The Misallocation of Federal Medicaid Dollars

Why does Connecticut get more than twice as much federal Medicaid funding, per person in poverty, than Mississippi?

Recently, the Centers for Medicare & Medicaid Services (CMS) announced that Medicaid’s improper payment rate — the proportion of program payments that should not have been made or were made in the wrong amount — was 8.6 percent, totaling more than $50 billion. Although not necessarily indicative of waste, fraud or abuse, these figures speak to serious lapses in program integrity.

But there’s a more fundamental problem with how Medicaid funds are distributed — one that challenges the core principles of how the program works.

Medicaid is the most prominent example of fiscal federalism in the United States. Overall, states cover about 40 percent of the program’s expenditures and the federal government pays about 60 percent. But those proportions vary substantially by state — and in ways that don’t always make sense.

In a policy brief published last month, I explore the allocation of more than $400 billion in federal Medicaid funds each year and find that current funding mechanisms often undermine Congress’ intent of establishing a basic healthcare safety net around the country and of equalizing states’ contributions to the program.

As Figure 1 shows, there’s enormous variation in how much federal Medicaid funding states receive, even after controlling for the size of their poor population. In 2019, two states received in excess of $20,000 in federal Medicaid funds for each person in poverty, while one state received less than $5,000.

Figure 1: Distribution of Federal Medicaid Spending per Person in Poverty, 2019

One potential explanation for these disparities is that higher federal Medicaid payments are directed to states with smaller tax bases that otherwise would have difficulty generating sufficient revenues to support an adequate safety net. But the data tell a different story.

Whether you look at own-source revenues (Figure 2) or a broader measure of total taxable resources (Figure 3), you find that higher federal Medicaid spending is associated with greater state fiscal capacity.

Figure 2: Federal Medicaid Spending and Total Own-Source Revenues, 2019

States that are best positioned to fund their own Medicaid programs — e.g., New York, Connecticut, New Hampshire — receive some of the fattest checks from the federal government, while the poorest states — e.g., Mississippi, Alabama, Oklahoma — aren’t given the support they need.

Figure 3: Federal Medicaid Spending and Total Taxable Resources, 2019

These patterns are not simply artifacts of the uneven adoption of Medicaid expansion under the Affordable Care Act. The trend lines are virtually unchanged when the analysis is limited to expansion states.

To a large extent, the problem stems from the Federal Medical Assistance Percentage (FMAP), which is the share of Medicaid benefit spending covered by the federal government. The FMAP is determined by a formula that provides more assistance to states with lower average personal income relative to the national average. The trouble, as I argued in a previous blog post, is that average personal income is a poor measure of state need.

Congress could take several steps to make the system work better:

• Revise the FMAP formula to include more accurate measures of the health of states’ poor residents, the level of states’ fiscal resources, and how states’ healthcare service prices compare to national averages.

• Make Medicaid administrative costs — which account for about 5 percent of total Medicaid expenditures—subject to the FMAP, instead of imposing a flat federal match rate on all states.

• Eliminate the arbitrary 50 percent minimum statutory FMAP level. This would oblige wealthy states to cover a greater share of their Medicaid expenses. Other adjustments could be made to the FMAP formula to use these savings to enhance federal Medicaid assistance to states with greater needs.

• Gradually reduce the enhanced FMAP rate for expansion adults under the ACA (which currently stands at 90 percent) to the regular FMAP rate.

You can read the entire policy brief here.