Medicaid Needs Commonsense, Cost-Saving Reforms

Instead of attacking lawmakers for ‘cutting Medicaid,’ Americans should support prudent reforms to strengthen its finances and target its resources toward those who need them most

Cutting Medicaid costs is necessary, and we can do it without harming the patients who need this program the most. Image Credit: krisanapong detraphiphat/Getty Images

Almost as soon as the U.S. House of Representatives unveiled its budget resolution in February, which envisioned saving hundreds of billions of dollars in projected Medicaid spending, political opportunists pounced, accusing lawmakers of heartlessly targeting the vital health benefits of poor people. A typical article in The Washington Post warned of grave substantive and political consequences, saying that the proposed “cuts” “could devastate America’s teetering rural health-care system and jeopardize Republicans’ political power among rural voters.”

These hyperbolic assertions are typical of what happens whenever lawmakers make a serious effort to deal with the federal government’s unsustainable fiscal situation. The attacks may be politically effective, but they are substantively wrong. Slowing Medicaid’s cost growth is a policy imperative, and there are many ways to do so that would actually strengthen the program’s capacity to serve needy populations.

Reasons for Reform

Some brief background is necessary to understand the issues in play. Medicaid is a joint state and federal program providing health insurance to low-income Americans. Historically, the program has long served vulnerable populations such as impoverished pregnant women and children, as well as parents, aged individuals and disabled adults who qualify for federal income assistance. The costs of covering these populations are split between the federal government and state governments, with the federal government historically providing somewhat more than half the funding.

In 2010, federal lawmakers dramatically expanded Medicaid as part of the Affordable Care Act (ACA), an expansion later rendered optional for the states by a Supreme Court decision. The expansion allowed states to cover nonaged, nondisabled adults with incomes above the federal poverty level—and, importantly, the federal government initially covered 100% of these costs, phasing down gradually to 90%. The expansion has precipitated several adverse policy consequences, as this piece will explain.

There are several reasons why Medicaid must be reformed to slow its cost growth. For starters, there is no choice in the matter: The rate of Medicaid cost growth, currently occurring on autopilot under existing law, exceeds our rate of national economic growth. This can’t go on forever, which means the question is not whether to slow Medicaid’s cost growth but how. The American public is ill-served by mischaracterizations suggesting that slowing Medicaid growth is optional, contemplated only by lawmakers harboring an ideological hostility to the program or to low-income people. An honest debate would recognize that Medicaid cost growth must be slowed and would focus on comparing alternatives for doing so.

Medicaid isn’t the only area of the federal budget where cost-saving reforms are needed, but it’s one of the biggest. I maintain a recurring analysis of federal budget deficits that I update every few years, and the most recent (2021) version showed that Medicaid and the ACA account for roughly 22% of emergent federal deficits. This means that these programs contribute more to the federal fiscal imbalance than anything else besides Medicare. Medicare, Medicaid and the ACA together account for over two-thirds of our worsening fiscal problem, while all other areas of tax and spending policy combined add up to less than one-third. Slowing Medicaid cost growth is not an option, it’s a requirement.

Beyond the need to save money, Medicaid reforms are also warranted in the interests of maintaining the program’s integrity and serving its beneficiaries. A fundamental problem exists at the heart of Medicaid’s design: States make the decisions on whom Medicaid should cover but pass off the majority of costs to the federal government. This distorts states’ incentives away from prudent fiscal stewardship toward maximizing their collection of federal dollars. This problem is greatest with respect to those added to Medicaid due to the ACA’s expansion, for whom the federal government currently pays 90% of states’ coverage costs.

On its face, it is unjust that the federal government’s reimbursement rate for the ACA’s expansion population is so much higher than its rate for Medicaid’s previously eligible population. There is no health policy reason why the federal government should pay far more of the costs of covering a higher-income, nonaged, able-bodied, childless adult than it does for covering a pregnant woman living in poverty. The only reason these grossly unequal reimbursement rates were ever established was to induce reluctant states to expand Medicaid per the terms of the ACA. Purely as a matter of fairness, this difference in rates should not persist.

Beyond the principle at stake, the evidence shows real-world adverse consequences of the ACA’s inflated expansion match rate. Before the ACA, the supply of Medicaid services was already less than the demand from Medicaid patients, in part because many healthcare providers do not accept Medicaid. When the ACA dramatically expanded the number of Medicaid patients competing for access, there was no corresponding increase in the number of Medicaid providers, which meant something had to give. Economist Liam Sigaud and I discovered in a 2022 study that expansion states had shifted Medicaid’s financial resources away from low-income children toward higher-income, able-bodied adults. Specifically, we found that “states that expanded Medicaid ... spent only 5.9% more per capita on children in FY 2019 than they did in FY 2013 compared with growth of 22.7% in per capita spending on children in nonexpansion states and of 27.0% in average healthcare spending per capita for the US population as a whole.”

How To Lower Costs

The realities of the ACA’s Medicaid expansion render ironic some of the attacks on proposals to address Medicaid spending growth. It’s incorrect to assume that more spending on Medicaid is always good for Medicaid patients, especially when spending on higher-income individuals causes program resources to be shifted away from needier patients. One of the best things lawmakers could do for long-time Medicaid beneficiaries is to ensure states aren’t getting greater financial rewards for covering better-off beneficiaries, who end up competing for access with more vulnerable beneficiaries, for whom less support is provided.

Parity between Medicaid participants would be most readily accomplished by equalizing reimbursement rates for all participants at pre-ACA levels. Brian Blase and Drew Gonshorowski of the Paragon Health Institute have estimated that equalizing reimbursement rates and moving those above the poverty line out of Medicaid and onto the ACA’s health exchanges would save the federal government more than $250 billion over 10 years. And that’s before assuming any behavioral changes by states or individuals that would likely lower federal costs even further.

Other things can and should be done to lower federal Medicaid costs without harming beneficiaries. One is to crack down on provider taxes, which are essentially a gimmick employed by states to shake more dollars out of Washington. Suppose, for example, that the federal government has promised to cover 60 cents of every dollar a state spends on Medicaid. A state can inflate its take by spending more—say, $1.50 instead of $1, thereby boosting federal support from 60 cents to 90 cents—and then recouping the extra 50 cents of spending from providers via a “provider tax.” This gimmick doesn’t help beneficiaries in any way, because the net amount given to health providers is the same. All that it accomplishes is to inflate federal Medicaid spending.

The skewed incentives arising from the federal government paying for the majority of states’ Medicaid coverage decisions are incompatible with prudent fiscal stewardship. This has always been a problem, but improper payments have metastasized since the ACA expanded Medicaid, as Paragon’s Blase and economist Rachel Greszler have shown. Medicaid reported more than $500 billion in improper payments over the most recent decade, but this measurement was limited by the rarity of eligibility review audits, which occurred in only two out of the past 10 years. Blase and Greszler found that if the error rates found during years of eligibility reviews also occurred in years such reviews were lacking, total improper payments might well have exceeded $1 trillion.

Excess payments can result from many causes, including misclassifications of individuals into categories that trigger higher federal reimbursement rates. For example, the ACA established higher federal reimbursement rates for covering nondisabled adults than disabled ones. In our 2022 study, Sigaud and I also found that expansion states were reporting a decline in the number of disabled beneficiaries, a mysterious result given that there was no similar decline in nonexpansion states. This reported decline in disabled beneficiaries coincided with expanded coverage of adults not described as disabled—for whom, notably, states received far more generous federal funding support. Regardless of the cause, correcting improper and excess payments is the right thing to do, in addition to producing cost savings.

Lawmakers should be applauded rather than demonized for confronting the rising costs of Medicaid. Whereas arbitrary, across-the-board cuts could be harmful to beneficiaries, the right cost-saving reforms will help them. Such reforms should include normalizing federal reimbursement rates, cracking down on provider taxes and other gimmicks and correcting improper payments.