Medicaid Empire: Why New York Spends so much on Health Care for the Poor and Near Poor and How the System Can Be Reformed

Policy Reports | Health

No. 284
Monday, March 20, 2006
by John C. Goodman, Michael Bond, Devon M. Herrick, Joe Barnett, and Pamela Villarreal

How the Federal Government Can Help

New York can take many steps on its own to improve its Medicaid program. But federal legislative changes are required to fundamentally reform the system.

Block Grant Federal Funds. In the 1990s there were proposals in Congress to give states more flexibility and responsibility through a block grant.221 A report by the National Governors Association suggests an inflation-indexed block of money for long-term care. The states would then decide who and how much to cover.222 This is probably a good idea for all portions of Medicaid. In 2003, the Bush Administration proposed converting the federal match to a fixed block grant to the states. 223 This is similar to how Congress allocates federal funds for state welfare programs. One of the advantages of a block grant is predictability.224 It would limit the federal government's financial exposure while allowing states to design programs to meet their unique needs with maximum flexibility.

Under the current system, every time New York Medicaid wastes a dollar, one-half of the waste is paid for by the federal government. Every time New York Medicaid eliminates a dollar of waste, only half the savings stays in New York , while the remainder is realized in Washington , D.C. With a block grant, New York as a state would realize the full benefits of every dollar saved and pay the full costs of every dollar of additional spending. Put differently, a block grant would allow New York to realize the full benefits of its good decisions and pay the full costs of its bad decisions.

In the current climate, a block grant to all states is unlikely. However, if five or six states requested a block grant, Congress in all probability would grant the request.

“Medicaid funds could be block granted to the states.”

A worry states have with a block grant is that the federal government might renege on the deal. A block grant converts a defined benefit entitlement into a defined contribution. Under the former system, payments are based on the state's willingness to spend. Under the latter, spending is based on the federal government's willingness to pay. So wouldn't the states be at the mercy of the federal government under a block grant system?

One solution to this problem is to write into the pilot program the specific formula that determines how much New York and other participating states receive. Specifically, if New York currently receives 13 percent of all federal Medicaid dollars, the agreement could specify that the state will continue to receive 13 percent of all federal Medicaid dollars for the next few years.

A further advantage of the block grant approach is that all the funds the states currently receive would be at their disposal to allocate as they choose. Currently, Medicaid is a convoluted system of matching grants with separate pots of money for specific purposes. One of these pots is disproportionate share hospital (DSH) payments, which are designed to reimburse hospitals that care for a larger than average number of indigent patients. Texas is a perfect example of some of the ways this fractured funding distorts incentives.

In 2003, the Texas legislature passed a law requiring the Texas Department of Health and Human Services (HHS) to provide Medicaid services in the most efficient manner possible. Subsequent research found Medicaid HMOs were the most cost-effective way to provide services. In early 2005 the director of HHS announced plans to expand a pilot project and place 400,000 Medicaid recipients into Medicaid HMOs for an estimated savings of $401 million dollars over two years. However, Texas HHS was fought by public hospitals that stood to lose DSH payments. The argument was that Texas hospitals stood to lose more federal matching funds and DSH funds than the proposed would save by providing care in a more efficient manner.

Under a block grant, a state would have the flexibility to use DSH payments to reimburse hospitals, or use the funds to cover indigent patients in more efficient ways. This would allow it to target funds to the most appropriate facility and pay for care only through the most efficient provider.225 For instance, a state could use the funds to reimburse neighborhood clinics or community hospitals rather than pay for expensive care in emergency rooms. It might also provide an incentive for hospital facilities to provide indigent care in the most efficient manner rather than seeking federal funds for care rendered in their emergency departments.

Allow Cost-Sharing. Copayments and increased cost-sharing have been used successfully by private health insurers for years to reduce unnecessary use of medical services.226 Out-of-pocket payments boost consumers' incentives to consume goods and services wisely. One way to apply this principle to Medicaid is to offer enrollees who wish to purchase a drug not on the formulary the opportunity to receive the drug if they make a higher copayment. If a physician thinks a nonformulary drug offers significant benefits, copayments could be waived.

“When patients pay, they reduce their use of unnecessary medical services.”

Currently, states are only allowed to charge nominal copayments of $1 to $3 for medical services and prescription drugs, unless they receive a waiver.227 Certain mandatory populations, such as pregnant women and poor children, are exempt from cost-sharing. The National Governors Association favors allowing states to require cost-sharing and copayments from both optional and mandatory populations at their discretion.

However, cost-sharing should not be imposed for those services and treatments that have been shown to reduce preventable medical costs. States should, for example, provide first-dollar coverage for asthma treatments, because hospitalizations for severe asthma attacks are costly.228 But doctor visits for routine sore throats are almost always unnecessary; they occur so frequently because they cost the patient very little.

Repeal Limits on Long-Term Care Partnerships. An inflexible federal law — the Omnibus Reconciliation Act of 1993 — effectively limited Long-Term Care Partnerships to the four states that already had pilot projects.229 The law also prevented other states from waiving the estate recovery requirement as an incentive for individuals to obtain qualifying long-term care policies.

New federal legislation allows states to begin to offer these incentives again. However, the federal government still needs to clarify a few remaining details, such as how individuals can retain protection when moving from one state to another. 230

Make Long-Term Care Premiums Tax-Deductible. Commercial long-term care insurance is available, but few seniors — and fewer working-age adults — purchase it, even though 40 percent of nursing home residents are under age 65. One reason is that long-term care insurance is not given the same tax treatment as other health insurance.

People can use their health savings accounts (HSAs) as well as their flexible spending accounts (FSAs) to pay a limited amount of long-term care premiums tax free. Unfortunately, many people don't have access to either HSAs or FSAs. And the amount of long-term care premiums that are non-taxable is limited based on age. For instance, individuals under 40 years of age can only deduct $260 per year while those 41 to 50 can deduct $490, 51-to 60-year-olds can deduct $980, 61-to 70-year-olds can deduct $2,600, and seniors over 70 can deduct $3,250. 231

Long-term care premiums are a medical expense under section 213(d) of the tax code, but those expenses are only deductible to the extent that they exceed 7.5 percent of adjusted gross income.

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