The Agenda

How to block grant Medicaid

In my City Journal Online piece on the Paul Ryan budget’s over-reliance on optimistic targets for health care savings, I touch on the issue of Medicaid block grants. I think Medicaid block grants are a good idea, but as proposed by Ryan they will put excess pressure on state budgets and gradually erode Medicaid benefits. Here’s how I think we should think about block granting Medicaid.

First, it’s important to step back and think about why Medicaid is a state-federal program. The federal government has a couple of key advantages in providing means-tested entitlements like Medicaid. One is that it can run budget deficits, making it easy to adjust the Medicaid budget upward and downward as caseloads move with economic cycles. Another is that some states are poorer than others, and federal entitlements create an avenue for progressive fiscal transfers across state lines.

Given that, we could set up Medicaid as an entirely federal program. But there are some advantages to letting state governments run Medicaid. One is that people in different parts of the country have different preferences about the generosity of entitlement programs; a state-federal structure makes it possible for New York to use New York tax dollars to augment Medicaid’s generosity. Another is that having 50 separate Medicaid programs creates more opportunities for innovation; Indiana has particularly been a leader in this regard, under Mitch Daniels.

But when you set up Medicaid as a state-federal program, there are also some pitfalls. Most importantly, states make decisions about expanding Medicaid, but get to send the bill to the Washington for part of the cost of expansions. When a state decides to spend an extra dollar on Medicaid, it only costs state taxpayers about 43 cents at the margin, so there are incentives to overspend.

A block grant program should be designed to realign those incentives—ensuring that an extra dollar of Medicaid costs state taxpayers a dollar at the margin—while retaining the advantages of the state-federal structure. What would that entail?

  • First, as I discuss in the piece on the Ryan budget, the block grant must grow fast enough. Ryan hopes to save money by growing the Medicaid block grants in line with population and the Consumer Price Index, but this would lag the growth of medical spending per capita by 3 or 4 percentage points per year. That lag would have to be made up with a growing state share of expenditures or reduced benefits, and would continue for as long as medical cost growth outpaces inflation. If the federal government is taking on too large a share of the low-income health care cost burden, the correct remedy is a one-time downward shift, not an index that will erode the program indefinitely. Instead, the index should be designed so that the federal cost share for a “typical” state Medicaid program stays roughly constant over time. As part of an integrated plan to reduce health care inflation, it makes sense to set this growth rate a bit below current expectations for cost growth—say, GDP plus 1 percent—but CPI is too low.

  • Second, the block grant should move with economic cycles. It’s not clear exactly what ‘population’ measure Ryan would use to set the grant. It should be a measure that tracks the Medicaid-eligible population. Since states would be able to set their own eligibility standards, actual eligibility wouldn’t work. Instead, the federal government should set a standard for “typical” coverage—e.g., 100 percent of the federal poverty line—and adjust the block grant as that population grows and shrinks. (The population measure should also take into account the less-volatile population that receives nursing care through Medicaid.)

  • Finally, there should be a feature so that the federal share of Medicaid expenditure actually grows in recessions, and then shrinks in recoveries. The federal government is much better positioned than states to handle Medicaid cost shocks, and so including some countercyclicality in the block grant formula would take the pressure off states to raise taxes or make deep spending cuts during economic downturns.

Medicaid block grants are themselves a form of cost control, as they will encourage the states that run Medicaid to be more frugal. (States should become more enthusiastic about combating Medicaid fraud, for example, when they get to keep all the money saved.) But block grants as I’ve described them wouldn’t produce savings of the sort Ryan is hoping for. Larger cost savings in Medicaid would have to come either from decisions to cover fewer people or fewer procedures—implicit in the Ryan budget—or from general reductions in health care inflation.

Josh Barro — Mr. Barro is the Walter B. Wriston fellow at the Manhattan Institute. His research is focused on state and local fiscal policy.


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