Should States Participate in the Medicaid Expansion?

Medicaid expansion, a critical element of ObamaCare, is expected to increase the number of low-income Americans enrolled in the program by 11 million by the end of the decade.  That number is down significantly from earlier CBO estimates because of last summer’s Supreme Court ruling that states are not required to adopt the new eligibility requirements.  To date only 18 states have decided to expand the program to meet the federal standards.  So the question for the rest looms forebodingly: Should we participate in the expansion?  Is expansion the only rational choice for states?  Or was your mother right in warning you that when something sounds too good to be true, it probably is? 

Proponents argue that in the long run state treasuries are only responsible for $1 of every $10 in new spending.  Furthermore, providing coverage to low-income patients will eliminate the need for hospitals to shift costs from those who don’t pay for their care to those with insurance (more on that later).  And to top it off, the stimulus provided by the federal spending will increase economic activity in the state enough to increase state tax revenue by more than the state’s required contribution for the expansion itself.   This may be something that will actually pay for itself. 

There are at least 2 important considerations that are largely ignored by proponents of the proposed Medicaid expansion.  The first is the formula for calculating the federal medical assistance percentage (FMAP) for a state.  Under the current formula the federal share of Medicaid spending ranges from 50-75% with states picking up the remainder.  The income threshold for eligibility is a state decision and varies from 25-200% of the federal poverty level (FPL). The Medicaid expansion is designed to cover all families with incomes less than 138% of the FPL and for the years 2014-16 the federal government will cover the total cost of the expansion.  Beyond 2016 the federal share will settle at 90% of the expansion cost with the state paying the other 10%.   Will the federal money be available at this rate forever?  The concern is whether the federal government will continue to spend money that it doesn’t have.  The time will come and is coming soon when Congress must address the problem of excess spending.  With entitlements responsible for a large share of the deficit, reform of the FMAP formula is likely.  Maintaining programs will require the states to absorb a larger share of the financing. 

The second consideration is the expansion’s effect on the existing Medicaid program.  The adult take-up rate in the current program is 65-70%, indicating that a large fraction of the eligible population does not participate at all.   Policy makers expect that the take-up rate will rise to 85% with the expansion.  Currently in Texas only 800,000 of the 1.23 million eligible adults are enrolled.  If the state expands Medicaid eligibility, not only will we see an additional 1.5 million newly eligible enrollees, but an estimated 365,000 of those currently eligible will emerge out of the “woodwork” and enroll.  The state will be responsible for 40% of the cost of their health care, effectively doubling the state’s share of the overall expansion costs. 

Taking a more practical approach to the argument, proponents claim that if the state refuses the federal funding to expand Medicaid that our tax dollars will simply flow to some other state.  That logic is flawed.  Medicaid spending is determined by the number of eligible enrollees in a state.  The only way that California gets more of the Medicaid expansion money is for otherwise eligible residents in Texas to move to California to receive benefits.

Estimates showing the economic benefits of these kinds of policy changes are often based on simulations using a category of economic models called regional input-output models.  The accuracy of these models depends critically on the basic assumptions buried in its estimating equations.  These models are notoriously sensitive to the assumptions made and when used improperly can easily be manipulated to provide just about any answer you want.  Input-output models are demand-side oriented and ignore supply-side constraints and the opportunity cost of resource investments.   These limitations result in overall estimates for job growth that do not consider whether the economy can attract the workforce to support the market expansion.   The Texas estimate of an additional 988,000 jobs in the health care sector begs the question: How will the state be able to attract an additional 988,000 workers?  Remember, every other state that is expanding with these federal dollars is trying to attract the same workers. 

The argument for accepting the federal money and expanding the Medicaid program is grounded in assumption that private insurance spending pays for the free care provided to the indigent population via the mechanism called “cost shifting.”  Cost shifting assumes that medical providers are able to offer free care to some patients knowing that they can pass the excess costs on to privately-insured patients.   The cost-shift theory is used in policy arguments because of its intuitive appeal, but like much of the conventional wisdom in health care, it is unfounded. 

The fact that Medicare and Medicaid pay only 90% of cost while private insurance pays almost 135% does not prove cost shifting.  It simply shows price discrimination across categories of payers.  And price discrimination does not prove cost shifting.  It merely reflects differences in relative bargaining power in local markets between payers and providers.  Research indicates that there may have been a time in the late 1980s when providers had the power to increase prices to private payers when Medicare and Medicaid lowered payments.  The reason that hospitals could do that was they had not fully exploited their market power and were able to practice cost shifting. 

By the 1990s the expanded use of managed care principles and the increase in the number of for-profit hospitals brought an end to that era.  With the elimination of indemnity insurance plans, the expansion of PPOs, and introduction of consumer directed health plans, coupled with expanded provider networks, payers are better able to resist price increases.  The only response left for hospitals when government payers cut payments is to reduce costs.    

Furthermore, Obamacare provides incentives to consolidate systems (evidenced by the recent agreement between Baylor Health Care System and Scott & White).  Consolidations will increase market power and enhance the ability to price discriminate among payers based on the number of covered lives they bring to the bargaining table.  Thinking that expanding Medicaid coverage will reduce or eliminate the price differences between private and public payers is not warranted by the evidence.    Some will blame the price increases on cost shifting, but they will be wrong. 

Where does that leave us?  If the state does not expand Medicaid what do we do?  If we do nothing, an additional 420,000 of the 1.75 million adults with incomes between 100 and 133% of FPL will be eligible for subsidies through the new exchange (set up by the federal government) at a premium cost of 2% of income, or about $40 per month. 

So what about the other 1.33 million who remain uninsured because the state did not expand Medicaid?  Why not expand the Texas Federally Qualified Health Center (FQHC) program with the money the state would spend expanding Medicaid?  The program is currently funded for $5 million per year.  Five new clinics began operation in 2012 bringing the state total to 69.  The state’s share of an expanded Medicaid program would cost at least $2 billion per year.  How many new FQHCs could be started with that kind of money?  I believe it was Albert Einstein who said “the definition of insanity is doing the same thing over and over again and expecting different results.”  Pumping more money into a flawed Medicaid program is not the way to make the program better; it may even be insane.