Cleaning the Augean Stables Of Medicaid Financing

One of the great tales of Greek mythology is Hercules cleaning the Augean stables of King Augeas.  The stables had become incredibly filthy due to decades of neglect, filled with an unimaginable amount of manure and detritus. The stench was so overpowering that it permeated the entire region.  This is an apt analogy for the financing mechanisms of Medicaid, a trillion dollar program whose financing has gotten totally out of control over the decades.

The Debt Dispatch just hosted a Capitol Hill event on Medicaid financing with Michael F. Cannon (Cato Institute), Chris Pope (Manhattan Institute), and Brian Blase (Paragon Health Institute).  It is clear that a Herculean effort will be required, not just physical strength but also ingenuity, perseverance, and the transformative power of overcoming challenges.  There will be no rivers of cash to divert to Medicaid:

https://debtdispatch.substack.com/p/fixing-medicaids-financing-structure

Fixing Medicaid's Financing Structure to Reduce Waste, Fraud, and Overspending
Recap of our Capitol Hill event with Michael F. Cannon (Cato Institute), Chris Pope (Manhattan Institute), and Brian Blase (Paragon Health Institute).
By Romina Boccia and Tyler Turman - August 18, 2026

Medicaid is one of the largest and fastest-growing items in the federal budget and is highly vulnerable to waste, fraud, and abuse.

We took that problem to Capitol Hill, hosting a panel featuring Michael F. Cannon of the Cato Institute, Chris Pope of the Manhattan Institute, and Brian Blase of the Paragon Health Institute to discuss Medicaid’s structural weaknesses and how to address them.

Cannon and Pope offered two competing visions for how to reform the program, each with its own trade-offs. Yet all panelists agreed that Medicaid’s flawed financing structure is at the root of many of its problems and needs an overhaul. Congress took steps in the right direction with last year’s reconciliation bill, but far more needs to be done.

The Financing Flaw Behind Medicaid’s Dysfunction

State and federal Medicaid spending totaled $931.7 billion in fiscal year 2024. Real federal spending on the program grew by nearly 40 percent from FY 2016 to FY 2025. This outpaced Medicare, Social Security, defense, food stamps, and nearly every other spending category over the same period (Figure 1).

Medicaid is also highly vulnerable to financial mismanagement. The Paragon Health Institute estimates that Medicaid made $1.1 trillion in federal improper payments from FY 2015 to FY 2024—nearly one of every four federal dollars spent on the program over that period.

Medicaid’s matching grant system is at the root of many of its dysfunctions. Although states run Medicaid, the federal government matches between $1 and $9 for every dollar that states spend on the program, with no limit on total federal contributions.

This arrangement weakens states’ incentives to police fraud and rewards them for overspending. As Blase pointed out, it also encourages states to “engage in money-laundering schemes,” such as provider taxes and state-directed payments, “to give the appearance of an actual expenditure that is just a fictional creation on paper.” States use these gimmicks to “get federal money for nothing” and off-load more of the financial responsibility for the program onto federal taxpayers.

It’s also poorly targeted. Although poorer states receive a higher federal matching rate, the wealthiest states with larger tax bases, such as New York and California, have more money to spend on optional Medicaid benefits to claim more federal matches. In effect, this directs the most money to the states that need it least.

Medicaid’s problems are not confined to the federal budget either. Government subsidies drive up the cost of health care for everyone while displacing private health insurance for the recipients it covers.

Two Competing Visions for Reform

After detailing numerous problems with Medicaid’s matching grant system, Cannon and Pope presented two competing visions for replacing it. But each carries its own trade-offs.

Cannon advocated for converting Medicaid into a fixed block grant. As he explained, this would curb the program’s spending growth, eliminate state incentives to draw federal dollars through financing gimmicks, and incentivize states to spend “much more responsibly” to better match “Medicaid spending and taxing levels [to] voter preferences.”

Pope, however, argued that block grants would leave poor states, whose smaller tax bases already limit their revenue, least able to absorb the costs of higher enrollment during recessions. This, he said, would encourage states to “come begging to Washington for a bailout,” expand the program when the economy recovers, and then ask for higher bailouts during the next downturn.

Pope instead favored fully federalizing mandatory benefits, such as hospital and physician services, for the core enrollees that states are already required to cover. Any optional benefits or eligibility expansions beyond that, such as payments to people providing home care to family members or dental services, would be left to the states to pay for. Pope argued that this would “end the moral hazard” of the federal government promising states money “for whatever obligations [they] incur,” including optional benefits “incidentally related to health care.” It would also reduce bailout pressure: As the federal government would fully fund mandatory benefits, states could no longer argue that those costs were unaffordable and required a bailout.

Cannon stated that bailout pressures could be managed by states setting aside “rainy-day funds” for downturns and Congress resisting the temptation to spend more. Pope’s plan, Cannon argued, would simply shift existing state Medicaid spending onto federal taxpayers, with states being unlikely to cut spending in response. The result, he said, would be federal spending added “on top of state spending” rather than replacing it. This would increase federal Medicaid spending and drive “the federal government even closer to a debt crisis.”

What OBBBA Did—and What it Left Behind

Faced with the program’s unsustainable fiscal trajectory, Congress made meaningful changes to Medicaid in the One Big Beautiful Bill Act (OBBBA) to rein in waste and tighten oversight. Notably, it:

• placed a moratorium on new provider tax schemes and reined in existing ones by gradually lowering the “safe harbor” threshold in expansion states;
• limited state-directed payments by tying them to Medicare’s reimbursement rates rather than the far higher rates states had been allowing;
• established work and community engagement requirements, generally 80 hours per month of employment, education, or service, for able-bodied adults in the expansion population;
• required states to redetermine eligibility for expansion enrollees every six months rather than annually; and
• directed the Centers for Medicare and Medicaid Services to build a system that cross-checks enrollment across states to catch people signed up for benefits more than once.

The Congressional Budget Office (CBO) estimated that OBBBA’s Medicaid reforms will save federal taxpayers roughly $1.2 trillion over the next decade.

Yet it left Medicaid’s matching grant system and all the perverse incentives that come with it intact. Moreover, OBBBA’s reforms merely slowed Medicaid’s growth rather than cutting spending (Figure 2).

Medicaid is still projected to grow each year and will cost federal taxpayers roughly $8.3 trillion over the next decade. As the Paragon Health Institute has pointed out, this is still more than $1 trillion above the program’s cost trajectory based on CBO’s 2021 baseline.

Further Reforms Are Necessary

Short of structural reform, Blase argued that Congress should address the worst distortions in the matching grant system. As he points out, “The federal government provides seven times more money for every dollar a state spends” on able-bodied adults in the Medicaid expansion than on the traditional population—low-income families, the disabled, and the elderly. This weakens state incentives to accurately verify able-bodied eligibility while encouraging them to misclassify traditional enrollees as expansion enrollees. Congress can address this by eliminating the enhanced federal match for the expansion population.

At a minimum, Congress must enforce and implement OBBBA’s new limits on provider taxes and state-directed payments and resist pressure to delay or roll them back.

Beyond incremental fixes, Congress should weigh the structural reforms the panel debated. All three panelists agreed that the status quo is unsustainable. As federal debt climbs, Medicaid’s price tag will make it among the first programs targeted for cuts. Acting now, while Congress still has options, is much more preferable to sudden, drastic reductions under worse conditions later.

Medicaid’s fiscally unsound matching grant system is a choice Congress made when designing the program. It’s also one Congress can change by reforming it.

Additional Resources:

Curbing Waste, Fraud, and Abuse in Federal Welfare Programs

Cato Handbook for Policymakers: Medicaid and the Children’s Health Insurance Program

Overcharged: Why Americans Pay Too Much for Health Care

Slowing Optional Medicaid Spending Growth

A Plan to Make Medicaid Fair, Focused, and Accountable 

The authors would like to thank intern Eleanor Barrett for her contribution to this piece.