Thinking about Tyler Cowen’s Medicaid Proposal

by Reihan Salam

Tyler Cowen offers “a new bargain on health care,” the goal of which would be to expand coverage while holding down costs for employers and taxpayers. Specifically, he calls for federalizing Medicaid, transitioning the Medicaid population to the exchanges, repealing the deductibility of state and local taxes (to reflect the shift of Medicaid costs from state governments to the federal government), and narrowing the scope of required insurance. It is an elegant proposal that has much to offer liberals and conservatives.

One of the barriers to coverage expansion has been Republican resistance to Medicaid expansion. Many conservative governors and state legislators are concerned that the expansion will lead to large increases in state expenditures, despite the fact that the Affordable Care Act stipulates that the federal government will bear virtually all of the cost of covering newly eligible individuals, at least for the first few years. One issue is the “woodwork effect,” i.e., while the ACA provides full federal funding for the newly eligible, it does not for those who were eligible pre-ACA — and the expectation is that large numbers of already eligible uninsured individuals will “come out of the woodwork.”

With this in mind, Cowen proposes federalizing Medicaid and gradually transitioning Medicaid beneficiaries to the state-based health-insurance exchanges. I like the idea of federalizing Medicaid, and I agree that federalizing Medicaid would prove attractive to state governments, regardless of political coloration. To understand why, consider Medicaid expenditures as a share of total state expenditures across the states. In 2011, federal funds accounted for 62.7 percent of state Medicaid expenditures and state and local funds accounted for the rest. Medicaid expenditures represented 23.7 percent of state expenditures, a national total that masks significant differences across states. Republican and Democratic governors would be delighted by the prospect of handing over this burden to the federal government.

One challenge, however, is that while federalizing the costs associated with Medicaid beneficiaries who are also Medicare beneficiaries would be relatively straightforward, fully federalizing the costs associated with low-income Medicaid beneficiaries would be more difficult, as most anti-poverty programs are administered at the state and local level. The federal government could fund the Medicaid program for low-income beneficiaries while state governments still administer program, but this might exacerbate the “pass-the-buck” dynamic that already plagues the program. Indeed, this is one of the larger conceptual problems with state-based insurance exchanges — the exchange subsidies are financed by the federal government, yet state governments will regulate the insurance products available on the exchanges. State governments will thus not bear the cost for regulations that raise the cost of medical care.

And in light of the various problems plaguing the exchanges, the political appeal of the exchange model might be waning. Ross Douthat’s Sunday column warns that the failure of the exchanges might strengthen the case for “bottom-up/top-down socialization,” in which near-retirees are given the option of buying into Medicare and Medicaid expansion proceeds apace. Conservative reformers who champion the idea of a lightly regulated, well-functioning individual insurance market now find themselves in a bind.

All that said, Cowen’s bargain is a good starting point for liberals and conservatives, and it’s definitely preferable to the ACA as it stands. James Capretta’s ACA replacement proposal offers a few useful tweaks, e.g., Medicaid could be transitioned into an additional subsidy on top of a universal refundable tax credit. But of course the Capretta plan entails a much larger rethinking of the U.S. health system.