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Administration's Medicaid Proposal Would Shift Fiscal Risks To States

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The Bush Administration’s fiscal year 2004 budget proposal appears to provide a modest amount of funding to help states meet Medicaid costs during this time of state fiscal crisis. This offer, however, comes with a major catch. States that opt for this fiscal relief would receive lower federal Medicaid payments than they otherwise would get, starting in fiscal year 2011. In addition, states would have to accept a significant risk that the capped federal payments they would receive even in the years before 2011 would not keep pace with increases in costs they incur and thus would fall short of what they would have received under current law.

  • From 2004 to 2010, states would, as a form of short-term fiscal relief, receive capped payments that would exceed by $12.7 billion the federal Medicaid and SCHIP payments they currently are projected to receive under current law. Then, in fiscal years 2011-2013, states would be required to repay these additional funds through reductions in the capped federal payments they receive in those years. The President’s budget shows that states would receive $150 million less in federal funding in 2011 than they are projected to receive under current law, $4.4 billion less in 2012, and $8.3 billion less in 2013.
  • In exchange for this “loan” against future payments, states would have to give up open-ended federal Medicaid financing and transform their Medicaid and State Children’s Health Insurance Programs (SCHIP) into a capped, consolidated block grant. Federal payments to states would no longer be tied to the actual costs that states incurred in operating their Medicaid programs.
  • If the actual costs that states incurred over the next ten years turned out to be higher than had been anticipated, the capped federal block-grant payments would fall short of actual costs, and states would receive less in federal funding even before 2011 than they would have received under current law. Actual state costs in Medicaid are affected by a number of factors that cannot be predicted accurately in advance, including changes in the economy, changes in the size and demographics of a state’s population, developments in medical technology (including the emergence of new and improved but costly treatments), and other difficult-to-predict factors that can affect health care costs in both the public and private sectors, such as the outbreak of an epidemic or the onset of new diseases. States opting for the block grant would bear the risk that actual costs would exceed the predictions the federal government used when setting the block-grant allotments. If that occurred, states would either have to pay the additional costs entirely from state funds or to scale back the coverage available to state residents.

Under the proposal, states would receive an annual allotment from the federal government to fund two programs — one for acute care (e.g., physician, pharmacy and hospital services) and one for long-term care (e.g., nursing home and community-based long-term-care services). [2] States could use up to 15 percent of their allotment for program administration and direct payments to safety net providers.

A state’s allotments would be based on the amount of federal Medicaid funds (including DisproportionateShareHospital payments) and certain SCHIP funds the state had received in fiscal year 2002. The amount of the capped payments that would be provided to states would be adjusted upward each year, with the annual adjustments based on a pre-determined formula that would be established in legislation or through negotiated state adjustment rates, rather than on changes in the actual number of people served and the actual cost of services. If program costs exceeded the capped amount, a state opting for the block grant would not receive additional federal funding.

This approach holds risk for states.

  • The federal government and the states currently have a financial partnership, under which they share the risks and the burdens of greater-than-anticipated increases in Medicaid enrollment and health care costs, which are notoriously difficult to forecast accurately. The block grant would terminate this partnership. It would cap the federal government’s financial commitment and absolve the federal government of any risk or responsibility related to greater-than-expected increases in costs.
  • This change would come at a time when health care costs are rising rapidly and the retirement of the baby-boom generation, which will bring with it large increases in health care costs whose magnitude cannot be predicted precisely, is only a few years off.
  • No information has been provided on how the annual adjustments in block-grant allocations to states would be determined. If the block-grant funding levels were adjusted each year by the same percentage amount for all states, the impact would be quite varied among the states, since the factors that cause state health-care expenditures to rise over time do not have uniform effects across the states. A one-size-fits-all percentage adjustment would not serve states well.
  • State-specific block-grant adjustment rates would not fully address these problems either. Under such an approach, the total amount of federal block-grant funding for a fiscal year would presumably be fixed. The amount that each state would receive would then be determined either through negotiated adjustment rates (with different rates established for each state) or through a formula that would be used to compute state-specific adjustment rates each year, based on a set of pre-determined factors. If payments to states were based on negotiated adjustment rates, states would essentially compete with each other over how much of the increase (and in later years, the decrease) in federal funding each state would get. States would have difficulty estimating and defending the proper adjustment rate for their state, given the difficulties involved in projecting the percentage amounts by which Medicaid costs will rise each year. The process would likely be somewhat arbitrary and could be subject to political influence, in part because of the lack of objective standards for setting state-based adjustment rates.
  • If instead of state negotiated adjustment rates, a formula for distributing funds to states was developed that resulted in the computation of annual payment adjustments for each state based on a pre-determined set of factors, the formula would only be as good as the factors included in it and the data used to make the adjustments. It would be virtually impossible to take into account in such a formula all of the myriad factors that contribute to changes in state Medicaid costs. In addition, the state-based data that would be needed to effectuate such adjustments often are not unavailable, are not reliable (or at a minimum, are subject to varying reliability across states), or are available only after a significant time lag.
  • Even if a formula did a tolerable job of anticipating cost increases in a particular state, this would be of limited help if the overall adjustment factor used to determine the increase in the total amount of federal block-grant funding available nationally fell short of fully reflecting the increases in costs that states incurred. If that occurred, most or all states electing the block grant could be adversely affected.
  • At bottom, setting capped allotments for states entails, by its very nature, making projections in advance of how much health care costs will rise. Over the years, the most sophisticated projections often have fallen well short of costs. For example, the projection the Congressional Budget Office made in 1998 for federal Medicaid spending five years hence (i.e., in 2002) turned out to be 12 percent — or $17 billion — below actual 2002 expenditures.
  • Finally, the reduced federal payment levels that states would receive in 2011-2013 could form the basis for reduced payments to states in years after 2013, when the block grant would be reauthorized. Given the budgetary difficulties that the federal government is expected to be facing at that time, it is likely that the level of block grant payments that states would receive in 2013 — when the payments would be $8.3 billion below what states are projected to receive under current law — would serve as the starting point for deliberations over federal block-grant funding levels for years after 2013.

For such reasons, New Mexico governor Bill Richardson recently observed, “Capping the federal portion of Medicaid spending leaves states with all the risk.”[3]

Once in the block-grant structure, a state would be required to juggle a plethora of needs and demands within a fixed pot of funds. Capped funding essentially creates a “zero sum” game for states.

  • Although some question remains about whether certain segments of the Medicaid population (the so-called “mandatory” beneficiaries) would be served with block-grant funds or whether states would continue to receive open-ended federal matching funds for these people, some of the most costly and fastest growing parts of state Medicaid budgets — including most costs for elderly and disabled beneficiaries — clearly would come under the capped payment structure. While states would have increased flexibility to change the rules for many beneficiaries and services, it appears unlikely that this flexibility could lead to large savings unless a state took steps to reduce coverage or services significantly.
  • In addition, once the economy turns around and states are again in a position to consider making improvements in their Medicaid programs to cover more of the uninsured (and thereby to lower costs for uncompensated care), they would be foreclosed from receiving any additional federal Medicaid payments to help finance such improvements. The federal funds they would receive would be limited to their capped allotments. Any new resources for expansions or other improvements would have to be financed entirely by state funds (or by reducing coverage or services for people whom the state already is covering or cutting provider payments). As a consequence, states would have less ability under the block grant to address unmet health care needs and reduce the ranks of the uninsured than they possess under the current financing arrangements.

In short, while the proposal would increase state flexibility in some areas, it would eliminate what is perhaps the most important element of flexibility for states that is built into Medicaid — the flexible, open-ended federal funding arrangement that lies at the heart of the program and under which states can count on the federal government to bear its share of any unanticipated costs that occur and any eligible expenditures that states determine they need to incur on behalf of their residents. States would no longer be assured of additional federal Medicaid funds in the case of an outbreak of a potentially lethal disease, such as Severe Acute Respiratory Syndrome, or if a new treatment for AIDS or cancer became available or a plant closed and hundreds of families and retirees in a state suddenly qualified for public coverage. The current flexible financing mechanism would be replaced by an inflexible, capped federal funding allocation. That could put states in something of a fiscal straitjacket.

As noted, the block-grant approach would be optional for states. States that declined this offer, however, would be denied any federal fiscal relief during this time of severe budget crisis.

These and other issues related to the block-grant proposal and its financial implications are discussed in more depth below.

End Notes

[1] Cindy Mann is a Research Professor at the Georgetown University Institute for Health Care Research and Policy. She is the former Director of the Family and Children’s Health Program Group at the Health Care Financing Administration (now the Centers for Medicaid and Medicare Services). Melanie Nathanson and Edwin Park are Senior Health Policy Analysts at the Center on Budget and Policy Priorities.

[2] Initially, the Administration proposed two distinct allotments but this part of the proposal has reportedly been dropped.

[3] Testimony of Governor Bill Richardson before the House Committee on Energy and Commerce, March 12, 2003.