Medicaid Reform: The Elephant in the Room

Medicaid Reform: The Elephant in the Room
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While headlines fixate on the future of the Affordable Care Act’s health insurance exchanges, a more consequential fight is brewing over the future of Medicaid. Proposed reforms would affect tens of millions of Americans and state governments across the country. Previous attempts have failed, however, and longstanding roadblocks may sink this administration’s efforts as well.

With over 70 million enrollees, Medicaid covers more Americans than any other insurer.   Responsibility for funding the program – which accounts for nearly 20 percent of all healthcare spending – is shared between states and the federal government. At a minimum, the federal government covers 50 percent of costs, with that share rising to nearly 75 percent in the poorest states and more than 90 percent for those covered through ACA Medicaid expansions. This amounts to nearly $350 billion in federal funding per year.

Importantly, this money is allocated in an open-ended manner. As states increase the generosity of their Medicaid programs, the federal government is obliged to pay its portion of the higher costs.

During his campaign, Donald Trump joined a long list of Republican lawmakers who argue that this gives states the wrong incentives. Because the federal government covers at least half of each dollar spent, they argue, states may take less care to weed out inappropriate and inefficient spending as they otherwise would.

To eliminate this open-ended feature, Trump’s plan calls for federal money to be allocated in fixed lump sum payments known as block grants. 

First proposed in 1981 by President Reagan, block granting of Medicaid hardly represents a novel policy option. Why then has the current system endured, and what does this portend for the resistance Trump’s efforts may encounter? 

To understand, consider the most basic decision for any block grant policy: How should each state’s grant be initially determined?

Policymakers have two basic options. Either use current state Medicaid spending as a base, or use some independent measure of funding needs. Both approaches are open to criticism.

Allocating money based on current spending would lock in large and arguably unfair variation in funding across states. Current federal spending per low-income resident varies by a factor of 11 to 1 across the country. Permanently entrenching this variation would justifiably draw the ire of states locked permanently into low federal contributions.

Alternatively, block grants could be allocated using need-based calculations independent of previous state Medicaid decisions. A natural approach, for example, would be to base grants on differences in each state’s per-capita income, which is already used to determine the federal government’s share of each state’s spending.

Income-based block grants are attractive in their ability to channel resources to the states that are most in need. And this approach might seem obvious if Medicaid were being designed from scratch. Medicaid is not, however, being designed from scratch. Consequently, this seemingly appealingly reform would result in a seismic redistribution of federal spending.

We illustrate this redistribution using data from 2015. In our example, each state’s grant is based on its per-capita income relative to the average national level. Poorer states have higher values and vice versa. We scale for the population such that the sum of federal dollars equals 2015 levels.

This reform would create major winners and losers. Federal dollars would flow from states in the northeast and Pacific coast to states in the southeast and plains. Some would win big – states like Florida and Texas would receive an extra $8 billion per year.

Conversely, this system would be highly disruptive to states on the losing end. New York and California, for example, would lose over $15 billion per year, creating major state budgetary problems. 

What do these numbers mean in practice? In New York, recouping a $15 billion shortfall would require increasing all tax rates, fees, and charges by 16 percent. The loss falls just short of the state’s combined spending on education and transportation infrastructure. 

Beyond the sheer volume of dollars at stake, seemingly technical details can have significant long-term consequences. According to what formula, for example, would the federal contribution grow over time? Will the federal contribution expand during recessions or will states be left more exposed to economic downturns than under the current system? While these and other design elements must be addressed, proposals are often sparse on such detail.

Ultimately, Medicaid reform offers President-elect Trump and Congressional leaders the same challenge it offered previous administrations. Technical details abound and the dollars at stake are substantial. Navigating these issues will be easier said than done.



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