The nearly $1 trillion stimulus bill making its way through Congress includes a little bit of everything, but if the bill passes as is, a large chunk of the money will go toward relieving state budget shortfalls by increasing federal subsidies for Medicaid. Assisting state efforts to provide health care for the poor may seem like a worthwhile goal. The history of Medicaid and some simple economics, however, reveal that it would probably be a very expensive mistake.
Medicaid is the second-largest component of state spending, after education. Medicaid spending is growing rapidly–it nearly quadrupled between 1990 and 2004–and represents over 20 percent of the average state budget. The little-known secret behind this increase: Federal subsidies largely caused it.
During the Reagan presidency, overall federal grants to states shrank substantially. Medicaid grants did not shrink, however, so the program became the main method by which states could get money from the federal government. The federal subsidy for the wealthiest states is 50 percent of Medicaid spending; for poorer states, the number can rise above 75 percent. Put another way, even wealthy states get a dollar from the federal government for every dollar they spend, and poorer states can get more than $3.
The converse is also true: When a state cuts its Medicaid program by a dollar, it loses at least a dollar of federal money. This gives all states, and especially poorer ones, an incentive to milk the system by increasing Medicaid spending. In my research into the topic, I found that a 1 percent increase in the subsidization rate leads states to spend an additional $15 per capita.
States have often taken this to creative lengths. For example, as Medicaid eligibility for children and pregnant women has expanded, states have used less state maternal and child health funding to serve these clients–and instead used Medicaid money. Also, in a 2004 report before Congress, Kathryn Allen of the Government Accountability Office explained how some states turn Medicaid dollars into general-use dollars: “[These] states receive federal matching funds on the basis of large Medicaid payments to certain providers, such as nursing homes operated by local governments, which greatly exceed established Medicaid rates. In reality, the large payments are often temporary, since states can require the local-government providers to return all or most of the money to the states. States can use these funds–which essentially make a round-trip from the states to providers and back to the states–at their own discretion.”
All this is simply a misallocation of resources. When a state spends $1 on Medicaid, it gets more than $1 in what seems like free money–but that money comes from federal taxpayers (basically the same people as state taxpayers), and to them the money is not free at all. Thus, from the taxpayers’ perspective rather than the state governments’, there’s no reason to spend more money on Medicaid than would be spent without federal subsidies.
Increasing subsidies via the stimulus will produce even greater inefficiency than we see now. And states have already expanded their programs beyond affordability.
Expanding Medicaid would have adverse results on American economic health. A better course of action would be to cut the Medicaid subsidization rate, restoring the incentive for states to spend money only when it’s worth spending. With the money saved, the federal government could genuinely stimulate the economy, perhaps through federal tax cuts. This type of stimulus would clearly be better medicine.
– Brian Blase is a Ph.D. candidate in economics at George Mason University.