Reforming Medicaid

Studies | Health

No. 257
Friday, February 28, 2003
by Michael Bond,John C. Goodman, Ronald Lindsey, and Richard Teske


Executive Summary

Medicaid is enormously expensive. For the second year in a row, spending on Medicaid (for the poor) will exceed spending on Medicare (for the elderly). At $280 billion this year, Medicaid costs almost $1,000 for every man, woman and child in the country - or $4,000 for a family of four. Indeed, it is likely that many taxpayers are paying more in taxes to fund health insurance for the poor than they pay for private health insurance for themselves and their own families.

In the future, the taxpayer burden will get worse. Left unreformed, Medicaid will bankrupt every state in as little as 20 years, possibly absorbing 80 to 100 percent of all state revenues. Delay is not an option. States and the federal government must act now to avoid a real human and fiscal disaster.

Reason for Rising Costs. Why are Medicaid costs rising so rapidly? Part of the reason is that many states are paying for health care in ways that needlessly contribute to rising health care costs. Another problem is that most states have not taken advantage of cost-control techniques widely used in the private sector. For example:

  • Because Texas' method of paying for hospital care is largely cost-based, Medicaid pays some Dallas hospitals three times as much as other hospitals for the same services.
  • Because Ohio's method of paying for nursing home care is essentially cost-based, the state is paying for 13,000 empty beds.
  • In virtually every state, Medicaid pays for inputs rather than outputs. This means that the more physicians and facilities do, the more they earn - even if patients would have been better off if less were done.
  • Medicaid patients also have incentives to waste resources; the only way they can realize more benefits is by consuming more health care.

Medicaid from top to bottom is organized in ways that create perverse incentives for those who are supposed to benefit from the system. For example:

  • Because Medicaid benefits are conditioned on having a low income, the program penalizes those who succeed; individuals can lose eligibility and therefore health coverage for themselves and their families simply by getting a workplace promotion or a raise.
  • Because Medicaid benefits are conditioned on having few assets, the program encourages people to spend rather than save their income.
  • Because Medicaid is an alternative to private insurance, the program encourages people to drop coverage for which they or their employers pay and turn to "free" insurance for which all taxpayers pay.

Studies estimate that as much as 75 percent of the expansion of Medicaid nationwide has been offset by a reduction in private insurance. This is one reason why the number of uninsured in America keeps rising, despite the expansion of costly public programs.

Traditional Solutions. In order to participate in Medicaid and receive matching funds from the federal government, states must provide minimum benefits to certain categories of people. Nationwide, however, about 70 percent of all Medicaid spending covers either beneficiaries who do not have to be covered or services that do not have to be covered or both. Thus one alternative is to eliminate "optional" people and "optional" services. There is also an ever-present pressure to lower payments to providers. Cutting costs in these ways, however, is easier said than done:

  • Most of the optional people are likely to be uninsured after they are dropped from the rolls. And evidence from Texas suggests that regions that spend less on Medicaid spend more on free care for the uninsured and vice versa.
  • A major optional benefit is coverage for prescription drugs. Yet because drug therapy often substitutes for more expensive hospital and doctor therapies, eliminating coverage for drugs may not save the state any money.
  • Another large optional benefit is mental health care. But mental health services are also often a substitute for other health services, and without Medicaid the state may have to spend money on many of the beneficiaries anyway - but without federal matching funds.
  • Reducing payments to providers will disproportionately hurt rural and inner-city areas at a time when the nation's safety net of local clinics, hospitals and charities is overburdened and threadbare.


A New Approach. The time has come for a "pro-patient" approach to health care. The following are some elements of that approach.

Choice. Medicaid is a defined benefit program, under which the state determines the covered health services, and patients and doctors decide how much to spend on those services. It should be converted into a defined-contribution system, under which the state determines how much it is willing to spend and patients (along with their doctors) choose how to spend it.

Competition. Most of the problems with Medicaid and Medicare stem from the fact that these two programs have changed very little since they were created in 1965. By contrast, private insurance is continually evolving in response to changes in medical science and changes in consumer wants and needs. Medicaid enrollees would benefit enormously if they had access to private sector plans, including the plans of their employers.

Portability. At least a quarter of all Medicaid eligibles move in and out of the program each year, as patients are tossed from physician to physician multiple times. As a result, many find the hospital emergency room more convenient than having a primary care physician. A better approach is private, portable insurance - where enrollment continues even after eligibility for Medicaid has lapsed.

Empowerment. Arkansas, New Jersey and Florida have obtained federal waivers under which disabled Medicaid beneficiaries manage some of their own health care dollars and make decisions on how to spend those dollars. These experiments have been highly successful and much more needs to be done. Enrollees need access to private sector Medical Savings Account (MSA) plans. Those who remain in traditional Medicaid need access to something similar: a Medicaid Benefit Account (MBA).

Paying for Results. Whenever possible, the state should pay for outputs, not inputs; for results, not for efforts made to achieve those results. At a minimum this means abandoning variations on cost-plus reimbursement and adopting some of the payment methods used by private insurers instead.

Devolution. For those who remain in traditional Medicaid, another useful idea is to give local communities more control, say through a block grant of funds. Under the current system, Texas reimburses El Paso hospitals at rates that are above the state average, while a typical primary care clinic lacks an X-ray machine or even a lab and must send patients to a hospital for simple diagnostic tests. As a result, El Paso's low-income population overutilizes hospital care and underutilizes outpatient care. The city and its people would be better off it were free to reallocate funds from inpatient to outpatient care.

More Radical Devolution. Despite a raft of studies claiming that being insured affects access to health care, there is no difference in services rendered to those who seek care - at least at Parkland Hospital in Dallas. The insured, the uninsured and the Medicaid patients who are treated there enter the same emergency room door, see the same doctors and receive the same care. As a result, patients have no reason to fill out the lengthy forms and answer the intrusive questions that Medicaid enrollment requires. Similarly, the doctors and nurses who treat these patients get paid the same, regardless of the patients' enrollment in an insurance plan. This is part of the reason why at least 10 million people who are theoretically eligible for Medicaid have not bothered to enroll.

If the patients and the doctors who treat them do not care who is enrolled in which program, why should policymakers care? Why not just give Parkland Hospital a sum of money each year and let it deliver indigent health care? Our primary goal should be to enroll people in private sector plans. But to the degree that we fall short, we should make access to care as easy as possible.

The Need for Federal Waivers. In order to take full advantage of private sector techniques and private sector opportunities, states should apply for a federal waiver, called a HIFA waiver. For example, a waiver might work like this:

  • All "mandated" Medicaid enrollees would have the opportunity to enroll in employer plans or other private sector plans with premium subsidies from the state.
  • To qualify, the private insurance would have to be similar to the plans currently offered to state employees.
  • Those beneficiaries who do not qualify for an employer plan would have the opportunity to enroll annually in a plan of their choice through an insurance exchange (a health mart), organized and operated by the state.
  • At least one of the plans offered would make use of a Medicaid Benefit Account (MBA), which would be similar to a medical savings account, except that the funds could be used only to pay health care expenses or health insurance premiums, now and in the future.
  • Projected savings (in a static sense) from these changes would be used to enroll additional, "optional" people in Medicaid (this is a necessary condition to get approval for a HIFA waiver).
  • The optional enrollees, consisting of additional people with disabilities and low-income families, could be offered a limited set of benefits (e.g., primary care benefits only) or they could be given the same options as other Medicaid enrollees - with premium support from the state diminishing as family income rises.

Expected Results. The HIFA waiver, combined with other recommendations in this report, would allow the state to take advantage of the full range of techniques employed by the private sector. It also would allow the state to move large numbers of people from state-funded insurance to insurance largely paid by employers and - since employer-provided benefits are earned by working - by the beneficiaries themselves.


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