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The Medicaid Disaster Ahead

by Roger Stark
April 26, 2011

The Patient Protection and Affordable Care Act (PPACA, or Obamacare), passed last spring, will create a greatly expanded Medicaid program. This expansion is expected to make up one-half of the cost of the law, pegged by CBO at $1 trillion over just the first 10 years. It will also compound the problems of what is arguably the worst health insurance plan in the country. Medicaid has expanded massively beyond its original intent in 1965 and is now one of the two or three largest budget items for nearly every state. Because of low provider reimbursements, many patients have difficulty finding care. The number of doctors who are not seeing new Medicaid patients grows larger each year. The new health care law will add at least 23 million new patients to Medicaid rolls without providing for more physicians and nurse practitioners, which can only compound the access problem. And after more than 40 years, there is little evidence that Medicaid has improved the health of the poor.


A History of Rising Costs

The current Medicaid program began with the passage of the 1965 Social Security Act. The Medicaid entitlement commits the federal government to providing health services, regardless of cost, to all U.S. residents who meet the eligibility requirements. When created in 1965, eligibility was defined as: (1) all children in families with incomes of less than 133 percent of the federal poverty level (FPL); (2) all adult caretakers of eligible children; (3) elderly people not receiving supplemental social security benefits; (4) the legally blind; and (5) the disabled.

The program has always been an entitlement, with no defined limit on the number of beneficiaries or the cost of the program. The current Medicaid program is now the largest health insurance system in the United States and is the largest means-tested health care program in the world.

The cost of the current Medicaid program is shared between federal and state governments. Each state receives federal money on a sliding scale based on average personal income, with poorer states getting a higher percentage of federal funds. At present, the average match for Medicaid spending is 57 percent in federal money and 43 percent in state funds.

Incentives to Expand. The original purpose of requiring states to match the federal funds they receive for Medicaid was to control costs. The thinking of congressional sponsors was that state lawmakers would be cautious about obligating the money of their own taxpayers to fund a federal program. In practice, the exact opposite has occurred.

When a state spends one dollar for education, it gets one dollar of education services. On the other hand, when a state spends one dollar on Medicaid, it effectively gets at least two dollars of health care—its own plus the matching federal funds. Far from being cautious, state lawmakers feel they are leveraging federal dollars by expanding their own Medicaid program. Their reasoning is that limiting their own state’s spending only leaves federal money on the table, which will simply go to other states.

Federal lawmakers face similar incentives. Each federal dollar spent on Medicaid leverages a state dollar for the program, so members of Congress feel they get the full political credit for expanding government coverage of health care, while spending only half the money. In reality of course, state and federal legislators have only one source of money—the American taxpayer.

By the Numbers. Medicaid spending is now the fastest growing item in the budgets of nearly every state in the country, accounting for 21 percent of the average state budget in 2008. And that proportion is expected to grow, according to the National Association of State Budget Officers. For 2008, Medicaid expenses for federal and state governments combined were $339 billion. The Centers for Medicare and Medicaid Services projects this number will reach $523 billion by 2013, a 54 percent increase in just five years.

Spending for the current Medicaid program will double by 2017, and by then it will consume 6 percent of the nation’s gross domestic product, according to the Congressional Budget Office. The program’s average growth rate of 8 percent per year makes it the fastest- growing federal entitlement program. In the years since it was enacted, Medicaid has grown at twice the rate of health care price inflation, and significantly faster than inflation in the general economy.

In the area of cost containment, Medicaid has never lived up to the promises made for it. The 1965 cost projection for the program in its first year was just under $500 million. The actual cost in the first year was double that figure, $1 billion. By 1970, the cost of the program had grown by 500 percent to $5 billion, during which time the price level increased by only 23 percent.

By 2007, Medicaid’s total cost (state plus federal spending) was a staggering $336 billion, despite the fact that only two-thirds of potential Medicaid recipients are signed up at any one point in time.

Medicaid now represents almost 15 percent of the $2.1 trillion in total annual health care spending in the United States. In 2007, this single program accounted for fully 7 percent of all federal spending.


Making Health Car e Worse

Expanding Medicaid has not been a cost-effective way of increasing health insurance coverage because many enrollees simply substitute free public insurance for the private insurance they already have. Economists Jonathan Gruber of MIT and Kosali Simon of Cornell University have calculated this “crowd out” effect for recent expansions of eligibility. They estimate that 60 percent of recent enrollees ended up dropping the private coverage they already had.

Is There a Doctor Here? Free insurance might seem a bargain, until enrollees need to find a doctor, and that can be a challenge because of the program’s low reimbursement rates. Even though Congress over the past 20 years has steadily reduced the Medicare program’s doctor reimbursements in real terms, Medicaid reimbursements still win the race to the bottom. Despite consistent declines in Medicare payments, Medicaid payments still average only 60 percent of what Medicare pays to doctors.

Low reimbursement rates have led some doctors to stop taking Medicaid patients altogether. From 1999 to 2003, the percentage of physicians accepting all new Medicaid patients dropped from 48.1 percent to 39.4 percent, according to a survey by Julie Schoenman and Jacob Feldman for the Project HOPE Center for Health Affairs. Schoenman and Feldman also found that the percentage of physicians who stopped accepting new Medicaid patients completely increased from 26.4 percent to 30.5 percent. The unfortunate, but predictable, consequence of low doctor reimbursement is a decrease in access to health care for Medicaid recipients.

Other People’s Money. Doctors have also responded to low reimbursement rates by shifting costs to patients who pay cash or who have private insurance and to over-treat some conditions (in order to earn fees for more services). In a 2004 paper published by the National Bureau of Economic Research, economists Mark Dugan and Fiona Scott Morton estimate that the cost shifting adds 10 percent to 15 percent to the price of private health insurance.

One of the major reasons health insurance costs so much today is the rise of third-party payment, and Medicaid is a major component of that problem, too. Today 87 percent of U.S. health care is paid for by someone other than the patient receiving the services. When things are free to the consumer, he has no incentive to match the value he receives with the cost of the resources used, and overconsumption follows. If the overutilization problem in Medicaid is similar to that in Medicare, the overuse could be as high as $50 billion per year. These factors making private health insurance more expensive only compound the “crowd out” problem by making free health insurance that much more attractive.

Medicaid has also discouraged job advancement and entrance into the job market for thousands of people. Getting a raise or a better paying job puts low-income workers at risk of losing their Medicaid benefits. And as the scope of Medicaid has increased, the number of people discouraged from job advancement has likewise increased.

Better Health? One of the greatest misconceptions in today’s health care debate is that having health insurance is the same thing as having quality health care. Medicaid demonstrates how misguided that notion is. A number of studies show that Medicaid recipients fare no better and in some cases fare worse than people who have no health insurance at all. And they fare far worse than those with private health insurance. For example, a 2010 study published by the journal Cancer found that throat cancer patients on Medicaid were 50 percent more likely to die compared to privately insured patients with throat cancer; but throat cancer patients without health insurance were also 50 percent more likely to die than those with private insurance. A 2010 study published by the Annals of Surgery found that surgery patients on Medicaid experienced longer stays, higher total hospital costs, and were more likely to die in the hospital than surgery patients with private health insurance. Uninsured patients who underwent surgery were 25 percent less likely to die in the hospital than surgery patients on Medicaid. And a 2011 study published by the American Journal of Cardiology found that Medicaid patients who underwent coronary angioplasty were 59 percent more likely to have a stroke or heart attack than were privately insured patients receiving the same treatment. Medicaid patients were more than twice as likely to a have a major heart attack after angioplasty as were patients without health insurance.

Obamacare will usher nearly 25 million additional people into this very system.


The New Medicaid

The national health care reform law greatly expands and changes the Medicaid program starting in 2014. This “new Medicaid” will provide health insurance to anyone in the country who earns less than 133 percent of the Federal Poverty Level and is under age 65. The FPL is currently $10,830, so any individual making less than $14,400 will be eligible. For a husband and wife, 133 percent of the FPL is $19,400.

The details have not been worked out, but presumably, the new Medicaid will be administered through the existing state Medicaid agencies. Mandatory rules, regulations, and oversight, however, will come from the federal government.

Instead of 50/50 state-federal cost sharing, the new program will be paid for exclusively by federal taxpayers for the first three years. From 2017 until 2020, the percent paid by state taxpayers will gradually increase from zero to 10 percent, with this 10/90 state-federal split extending indefinitely. Since state taxpayers are also federal taxpayers, expanding Medicaid means higher taxes no matter what the federal/state split is. The overall costs of the Medicaid expansion are estimated to be $445 billion from federal taxpayers and $21 billion from state taxpayers between 2014 and 2019. This $466 billion represents approximately half of the overall estimated future costs of the new health care reform law.

States will continue to have the choice of opting out of Medicaid. However, because the vast majority of funding (100 percent initially, then 90 percent indefinitely) will come from the federal government, opting out will not save states much money. The temptation for state lawmakers will be that they get to distribute benefits without having to raise taxes to pay for them.

According to Medicare’s actuary, 24.7 million additional people will enroll in Medicaid as a result of Obamacare. The PPACA mandates that everyone in the country must have health insurance. Because this individual mandate may cause previously uninsured people to “come out of the woodwork,” this estimate may be too low.

As discussed above, Medicaid’s low reimbursement rates make it hard for Medicaid patients to find care. The new law does not provide for an increase in physician pay except for primary care on a limited basis. Thus, as demand explodes after 2014, access to health care services is likely to become dramatically worse for Medicaid patients.


Real Reform

The Congressional Budget Office estimates that before Obamacare, Medicaid was on a path to consume almost 6 percent of the nation’s GDP by 2017. Adding 23 million more recipients makes this cost problem worse. The country cannot afford to pay for Medicaid in its present form. Reform will be necessary in order to avoid the program’s financial collapse.

Congress passed a fairly broad Medicaid reform package in 1995. That bill gave block grants to the states, gave states more individual control, and eliminated the program as a federal entitlement. President Clinton vetoed the bill, although a year later he signed a bill that reformed welfare using similar principles.

Had the 1995 reform bill been signed into law, the Medicaid program would be on a much sounder financial footing today.

Many Medicaid reform proposals have been recommended through the years. Some of these, such as negotiating discounts for services, increasing provider fees to keep patients out of emergency rooms, and controlling drug costs, do not address the underlying problem of funding a broad health care entitlement.

There is virtually no evidence that any of these ideas would significantly impact the cost or the effectiveness of Medicaid. On the other hand, such initiatives as health savings accounts, pursuing fraud aggressively, tightening eligibility requirements, and using block grants to states have been shown to be effective in controlling costs in both health care and welfare.

Rather than compounding the existing Medicaid problems, the new federal health care law should be repealed. There is no logical reason to enlarge a bankrupt entitlement.


Dr. Stark is a health care policy analyst at the Washington Policy Center, a free market think tank located in Seattle, Washington. This article is adapted from his longer paper “National Health Care Reform and the New Medicaid,” published January 2011, by the Washington Policy Center.


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