Medicaid: A System Designed to Fail:

Skyrocketing Medicaid Spending

In contrast to Medicare (the federal program discussed above that helps pay for hospital, physician, Medicare Advantage, and prescription drug coverage for seniors), the joint federal-state Medicaid program supports healthcare for low-income families, individuals with disabilities, and long-term care.

Because of its underlying structure, Medicaid is a system designed to fail. At present, Medicaid is a joint federal-state venture where both the federal and state governments maintain an administrative bureaucracy. However, rather than federal oversight adding to the program’s efficiency, this arrangement breeds inefficiency and waste. Because of myriad federal regulations, Washington prevents states from adequately restructuring their Medicaid programs to adapt to their inevitable challenges.

National Medicaid expenditures increased from $75 billion in 1990* to $427 billion in 2010**. This runaway growth is driven by a system of open-ended federal matches for state spending. The more a state spends on Medicaid, the more federal matching funds it receives. Because Washington supplements state Medicaid budgets, states do not demand a full dollar’s value for each dollar spent. Even more, states can actually augment their revenue by increasing their Medicaid spending. These two forces work synergistically to fuel the skyrocketing cost of Medicaid.

Federal Medicaid Subsidies

Though the subsidy varies from state to state (see Table 1 on page 16), the federal government currently pays approximately 60 percent of the total cost of Medicaid in the form of a Federal Medical Assistance Percentage (FMAP). If a state spends a total of $2.5 billion on Medicaid in a given year, the federal government picks up $1.5 billion (60 percent of $2.5 billion) of the tab. This means that for every 1 billion dollars a typical state spends on Medicaid, Washington supplements that state with an additional 1.5 billion dollars—without limit. This arrangement encourages states to expand Medicaid eligibility and increase their Medicaid spending.

The stimulus bill exacerbated the situation. Under the “Enhanced FMAP” of the stimulus legislation, the average FMAP increased from 60 percent to 70 percent. In fact, some states received over $4 billion from Washington for every $1 billion dollars of state Medicaid spending (see West Virginia in Table 1).

This federal subsidy incentivizes states to expand Medicaid far beyond the program’s original intent. In fact, states steadily expanded coverage to move individuals who previously had insurance into the program. Economists estimate from past Medicaid expansions the crowd-out rate stands at approximately 60 percent. This means that out of every 10 new Medicaid patients, six previously had private insurance.***

Table 1****

While the federal matching system was intended to “help” states, the unintended consequence is that Medicaid now overwhelms most state budgets. Inflation-adjusted, per capita state Medicaid spending increased 192 percent over the past two decades; this was quadruple the increase in state spending on education and nine times the increase in state spending on transportation.#* (See Appendix for data from selected states.)
A closer look at the Table 1 reveals two structural problems:

Problem #1:

When the stimulus funds ran out, most states were left facing massive budget shortfalls. As Table 1 indicates, the difference between the federal assistance states received under the stimulus bill (the Enhanced FMAP column on the left) and what states received post stimulus (the 2011 FMAP column on the right) was substantial.

The stimulus bill gave states additional funds to support Medicaid. However, when the stimulus money ran out states were still left with over-extended Medicaid programs they could not afford. North Carolina provides a good example.

Under the stimulus bill Washington paid 75.3 percent of North Carolina’s total Medicaid spending. This meant North Carolina received $3.05 billion from Washington for every $1 billion it spent on Medicaid. This clearly incentivized the state to transfer as much of its healthcare spending as possible into Medicaid to draw in federal dollars.

However, when the Medicaid stimulus money ran out July 1, 2011, North Carolina’s FMAP dropped to 64.7 percent. Because North Carolina’s Medicaid program costs approximately $10 billion each year, this 10.6 percent reduction in federal aid resulted in a loss of approximately $1 billion of federal funding, but the size of the program remained the same.

The common sense solution to close this budget gap was to restructure Medicaid to fit the budget. However, the Patient Protection and Affordable Care Act (PPACA) specifically prohibits this solution. The Maintenance of Effort (MOE) requirement in the PPACA threatens to remove all federal Medicaid support if a state restricts Medicaid eligibility. This requirement locks states into financially unsustainable programs. (In a sense, the Maintenance of Effort provision amounts to the federally mandated bankruptcy of many states.)

This example demonstrates why a stimulus-based economy will not work. Washington infused massive amounts of stimulus money to support state run programs like Medicaid. This “saved” hundreds or perhaps even thousands of healthcare related jobs in North Carolina. However, the stimulus spending did not produce sustained economic growth. The moment the stimulus funds ran out, North Carolina (and every other state) was left in exactly the same place as the year before—cash strapped and overextended. Only the federal government was now much deeper in debt.

This path is unsustainable for both the federal and state governments. The U.S. must find another approach.

                                                                                            
Problem #2:

Medicaid’s federal matching system encouraged states to look for creative ways to augment Medicaid spending to fill their budget shortfalls. Paradoxically, the unlimited federal match drove a rampant increase in Medicaid spending at a time when both the states and Washington had no money.

Given our current debt crisis, both Washington and most states are running massive deficits. The common sense response for both would be to limit spending. However, driven by the combination of Medicaid’s system of unlimited federal matches and the Maintenance of Effort requirement of the PPACA, the opposite has taken place.

Medicaid’s open-ended federal match encourages increased state spending and inefficiency rather than cost control through increased efficiency—even when our nation faces a national debt crisis. Clearly, Medicaid was designed to fail.

Though the size of the federal match varies from state to state, every state faces the same temptation to draw in more federal dollars to meet state budget shortfalls. Thus, every state plays the same game. The more it spends on Medicaid, the more money it receives from Washington. This creates the classic prisoner’s dilemma:

Given the massive national debt, the country would be better off if each state constrained Medicaid to reduce the total federal match (no prisoner talks). However, if one state limits Medicaid spending while its neighbor expands the program, the first state essentially send its tax dollars to the second. The name of the game? Exploit the federal match more aggressively than your neighbor. Not only does this produce jaw-dropping chicanery, it is bankrupting the nation.

Let’s return to the North Carolina example. Confronted by a multi-billion dollar budget shortfall, North Carolina finally adopted a mechanism many other states already employ. In fact, North Carolina was slow to fully exploit this legal scam. Here is how it works:

States can augment their Medicaid spending (and their federal match) by placing a “user tax” on hospitals and nursing homes. This moves money to the state capital. The state capital then returns most of the money to the hospitals and nursing homes. This “new” state Medicaid expenditure pulls in additional federal matching dollars. The amounts of money involved are stunning.

By levying a “Medicaid Provider Assessment,” North Carolina anticipates generating $735,629,969 in revenue. Raleigh will keep $60,183,120 for general funds and return $675,446,849 to the hospitals and nursing homes.#** By claiming this $675,446,849 as a “new Medicaid expense,” the state will secure $1.2 billion ($675 million x 1.83) of federal matching funds via the FMAP. The state can then use this $1.2 billion of federal money to return the remaining $60 million to the hospitals and nursing homes plus a modest increase in reimbursement.

At the end of the day, hospitals and nursing homes really paid no tax (their money was more than returned), North Carolina gained $60 million in general revenue, and the state secured 1.2 billion Medicaid dollars via the federal match. This must be the only “tax” levied in America where businesses actually seek to be taxed.

The Problem Behind the Problem

When employed by multiple states, this legal scam consumes tens-of-billions of federal tax dollars every year. While appalling, one can see the forces that compel it:

First, Medicaid reimburses hospitals approximately 86 percent of the actual cost of delivering care.#** Hospitals need supplemental funds to continue serving patients on Medicaid.

Second, the “Maintenance of Effort” provision in the Patient Protection and Affordable Care Act (PPACA) prohibits states from downsizing their Medicaid programs to fit their budgets. The loss of stimulus money forced North Carolina (and every other state) to quickly generate alternative revenue.

To escape this prisoner’s dilemma where each state increases its Medicaid spending to draw in federal funding, America must find a solution as bold as Alexander’s when confronted with the Gordian Knot. Washington must replace Medicaid’s current system of unlimited federal matches with a system of limited state block grants. At the same time, Washington must free the states from endless federal regulation and empower them to craft streamlined and efficient programs.

Key point:By fundamentally changing Medicaid from a system of open-ended federal matches to a system of limited state block grants, the increased efficiency of Medicaid can save the federal government between $30 and $35 billion annually. This equals or slightly surpasses, the amount of money needed to prevent the SGR cut and keep Medicare fiscally viable.