The newly elected Republican Congress seems set to place Medicaid reform at the top of its legislative agenda. Previous reform attempts have stumbled due to fears that cuts would leave the poorest beneficiaries uninsured. But, rather than cutting payments for core services, Congress can best curb rising Medicaid costs by limiting high-spending states’ further expansions of benefits and eligibility.
To claim federal Medicaid funding, states must provide a core package of healthcare benefits to low-income parents, children, and elderly and disabled people. But 63% of Medicaid spending comes from states opting to expand benefits and eligibility beyond what is required by federal law.
Federal Medicaid spending surged from $265 billion in 2013 to $616 billion in 2023. This increase was partly due to COVID-19, but mostly because states exploited an extraordinarily lucrative revenue opportunity: For every $1 that states spend on most beneficiaries, the federal government will normally provide between $1 and $3 in matching funds. For beneficiaries made eligible by the Affordable Care Act, the federal match is $9 for every $1 spent, with no upper limit.
Although low-income states are entitled to more federal aid per dollar they spend, the wealthiest states with the deepest tax bases can put up many more dollars and claim more federal funding. For example, Delaware obtained $24,639 in federal Medicaid funding per poor resident in 2021, whereas Alabama received only $7,052.
The disparity in spending between states owes much to unilateral expansions of eligibility: In 2022, Delaware’s Medicaid program covered almost twice as many enrollees per poor resident as Alabama’s. Costly programs also offer more generous benefits: For instance, New York spent $9.1 billion in 2023 (up from $0.6 billion in 2016) on a Medicaid benefit to pay family members to care for elderly relatives, which even Gov. Kathy Hochul (D-NY) called “a racket.”
States are supposed to claim federal funds only for covered benefits, but they lack incentives to minimize improper payments. Medicaid’s enrollment has been concentrated among beneficiaries with incomes above the program’s supposed eligibility cutoff. In 2022, 26 million of 88 million enrollees did not know they were covered, yielding enormous windfalls for insurers to cover beneficiaries who did not use any medical services because they had other forms of insurance.
States have often accepted such arrangements in return for insurers using overpayments for purposes for which direct federal funding would be unavailable. This has allowed an expansion of Medicaid’s dark money arrangements, whereby states overpay medical providers for covered beneficiaries, with the understanding that surplus funds be used for purposes that are normally prohibited. For decades, states have used overpayments to hospitals to fund expenditures beyond healthcare, and such resources have increasingly been used to finance services such as abortion or treatment for illegal immigrants, for which federal aid is specifically prohibited. This year, the Biden administration doubled the limits on payments states could claim for hospitals.
The new Republican-led Congress is therefore considering Medicaid reform to offset the cost of renewing the 2017 Trump tax cuts. Proposals include work requirements for able-bodied enrollees, reducing federal matching rates, and restricting dark money financing schemes. However, these don’t address Medicaid’s core underlying problem: unilateral spending expansions by the wealthiest states. Instead, they would likely provoke a backlash by leaving millions of beneficiaries suddenly worse off — including in Republican states that currently receive relatively little in federal funding.
As a new Manhattan Institute report concludes, capping payments to states is the only way to curb the escalation of Medicaid spending. This was the original structure of federal medical assistance to states until the Kerr-Mills Act of 1960, which was expanded into Medicaid in 1965. After New York quickly claimed more federal Medicaid funding than had been budgeted for the whole country, the legislation’s architect, Rep. Wilbur Mills, sought to reestablish caps. He failed to do so, as did Presidents Gerald Ford, Ronald Reagan, Bill Clinton, and Donald Trump.
Medicaid payments to states have been hard to cap because the program’s costs often increase for reasons states may not be able to control, such as a growing population of eligible low-income beneficiaries. States especially struggle to maintain the program’s core benefits during recessions, as they are unable to run budget deficits.
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A better approach would be to distinguish between the program’s mandatory benefits, which states are required to provide to poor beneficiaries, and optional expansions of benefits and eligibility (for which the wealthiest states have claimed the bulk of additional funding).
Congress should preserve the program’s current funding structure for its core beneficiaries and services while limiting the growth of matching funds for other expenditures. That would limit the ability of the wealthiest states to fleece federal taxpayers without disrupting funding for beneficiaries who most need assistance.
Chris Pope is a senior fellow at the Manhattan Institute.