December 11, 2001

Administration's Regulation to Reduce Medicaid "Upper Payment Limit"
Would Further Worsen State Budget Crises

by Leighton Ku and Edwin Park

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The Administration has issued a proposed regulation to lower the Medicaid "upper payment limit" (UPL) for public hospitals. This regulation would limit how much states could reimburse such hospitals, which would have the effect of reducing federal Medicaid matching payments to a number of states. Because the Administration wants to implement this change in the very near future, states would find their federal Medicaid matching funds reduced during the recession. This would worsen the budget deficits that states face this fiscal year — which are expected to exceed $35 billion and may reach $50 billion, according to the National Governors Association — and force states to cut program expenditures or raise taxes to an even greater degree than they already will have to do to balance their budgets.

The Administration argues that states are abusing the "upper payment limit" rules by using these rules as a mechanism to secure funds from the federal government that are not provided to hospitals but instead are used elsewhere in state budgets. This is true in part. Some of these funds are being siphoned off for other purposes. But it also is true that a significant share of these funds are used to support local public hospitals. The hospitals that receive this assistance generally serve substantial numbers of uninsured patients, including individuals who have recently become unemployed. Moreover, as a result of the recession, safety-net hospitals are likely to be caring for even more uninsured and low-income patients in coming months. The finances of some of these hospitals could be jeopardized by the imminent change in UPL policy.

The Administration's efforts to change this rule now are ill-advised. If a change is to be made in these rules and federal UPL payments to states are to be reduced, it should not be done while the economy is in recession and states face gaping budget deficits. Indeed, although the fact that some of these funds are siphoned off for use elsewhere in state budgets is a serious problem that warrants redress in normal years, in a recession such action lessens the degree to which states must cut other expenditures or raise taxes. State actions to cut expenditures or raise taxes during a recession further dampen economic activity and thereby aggravate the downturn. Furthermore, there is a need during recessions for an increase in federal funding to states to serve uninsured patients, not a decrease in such funding.

After the downturn is over, a tightening of the UPL rule would be in order if it is done as part of an effort to increase the effectiveness of federal health care spending in reducing the ranks of the uninsured — that is, if the savings the federal government realized from cutting UPL payments to states were used to provide added funding to states to reduce the number of uninsured in a manner not susceptible to diversion of these funds for other purposes. This is not the case, however, with the proposed UPL regulation the Administration has issued. None of the savings from that regulation would be rechanneled for such purposes. (Instead, the savings would apparently be used to narrow future budget deficits and ease pressure on elements of the tax cut not yet in effect.)

Lowering the UPL now goes in the opposite direction — it would make state budget shortfalls larger rather than smaller. It would have the counterproductive effect of causing a number of states either to raise taxes or to cut program expenditures — including expenditures for Medicaid — to a greater extent than they already will have to do.

At a later time, it would be appropriate to reassess Medicaid UPL policy and determine the actual extent to which the existing payments are being used to support health care or are being diverted for other purposes. This, however, is the wrong time for a regulation reducing UPL payments, as it would reduce funding to states and thereby force them to raise taxes or cut program spending to a greater degree during a downturn. If UPL policy is revised later, any resulting savings should be used to expand health insurance coverage or strengthen the health care safety net.