Action necessary to fix Medicaid so spending growth is restrained

By Dan White

The Philadelphia Inquirer

Over the past few weeks, much of the country seems finally to have woken up to the reality that we are on a highly unsustainable fiscal path. One of the key drivers of that unsustainability, at both the federal and state levels, is Medicaid.

Much has been written on this subject in response to the health-care bill winding its way through the Senate, and at this point it can be easy to conflate opinion with reality. Here are three of the most important facts about Medicaid.

First and foremost, the program is incredibly important. Just over 70 million Americans get their health insurance through Medicaid. Many of those people are on the extreme lower end of the income distribution, and the program’s existence has saved countless lives since its inception in the mid-1960s.

Second, insuring that many people isn’t cheap. The program will cost roughly $600 billion this year, around $8,500 per Medicaid recipient.

Third, and of most interest lately, the program’s costs are growing much faster than the revenue used to pay for them.

Medicaid costs

This is projected to continue. According to the last actuarial report from the Obama administration, Medicaid costs will grow an average of more than 6 percent per year over the next decade. Meanwhile, nominal personal income, the collective pool of income out of which all of us pay our taxes, will grow just over 4 percent per year.

This means that every year, there will be a roughly 2 percentage-point growth mismatch in the amount of money we need to spend on Medicaid and the amount of money we will collect to pay for it. This funding gap is not new; it has persisted ever since the program was first instituted, and has resulted in Medicaid taking up a larger and larger portion of overall government spending.

At the federal level, this is relatively simple to deal with. We issue more Treasury bonds and run up the national debt to pay for the mismatch. At the state level, things get a bit more complicated. States must have balanced budgets, and as such are a zero-sum game. Every additional dollar they have to spend on Medicaid is a dollar that cannot be spent on other things like education, public safety or infrastructure.

Thus, as Medicaid has grown from about 9 percent of state budgets in the mid-1980s to almost 20 percent today, other spending programs have shrunk in proportion. The next time you get upset because you see funding for things like public universities or K-12 schools decline as a share of the budget, you’ll know why. In response, one of the most simplistic and commonly proposed solutions to this problem is to raise taxes.

Raising taxes is the right solution when a level shift in funding is required, for example when adding a new program to the budget. But Pennsylvania and other states don’t have a level problem; they have a growth problem.

Tax burden

Raising taxes in this instance would only give us more rope to hang ourselves with. Because spending would still accelerate faster than revenue, in short order we would be right back to where we started, only with a greater tax burden on the economy.

The Medicaid debate shines a harsh spotlight on Pennsylvania. For one thing, we spend more on Medicaid than almost any other state as a percentage of our budget – Medicaid made up 29 percent of the commonwealth’s general fund budget last year compared to 12 percent in New Jersey. For another, Pennsylvania’s senior senator, Pat Toomey, is one of the lawmakers pushing hardest for reform.

One of the biggest points of contention in the Senate health-care bill is Toomey’s proposal to cap Medicaid growth at the rate of inflation. In a strict sense this would not be a cut to Medicaid, in that Medicaid spending is not declining from one year to the next. Rather, the measure would force the program, at the federal level, to grow much more slowly than it otherwise would.

This provision of the bill holds monumental implications for Medicaid as well as the federal and state budgets. The only problem is that reasonable people can disagree vehemently about whether those implications are good or bad.

At the heart of the matter is whether or not you can slow the pace of health-care cost growth by turning down the amount of government money you pour into health care. Medicaid has continuously grown faster than the economy, not because of increases in the number of people enrolled, but because of increases in the cost per enrollee.

Sound theory suggests that this is at least in part because the government is required by law to pay into the system as much as is necessary to cover a recipient’s health-care costs, and this gives little incentive for the system to keep costs low.

Conservative economists

This is a core tenet of many conservative economists’ work, but it is a concept also recognized by many left of center as well. In theory, then, capping the pace at which Medicaid spending can increase from one year to the next should eventually reduce the rate at which underlying health-care costs grow, which again is a fiscal necessity for both the federal and state governments.

The problem is what happens if this approach does not work, or does not work quickly. The federal government would be better off fiscally and protected from risk because of the cap. State governments are the ones essentially operating without a net under this scenario.

If underlying costs don’t fall in line with the capped growth in federal spending, states will have to make up the difference. Thus so much of the consequences of this proposed policy ultimately depend on how states handle the reforms. Their reaction would be limited to two options: Limit the number of Medicaid enrollees, or find ways to limit growth in cost per enrollee. Neither would be an easy lift.

The only thing that is clear in this debate is that we are beyond the point of questioning whether or not action is necessary. The only question now is what action to take.

Continuation of the status quo is not an option.

In isolation, capping federal Medicaid growth is obviously risky. As an economist, I can come up with well-reasoned arguments both for and against it. In the context of the unsustainability of overall U.S. fiscal policy today, however, it might be worth the risk.

Dan White is a director at Moody’s Analytics in Pennsylvania and an adjunct professor of economics at Villanova University. He wrote this for the Philadelphia Inquirer. Distributed by Tribune Content Agency, LLC.