Opportunities for State Medicaid Reform

Policy Reports | Health

No. 288
Thursday, September 28, 2006
by John C. Goodman, Michael Bond, Devon M. Herrick, and Pamela Villarreal

How the Federal Government Can Help

States can take many steps on their own to improve their Medicaid programs.  The recently-passed Deficit Reduction Act is a good step in allowing states more flexibility in redesigning their Medicaid programs.  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 program.190  A report by the National Governors Association suggests an inflation-indexed block of money for long-term care.  Each state would then decide who and how much to cover.191  This is a good idea for all portions of Medicaid. 

Under the current system, every time a state wastes a dollar, at least half of that waste is paid for by the federal government.  Every time a state eliminates a dollar of waste, at least half the savings stays in the state, while the remainder is realized in Washington, D.C.  Block grants would allow states to realize the full benefits of every dollar saved and pay the full costs of every dollar of additional spending.  Put differently, block grants would allow states to realize the full benefits of their good decisions and pay the full costs of their bad decisions. 

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

In 2003, the Bush Administration proposed converting Medicaid's federal match to a fixed block grant to the states.192  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.  This is similar to how Congress allocates federal funds for state welfare programs.  One of the advantages of a block grant is predictability.193  It would limit the federal government's financial exposure while allowing states to design programs to meet their unique needs with maximum flexibility. 

If five or six states requested a block grant, Congress would probably approve the request.  However, some states are concerned that the federal government might renege on a block grant deal.  One solution to this problem is to write into a pilot program the specific formula that would determine how much participating states receive.  For example, if New York currently receives 13 percent of all federal Medicaid dollars, the agreement could specify that it would 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.  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.  They argued that they would lose more federal matching funds and state DSH funds than the proposed program would save.

A block grant would give a state the flexibility to use DSH payments to reimburse hospitals or use the funds to cover indigent patients in more efficient ways.  Thus it would target funds to the most appropriate facility and pay for care only through the most efficient provider.194  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 could also provide incentives for hospitals to provide indigent care in the most efficient manner rather than seek 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.195  In the past, a state was only allowed to charge nominal copayments of $1 to $3 for medical services and prescription drugs, unless it received a waiver.196

The new Deficit Reduction Act (DRA), however, allows states to charge nominal copays for all nonpreferred prescription drugs for Medicaid recipients 150 percent or more above the federal poverty level.  Furthermore, states are permitted to increase copays commensurate with rises in the medical component of the consumer price index, and they are not prohibited from requiring mandatory populations to make copayments for nonpreferred prescription drugs.197  The National Governors Association favors allowing states to require cost-sharing and copayments from both optional and mandatory populations of up to 5 percent of a family's income.  One way to apply this principle to Medicaid is to offer enrollees who wish to purchase a nonformulary drug the opportunity to receive the same drug if they make a higher copayment.  If a physician thinks a nonformulary drug offers significant benefits, copayments could be waived.

The DRA also allows states to implement cost-sharing (through higher copays) for nonemergency services provided in an emergency room setting.  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, but can be easily prevented.198  But doctor visits for routine sore throats are almost always unnecessary; they occur so frequently because they cost the patient very little.

“Benefi ts could be tailored to fi t different patients’ needs.”

Allow Flexibility in Benefits among Medicaid Populations.  Medicaid populations include old and young adults, children and individuals with special needs, such as the blind and disabled.  One of the problems with providing benefits for mandatory populations is "comparability" - the requirement that everyone in a state eligible for Medicaid must have the same benefits.  Prohibitions against tailoring benefits to individual needs often forces states to drop optional populations from their rolls in order to reduce costs, instead of simply reducing benefits for some populations that would not likely need them.  Under the Deficit Reduction Act, however, states now have the flexibility to provide different benefits for different groups of Medicaid beneficiaries.

The governor of Kentucky recently announced a plan to cover the state's current mandatory and optional Medicaid populations, but vary benefits based on the needs of four eligibility groups:  the general adult Medicaid population, children, people with disabilities or needing institutional care, and the elderly.  The new program will also provide incentives to encourage healthy behaviors similar to programs in West Virginia and other states and provide disease management benefits for those with chronic conditions such as diabetes.  Kentucky's Medicaid Commissioner estimates the program revisions will save the state $200 million over two years.199 

Level the Playing Field for Individually-Purchased Private Health Insurance.  Federal tax laws increase the cost of private health insurance, encouraging individuals who buy their own health policies to drop them.  Most Americans receive private health coverage through employer-sponsored group health plans.  Employer-paid premiums are tax-deductible as a business expense, and any premium payments the employee makes are paid with pretax dollars - which means they are not counted as taxable income and payroll taxes are not withheld.  However, nearly 17 million people currently purchase insurance for themselves and their families in state-regulated individual insurance markets.  Unlike employer plans, which are purchased with pretax dollars, individual health insurance is purchased with after-tax dollars, creating an unlevel playing field for those without employer-sponsored health insurance.  The federal government should allow individuals to pay health insurance premiums with pretax dollars.200

“Federal tax laws increase the cost of private health insurance.”

Make Long-Term Care Premiums Tax-Deductible.  Individual long-term care insurance is available from commercial carriers, 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 employer-sponsored group 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, most Americans don't have access to either HSAs or FSAs.  And the amount of long-term care premiums that are nontaxable 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 $3,250.201  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.

The deductibility of premiums should not depend on adjusted gross income or age.  Long-term care insurance is cheaper if purchased when young; full deductibility of premiums would encourage individuals to purchase coverage in advance of their need.

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