Former Governor George Voinovich called Medicaid the “Pac-Man” of the state budget and its easy to see why.  It is also easy to see why reforms need to be made in Washington to free up Ohio to better manage this behemoth of a program.

First, some context.

After adjusting for inflation, Medicaid spending has increased 7.85 times what it was in 1975. That’s a 785% increase – not counting inflation. After peaking in 2006, state spending slowly declined until 2011. This coincides with the federal government offering the state’s matching funds, so while the state was spending less, at the federal level money was being dumped in. Now that program has expired, where is spending headed? According to the Ohio Legislative Services Commission, in FY 2011 spending will increase 21 percent. In FY 2012? 45.3 percent

The Department of Health and Human Services increased federal matching money for Medicaid from 64.15 percent to 74.91 percent through the federal stimulus bill and a subsequent extension. This rate is officially called the “Federal Medical Assistance Percentages” or FMAP.

The enhanced rate for most services was phased out at the end of June 2011, though the Ohio SCHIP FMAP continues at a higher, nearly 75 percent rate.

Unfortunately, FMAP introduces a whole host of perverse incentives for state spending. In particular, a policy brief from the National Health Policy Forum notes that “minimum federal matching rates and federal expenditures [are] driven by state-determined levels of program spending”. Essentially, the amount of money the federal government provides can be increased by increasing state spending. This system encourages the state to spend beyond its funding capabilities, and then use federal dollars to fill in the rest. It actually punishes states for attempting to reduce their spending by also reducing their amount of federal matching.

At the 75 percent FMAP rate, for every dollar Ohio spends on Medicaid, the federal government kicks in three. The flip side of this is that for every dollar of spending that is reduced, we lose that dollar and the three the federal government provides. It’s pretty difficult to cut spending when you lose 4 total dollars for every dollar the state saves.

This complexity is one of the major reasons for Ohio’s Medicaid expenditures rising in the current biennium.

However, there are larger trends at work besides the unique circumstances surrounding the stimulus.  According to the Ohio Office of Healthcare Transformation,

“1% of the US population consumes 23% of total health spending. 5% of the US population consumes 50% of total health spending. Most people (50%) have few or no health care expenses and consume only 3% of total health spending.”

76 percent of Medicaid enrollees are covered families and children, yet they account for only 32 percent of the Medicaid costs. Only 24 percent of enrollees are aged and disabled but they account for a whopping 68 percent of expenditures. Ohio spends 44.7 percent more than the national average on elderly Medicaid enrollees.  This is an issue with which Governor Kasich’s Administration has been grappling.  The Buckeye Institute has referred to this in several previous blogs.

In order to move this process along, multiple reforms are needed.

Reforming the FMAP system is the first step in getting Medicaid spending under control. It is currently calculated as 1-(0.45 x ((State Per Capita Income²)/(U.S. Per Capita Income²)) and takes only the last 3 years of income into account. This incredibly broad measure was included when Medicaid was originally passed in 1965, and is a very poor determiner of true need. It doesn’t take into account poverty rates, and because it uses the average of the 3 years prior, it is ineffective at providing funds during economic downturns. As a result, Congress acts to increase and “enhance” the FMAP rates, so that Ohio’s rate has increased from 62.14 percent in FY 2009 to 74.91 percent in FY 2011. These astronomical increases in federal money are wasteful, and make it nearly impossible for the state to rein in spending to sustainable levels.

Lowering FMAP rates is an essential part of beginning to rein in this open-ended system. The states that have incomes significantly higher than the national average, such as California, already have FMAP rates closer to 50%. If Ohio’s state spending on Medicaid was 1:1 with federal spending, the losses from reducing spending would not be nearly as significant.  States would be less incentivized to keep spending money just to make sure that we continue to receive increased amounts of federal funds.

However, this is really only a temporary solution.  So long as there are any perverse incentives to “spend money to get money”, there will be a never ending stream of advocates seeking just “one additional dollar” for their respective group in need.  A serious examination of federal reform such as “block grants” to the states that mirrors the welfare reform provisions from the 1990s should be considered.  These are ideas that are being promoted by a wide variety of figures including U.S. Representative Paul Ryan (R- WI), the Chairman of the US House Budget Committee.

Such a reform would allow states maximum flexibility to decide how to run their own programs while having a real shut down valve on an ever running federal spigot.