States' Finances Underlie Need for Medicaid Reform

This piece is cross-posted at the Manhattan Institute's state and local issues blog,

Fiscal instability is not only an issue nationally - driven largely by health care spending - but at the state and local levels as well. A new GAO report illustrates the magnitude of the fiscal challenges facing states, and identifies the (unsurprising) culprit:

The [simulation] show[s] that [state and local] health-related costs will be about 3.8 percent of GDP in 2013 and 7.2 percent of GDP in 2060...[t]he model projects that the [state and local] non-health-related costs will be about 10.5 percent of GDP in 2013 and about 7.7 percent of GDP in 2060.

The ever-growing burden imposed by health care spending means that by 2060, the national state and local fiscal gap will be around 4 percent of GDP - in nominal terms, that's about $5 trillion based on CBO projections. Because health care costs - enshrined in promises to government employees and retirees, as well as Medicaid spending on the poor - will drive this fiscal growth, which is unlikely to slow down (health care spending on current employees and retirees is governed by contracts, which makes it difficult to pare back; Obamacare's Medicaid expansion ensures that in the states that undertake it, many more residents will be covered making it more difficult to slow down its growth) other state and local outlays will fall on the chopping block. This phenomenon of "crowding out" is nothing new; because localities operate with limited funds (revenue must be raised through taxes, bond issuance, or from federal grants), each slice of the pie has to get smaller.

Indeed, the GAO report also acknowledges that wages paid to state and local employees will likely fall as a share of GDP (this phenomenon may ironically increase retirement promises that localities make to employees).

For states that are expanding their Medicaid programs under Obamacare, the expansion may seem like a reasonable way to shift costs to the federal government. At first, the federal government picks up the full cost of new enrollees, while later on, states will only be responsible for 10 percent of the costs. For the majority of states, however, this will still mean an increase in spending.

Reports like this underlie the need to drastically reform government health care spending - Medicare (on the federal side) and Medicaid (on both the state and federal side) are seen, unambiguously, as eating up an ever growing share of revenue going forward. Obamacare expanded Medicaid, shifting some costs to the federal government, while bringing "productivity adjustments" to Medicare in the form of provider cuts. Neither approach represents actual reform, however; analysts in the private sector and at the CBO routinely note that government health care spending is on an unsustainable trajectory.

Worse still, the latest FY14 budget from the White House drew a line around Medicaid, taking it "off the table."

Perhaps the one silver lining for Medicaid is that it remains largely a state-administered program that simply has to operate according to federal guidelines. Because of this, states have become testing grounds for new approaches to offering the poor affordable health care. Managed care penetration for instance, where tight networks of providers are often given financial incentives to provide more efficient, outcome-based care, varies significantly among the states. New York has more than three-quarters of its Medicaid population in managed care contracts; Maine, on the other hand, has less than half. Other innovative approaches have also taken hold - the Healthy Indiana Plan took a "consumer-driven" approach, offering Medicaid beneficiaries an HSA product that was partly funded by the state, to help keep down unnecessary health care spending - the results have largely been positive.

Just because one reform worked in Indiana doesn't make it ideal for other states, however. State medical needs vary greatly, and no amount of central planning will change that - basic demographic differences like income and age distribution can drastically affect a state's health care spending. Fortunately, states can request waivers from the federal government to experiment with new ways of paying for Medicaid services or administering the program.

Whether these waivers will continue to be issues as regularly as they have in the past is unclear - a uniform Medicaid program is essential to Obamacare's coverage expansion, and HHS may choose to approve fewer and fewer waivers as a way of better controlling the program. Other, more drastic approaches are likely only pipedreams for now - Medicaid block grants based on the successful welfare reform of the 90s would create a natural cap on future spending growth, as my colleague Paul Howard has written.

Real reform to Medicaid would take advantage of states' abilities to be "laboratories of innovation"--the current administration could take the first step by assuring states that even with a Medicaid expansion, HHS would continue to consider even the most drastic waivers. 

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