid spending, combat fraud and abuse, and pursue cost-effective health care solutions.
With federal block grants, states may choose to transform their Medicaid programs into voucher-based systems. That reform would provide low-income individuals with fixed payments to buy health coverage in private markets, thus encouraging competition and likely providing higher-quality care at lower cost.
Federal deficits are rising, and health care spending is a major reason why. Reforming Medicaid with a block grant structure would allow federal policymakers to control spending while encouraging health care innovations in the states.
Rapid Growth
Congress enacted Medicaid in 1965 to provide medical aid to people with low incomes. The law expanded on the 1960 Kerr-Mills Act, which had provided the states with grants for low-income health care. Since the passage of Medicaid, federal and state legislation has expanded the program many times to cover more services and more people with higher incomes.
Medicaid provides comprehensive medical coverage to beneficiaries. It covers inpatient hospital stays, visits to doctors' offices, and prescription drugs. It covers items not usually included in private insurance plans, such as nursing home care. Federal rules require that states provide minimum levels of Medicaid coverage, but the states are free to expand benefits further, receiving a federal matching grant when they do so.
Medicaid costs have soared. Spending jumped from $118 billion in 2000, to $273 billion in 2010, to $383 billion in 2018.2 Even before the ACA passed in 2010, spending was growing rapidly. The law has boosted Medicaid spending by $70 billion a year, and payments continue to rise. 3 As a share of gross domestic product, federal Medicaid spending has almost tripled, increasing from 0.7 percent in 1990 to 1.9 percent today.4
One reason that Medicaid's costs have grown so rapidly is that health services are provided free with little in the way of copayments or deductibles. Recipients can also receive free transportation to their health care appointments. The program's generous benefits — with few out-of-pocket costs — have spurred an overuse of services.
Another cause of Medicaid's rapid growth is that policymakers have expanded eligibility and benefits numerous times. Medicaid enrollment jumped from 23 million in 1990, to 35 million in 2000, to 72 million by 2016.5 As a share of the U.S. population, enrollment grew from 9 percent in 1990 to 24 percent by 2016. Even though it is widely known that Medicaid is fiscally unsustainable, federal and state policymakers have continued to expand enrollment and benefits.
The costs of Medicaid expansions have often exceeded what legislators promised. For example, Congress added a hospitals subsidy to Medicaid in 1987 to aid facilities that served large numbers of uninsured patients. When enacted, it was supposed to cost less than $1 billion annually by 1992, but it ended up costing a stunning $17 billion that year.6
Another pattern evident in Medicaid — and in other federal subsidy programs — is that expansions spawn further expansions down the road. In 1997, Congress built on Medicaid by creating the Children's Health Insurance Program (CHIP), which provides aid to the states for people who have higher incomes than those on Medicaid. Once established, policymakers have expanded CHIP over time.
In addition to health care services, Medicaid covers long-term nursing home and home-based care for the elderly. Long-term care accounts for more than 20 percent of total Medicaid spending.7 Remarkably, Medicaid finances half of all long-term care and related services in the nation.8 Another thing to note is that "almost two-thirds of all Medicaid spending is for the elderly and persons with disabilities, who [together] make up just one-quarter of all Medicaid enrollees."9
The ACA increased Medicaid benefits, expanded services that states are required to cover, and expanded eligibility for the program. Previously, states were required to cover pregnant women and children under the age of 6 who had incomes below 133 percent of the official poverty level, and also children between the ages of 6 and 18 who were below 100 percent of the poverty level. Adults with no children were generally excluded from Medicaid coverage unless disabled.
For states that opt into the Medicaid expansion, the ACA extended eligibility to all people under age 65 with incomes below 133 percent of the poverty level, including childless adults.10 The great majority of Medicaid expansion costs are being borne by federal taxpayers, not state taxpayers. The law made the program more of a national program with more federal funding, which was the wrong direction to go in.
A 2012 Supreme Court ruling determined that the ACA expansion of Medicaid is a voluntary choice for state governments. So far, 31 states have taken the federal money and expanded the program, while 19 have not.11 The ACA expansion has added at least 13 million people to the program.12
The ACA is a budget-buster. By increasing benefits and further federalizing Medicaid, the law threw gasoline on the fiscal fire of runaway health care spending. Congress should reverse course, repeal the ACA, and downsize Medicaid.
Incentives to Expand
As the federal government has expanded Medicaid over the decades, state governments have had incentives to expand the program as well. Since Medicaid is an open-ended federal matching grant, the states receive additional federal cash when they expand eligibility or covered services. The states have substantial flexibility to expand their programs beyond federally required minimum levels.
Each expansion draws more federal funding to a state on the basis of a matching formula called the federal medical assistance percentage (FMAP). For every dollar of additional spending on the program, the federal government kicks in 50 to 75 percent of the costs, with higher-income states receiving a lower federal match and lower-income states receiving a higher federal match.13
Overall, the federal government pays about 60 percent of program costs, while states pay 40 percent.14 That means states can proactively increase spending on their programs and mail a bill for 60 percent of the costs to Washington, on average. The federal government is currently paying more than 90 percent of the costs added by the ACA.15
Medicaid's federal matching grants create an incentive for states to expand their programs beyond reasonable levels. Federal grants provide state policymakers with "free" money to bestow on their constituents, and that biases them to spend added state dollars on health care rather than on other state priorities such as education or transportation.
Budget expert James Capretta is right that "Medicaid's current federal-state design also undermines political accountability. Neither the federal government nor the states are fully in charge. As a result, each side has tended to blame the other for the program's shortcomings, and neither believes it has sufficient power to unilaterally impose effective reforms."16
With current federal matching, the states have little political incentive to reduce Medicaid waste because they would need to save two dollars or more in costs to save state taxpayers one dollar. Indeed, states have a strong incentive to abuse the program by trying to inflate the matching dollars they receive from Washington. The states, for example, have tried to push other state spending under the Medicaid umbrella to receive more federal matching money.17
States have created numerous accounting schemes to maximize federal aid.18 One scheme involves the states overpaying health care facilities run by local governments to artificially boost federal aid, while another involves the states fiddling with the structure of disproportionate share hospital payments.19
Another aid-boosting method — used by virtually all the states — is to impose taxes on health providers and then channel that revenue back to the providers.20 The Government Accountability Office (GAO) provides an example of how that method works: "In Illinois, a $220 million payment increase for nursing facilities funded by a tax on nursing facilities resulted in an estimated $110 million increase in federal matching funds and no increase in state general funds, and a net payment increase to the facilities, after paying the taxes, of $105 million."21
Such mechanisms are a nontransparent and paperwork-heavy method of financing health care. The Washington Post called them a "swindle."22 They should be repealed.
In sum, the intergovernmental nature of Medicaid and the matching aid structure discourage cost-effective health care choices by the states...
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