Reining in Medicaid Financing Gimmicks

As you watch the furore over Medicaid cuts, understand that the original basis of the program has been deviously undermined by legions of green eyeshade types at the state level.  Benedic N. Ippolito discusses the status of the federal/state cost split of the Medicaid program.

Benedic Ippolito is a senior fellow in economic policy studies at the American Enterprise Institute. His research focuses on a variety of topics within health economics, including the pharmaceutical market, Medicare Advantage, provider pricing, and the role of health care costs in the personal finances of Americans.  Ippolito holds a PhD and an MS in economics from the University of Wisconsin-Madison and a BA in economics and mathematics from Emory University.

https://www.aei.org/economics/some-encouraging-progress-on-reining-in-medicaid-financing-gimmicks/

Some Encouraging Progress on Reining in Medicaid Financing Gimmicks
By Benedic N. Ippolito - May 14, 2025

Both Congress and the current administration have proposed limiting controversial Medicaid financing strategies that allow states to artificially offload costs to the federal government. Even independent of near-term federal savings, they both represent sensible reforms to the program’s financing structure.

States and the federal government share responsibility for financing Medicaid spending, with the federal government covering between 50 and 90 percent of spending. The exact amount varies across states and enrollee types.

States can finance their share of spending from various sources, like general revenues. However, states have increasingly done so by imposing taxes on health providers or Medicaid insurers and using the revenues to cover their share of spending. Doing so triggers federal matching payments without requiring any actual state spending. States can then make supplemental payments to taxed entities to ensure their financial position is maintained or improved.

While states have long optimized to Medicaid’s financing rules, the proliferation of these tax strategies undermines the balance envisioned in the program’s financing structure. Estimates suggest this has increased federal share by five to seven percentage points on average (more so in the most aggressive states). The federal government now covers roughly 75 percent of program costs in practice.

This further reduces state incentives to constrain spending and raises questions about why states retain as much control over program design (and federal spending) as they do. These concerns are particularly salient as many states work to expand Medicaid spending to include categories like food and housing.

This week has seen two notable reforms to these contentious financing strategies.

The House reconciliation bill includes a moratorium on new provider taxes or increases to existing ones. While there is a strong argument for going further than simply freezing the status quo, the Congressional Budget Office (CBO) still estimated that this would reduce federal spending by $86.7 billion dollars over ten years. The fact that a moratorium alone generates savings of this level reflects the pace at which CBO expects states to adopt and expand these schemes.

Simultaneously, the Centers for Medicare and Medicaid Services (CMS) recently announced a rule that imposes new constraints on taxes aimed at Medicaid managed care insurers (a similar proposal was included in the House bill as well). In short, CMS’ proposed rule would limit how precisely sates can target these taxes to only Medicaid lines of business, among other tweaks.

CMS estimates this will save roughly $30 billion in five years. Absent a policy change, these financing arrangements are likely to grow significantly, suggesting a ten-year budget score will likely be more than double CMS’ five-year estimate.

There is substantial disagreement about the appropriate level of spending in the Medicaid program, but that does not justify the current financing arrangement. Even holding current spending constant, it would be preferable to transition towards a system with less open-ended federal contributions. Such a system could incorporate features like automatic stabilizers for economic downturns.

Absent more structural changes, policymakers are well-justified in targeting some of the most aggressive attempts to shift program costs to federal taxpayers. Doing so would also align with past legislative efforts, like introducing payment limits and initial reforms to provider taxes from the 1990s, that constrained states’ ability to exploit program rules.

It remains to be seen how much interest the Senate will have in Medicaid financing reforms, but these modest efforts to retain some financing discipline are worth keeping.