Medicaid expenditures and state budgets: past, present, and future.

INTRODUCTION

Medicaid is one of several major components of the nation's health care system. It has grown dramatically over time and now provides health benefits for approximately 52 million people, about one-sixth of the national population. A program of this magnitude touches on all aspects of economic life, affecting beneficiaries, health-care providers, private insurers, taxpayers, and every level of government. In particular, Medicaid has become a major expenditure item for state governments, with Medicaid spending of more than $315 billion in 2005, accounting for more than 21 percent of total state government spending in the nation as a whole. A large fraction of state Medicaid spending is financed by grants from the Federal government, and these grants are now major elements in the system of Federal transfers to the states.

The present discussion examines the Medicaid program from a fiscal perspective, especially with reference to the fiscal systems of state governments. The steady growth of Medicaid spending raises questions about fiscal sustainability. The states experienced a period of significant fiscal stress beginning in 2000, partly the consequence of weakened revenue flows and partly the result of earlier growth in expenditures. Revenue growth has since increased, but perhaps this offers only a temporary respite before the next economic downturn triggers another round of fiscal crises. Ominous demographic and other trends suggest that health care costs will continue to grow for decades to come. Will states be able to cope with the fiscal burden of Medicaid? Rising health care and other costs will subject the federal government to fiscal stress as well. Will the states find the federal government less willing in the future to share in the financial burden of Medicaid?

Lacking a crystal ball with which to provide definitive answers to these and other forward-looking policy questions, it is tempting to retreat to a cautious review of past trends and policy experience. (1) However, while it is not our purpose to engage in demographic, economic, fiscal, or political forecasting, it seems useful, nonetheless, to discuss, even if only in somewhat speculative terms, some of the policy options that the nation will face in the coming years.

We begin, in the second section, with an overview of Medicaid spending from the viewpoint of its impact on state budgets, describing its growth in aggregate terms and also the wide interstate variation in Medicaid spending. In the third section, we summarize some recent analytical efforts to explain observed Medicaid expenditures. Because the federal government plays such a large role in the Medicaid program, through its financing of state expenditures and through its regulation of the program, we focus particularly on the federal regulatory and fiscal determinants of Medicaid spending. We also present some preliminary results from ongoing research, highlighting possible interactions between the 1996 welfare reform and recent Medicaid spending growth.

The fourth section discusses the prospects for Medicaid in coming decades. Demographic change is likely to play a major role in the evolution of health care spending in the nation as a whole and may have very important effects on Medicaid in particular. The future of Medicaid in state budgets will also depend crucially on federal government policies, such as the recently instituted prescription drug coverage provided by Medicare Part D. Recognizing that the federal government faces growing fiscal stress, it is natural to consider also the prospect of more fundamental alterations in the federal/state division of labor in providing and financing health care benefits for the poor, the elderly, and for other groups. We, therefore, discuss, in an admittedly somewhat speculative spirit, the implications of a policy reform for Medicaid similar to the welfare reform of a decade ago. The fifth section concludes with a brief summary.

MEDICAID GROWTH AND STATE GOVERNMENT FINANCES, 1990-2003

The rapid growth of Medicaid spending is well-known and widely documented. Here, we offer a concise review of this growth, mainly from the perspective of its implications for state government finances and intergovernmental fiscal relations. (2) We will frequently compare it to the major "cash welfare" programs--Aid to Families with Dependent Children (AFDC) prior to the 1996 welfare reform (the Personal Responsibility and Work Opportunity Reconciliation Act, or PRWORA) and Temporary Assistance to Needy Families (TANF) subsequent to it. This comparison is of interest for at least two reasons. First, both Medicaid and cash welfare have been broadly targeted at low-income households and, indeed, they constitute two of the largest and most durable means-tested transfer programs in US history. Second, in both cases, a large proportion of state government spending has been financed by transfers from the federal government. Prior to the 1996 welfare reform, the structure of intergovernmental transfers for both programs was substantially the same: the federal government provided each state with open-ended matching grants for both programs, with matching rates varying among the states inversely to state per-capita income, subject to a minimum federal share of 50 percent. The welfare reform replaced the matching grants for welfare by a system of lump-sum grants similar in amount to those previously awarded, while leaving matching grants for Medicaid unaffected. Comparison of these two programs provides a unique opportunity to study the response of state governments to changes in intergovernmental grants.

Table 1A summarizes some of the key trends in Medicaid spending since 1990. Medicaid spending now amounts to approximately 21 percent of aggregate state government spending, this share having nearly doubled in the past 15 years (column 3). The rate of growth varies somewhat over time and by state, but the overall trend is unmistakably and almost monotonically upward (see Figure 1). This may be compared with cash welfare spending, which was about 3.3 percent of state spending in 1990, but which fell to only 1.7 percent by 2005 (column 4). At its inception in 1967, Medicaid and welfare spending were approximately equal in amount, but Medicaid spending has grown substantially faster over time. By 1990, Medicaid spending was nearly four times as large as cash welfare spending, and by 2005, it was more than 12 times as large (column 5).

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Medicaid spending varies substantially among the states, as illustrated in Table 1B. In 2005, two states (Utah and Wyoming) had Medicaid expenditures that were less than 13 percent of total state spending. At the top end, Medicaid spending exceeded 30 percent of total state spending for three states (Tennessee, New York, and Maine) (column 3). Cash welfare spending also varies widely by state, with 14 states (Arizona being the lowest, at 0.49 percent) having TANF spending of less than one percent of total state spending in 2005, while two (California and New York) had TANF spending of more than 2.5 percent (column 4). Although New York stands out for high spending on both programs, California, which has the second-highest TANF expenditure share, is fifteenth from the bottom in Medicaid spending as a share of total state spending, and the simple correlation between expenditure shares on Medicaid and TANF spending, as shares of total state spending, is only 0.29. Thus, simple generalizations about state "generosity" toward welfare and Medicaid beneficiaries, based on this metric, are unlikely to withstand scrutiny.

As noted, intergovernmental transfers have played a critical role in the financing of Medicaid and cash welfare programs. In 2005, Medicaid matching rates (3) were at the matching-rate floor of 50 percent in a dozen states, but exceeded 74 percent in West Virginia, New Mexico, Arkansas, and Mississippi (Table 1B, column 6). Prior to welfare reform, matching rates for AFDC exhibited similar variation among the states, but these matching rates all fell to zero after 1996. Given the large size and rapid growth of state Medicaid spending and given the high matching rates for this program, it is not surprising that federal transfers for Medicaid have become a major funding source for state governments. As a proportion of aggregate state government spending, Table 2A, column 2 shows that Federal Medicaid grants have risen from about 7.15 percent in 1990 to over 12 percent in 2005. (By comparison, state individual income taxes and general sakes each financed 15 percent of total state government expenditures in 2005.) Federal grants for cash welfare, on the other hand, have steadily declined in importance as state government funding sources. In 1990, AFDC grants were about 1.8 percent of total state spending, a figure that fell to only 0.96 percent by 2005 (column 3).

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Table 2B, column 2 shows that Medicaid grants exceeded five percent of 2005 total expenditures in all states (Wyoming, at 6.38 percent, was the lowest), while these grants exceeded 20 percent of spending for two states, Maine (20.09 percent) and Tennessee (21.48 percent). TANF grants, by contrast, were comparatively insignificant, with amounts ranging from a minimum of 0.32 percent of total state expenditures in Arkansas to 1.44 percent in California and 1.47 percent in New York; aside from these last two, the corresponding figure was less than 1.4 percent in all other states (column 3).