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MAY 2007

Chicago Fed Letter
A Forum on Medicaid and State Budgets: A summary
by Richard H. Mattoon, senior economist and economic advisor

When it comes to state budgets, the Medicaid program is almost always the proverbial
800-pound gorilla in the room. On March 15, 2007, the Federal Reserve Bank of Chicago
and the Civic Federation co-sponsored a forum to discuss the growing cost of Medicaid
and how states are responding.

For almost every state in the U.S., the

Materials presented at
the forum are available at
conferences_ and_events/

Medicaid program, which provides
health care coverage to 41 million families and 14 million elderly and disabled
people, is the largest single budget item.
It is often seen as the source of considerable budgetary stress. This forum on
Medicaid and state budgets brought
together top researchers and government leaders to discuss funding and
policy issues as well as best practices.
The first speaker, Robin Rudowitz,
principal policy analyst, Kaiser Family
Foundation, focused on the evolution
of the Medicaid program and the impact
of the most recent legislative changes.
Each year, the foundation surveys all
50 states to track how they are managing their Medicaid programs and how
these programs impact their budgets.
Rudowitz noted that Medicaid costs are
driven chiefly by elderly and disabled enrollees, who account for 25% of the total
enrollees but 70% of the total expenditures. In fact, just 4% of the Medicaid
population consumes 48% of all expenditures. Medicaid is the largest single
source of federal funds to the states,
representing 44% of the total.1 The
states’ own-source revenue to pay for
Medicaid equaled 18% of their general
fund spending in 2005.
In 2006, Medicaid spending growth
was below state revenue growth for the
first year in a decade (see figure 1).

Rudowitz suggested three reasons for
this: the low rate of growth in enrollment; the enactment of Medicare’s
Part D prescription drug program, which
moved dual eligibles off of Medicaid
and onto Medicare for drug coverage;
and state cost containment strategies.
Although total Medicaid spending
growth was held to 2.8% in 2006, the
state portion increased by 6.8%.
Rudowitz concluded that Medicaid
costs will continue to be driven by increasing health care costs, as well as an
increasing pool of the uninsured as
employer health care coverage declines.
Demographic changes also imply a rising number of aged and disabled people. Another trend fueling Medicaid
growth is that states are looking to develop universal health care plans and
are using Medicaid as a platform for expanded coverage. Finally, federal policy will play a role, particularly through
the new requirements for citizenship
documentation to qualify for Medicaid
and the current debate in Congress to
reauthorize the State Children’s Health
Insurance Program (SCHIP).
Time for a new approach?

Robert Kaestner, professor of economics,
University of Illinois at Chicago, talked
about the need for Medicaid and public health insurance to be redesigned.
Kaestner noted that public spending is

1. State tax revenue and total Medicaid spending growth

















Medicaid coverage
to families with incomes at 200% of
the poverty level or
more, which has the
effect of crowding
out private insurance
coverage. Kaestner argued that a state goal
of universal health
care coverage was unrealistic given state
revenue constraints.

Another promising
approach, Kaestner
1997 ’98
’99 2000 ’01
’02 ’03
’04 ’05
said, is to obtain a
State tax revenue growth
federal waiver to reTotal Medicaid spending growth
design Medicaid programs to better match
NOTES: State tax revenue data are adjusted for inflation and legislative changes. Values for
2006 are preliminary estimates.
the service needs of
S OURCE: Kaiser Commission on Medicaid and the Uninsured and Health Management
Associates, Low Medicaid Spending Growth Amid Rebounding State Revenues: Results
the recipients. South
From a 50-State Medicaid Budget Survey, State Fiscal Years 2006 and 2007, report,
No. 7569, October, available at
Carolina is developing customized insurance programs that
often allocated to provide health inreflect the health issues facing its tarsurance coverage rather than to directly geted population, rather than offering
improve public health outcomes. This
a one-size-fits-all health plan. Finally,
is in spite of the fact that most studies
Kaestner argued that spending on pubsuggest a weak link between health inlic health should be increased given the
surance coverage and healthier people. large returns that preventive health
Kaestner also noted that the fiscal bur- care can provide.
den of providing this coverage will conMatt Powers, principal, Health Managetinue to grow fast. In Illinois, Medicaid
ment Associates, discussed how states
already accounts for 25% of all income
have taken the lead in expanding health
and sales tax revenue and 20% of all
care coverage, as some have even taken
state revenue.
to adapting Medicaid as a platform for
A primary goal for any redesign would universal coverage. Powers noted that
be to lower the rates of medical utiliMedicaid remains the workhorse of the
zation by enrollees. In his own research health care system. The challenges facon utilization of medical services based ing Medicaid, he suggested, stem in
on insurance status, Kaestner has found
part from the expansion of the program
that publicly insured individuals tend
to broader populations, as well as the
to use more health care than individu- considerable difficulty and complexity
als with similar characteristics who are
of implementing changes in health care
either privately insured or uninsured
provision and management. Given these
(figure 2). Given this, he noted that rechallenges, some states may think it is
form has focused on supply side ration- just best to wait until the federal goving. One method is simply to offer low ernment offers a national health plan.
reimbursement rates for Medicaid proSimilarly, state policymakers may quesviders, although this likely leads to a
tion whether it is worth the effort to
lower standard of care. A more posidevelop their own plans if these will
tive approach is the increased use of
ultimately be trumped by federal policy.
mandatory managed care with full risk
State health care information systems
reimbursement and narrow provider
also need to be improved. Powers notnetworks. An additional problem, he
ed that when he was Illinois’s Medicaid
said, has been the tendency to extend

director, information on health outcomes
was hard to come by. Policymakers need
to know whether they can control costs
while expanding coverage. Finally,
states must demonstrate that reliable
revenue streams exist to cover these
program expansions.
Federal perspective

Ruth Hughes, technical director, Centers
for Medicare and Medicaid Services,
U.S. Department of Health and Human
Services (HHS), described the valuedriven reform effort that is at the heart
of HHS Secretary Michael Leavitt’s health
care initiative. The aims are to provide
the states with better health and price
information and to create positive incentives for high quality health care
purchases. Hughes stressed that improving the transparency of health care data
is critical to better management.
In reviewing developments in health
care reform in the Midwest, Hughes
noted that virtually all of the states in
the region have followed three strategies. First, they have instituted outreach
programs aimed at enrolling eligible populations in Medicaid and SCHIP. Second,
they have expanded their Medicaid programs to reach higher-income populations. And third, they are using federal
waivers to cover specific populations.
According to Hughes, several federal initiatives included in the Deficit Reduction
Act of 2005 have provided the states with
greater flexibility while promoting personal responsibility for healthier lifestyles. For example, the act allows states
to provide specific groups with alternative benefit coverage that better meets
their medical needs. As part of the act,
up to ten states may operate demonstrations to test alternative systems for
delivering their Medicaid benefits, such
as health opportunity accounts. These
accounts are designed to enable patients
to take greater responsibility for their
health outcomes, as well as provide enrollees with better health education.
There are also provisions to support the
movement of individuals out of institutional care and into community settings.
Studies have shown that community-based
care is preferred, but transition costs
of moving patients out of institutional

2. Children’s use of health care, by health insurance status
Publicly insured
vs. privately insured
(percent difference)

Publicly insured
vs. uninsured
(percent difference)

No. of visits to medical
professional in last
two weeks



No. of overnight stays in
hospital past 12 months



The program also aims
to improve fiscal transparency and chronic
disease management.

care were for individuals classified as
having ailments of moderate or high
severity, suggesting that these were appropriate uses.

To pay for this health
care initiative, the governor is proposing
several new taxes.

The future of U.S. health policy

The first is a payroll
tax on businesses with
ten or more employees that either pay very
Saw a specialist past
12 months
little or nothing toward the health care
Had a well child visit
past 12 months
costs of their employees. The larger source
NOTES: The publicly insured are those covered by Medicaid and the State Children’s
Health Insurance Program. The sample comprises individuals aged 0–15 from families
of revenue will be a
with an annual income of less than $45,000 in the 2005 National Health Interview
Survey. All values presented here have been controlled for gender, age, race/ethnicity,
gross receipts tax on
health status, nativity, citizenship, family structure, family income and poverty ratio,
companies with more
mother’s education, and region.
SOURCE: Robert Kaestner, 2007, “Redesigning Medicaid and publicly provided health
than $1 million in reinsurance,” presentation at Federal Reserve Bank of Chicago and Civic Federation
joint forum, A Forum on Medicaid and State Budgets, Chicago, IL, March 15.
ceipts. The tax rate
will be 0.5% of gross
receipts for sales,
care are significant. The act also provides manufacturing, and construction comseveral changes that increase state flexibili- panies and 1.8% for service providers.
ty in managing long-term care programs Companies will receive a 100% credit
and clarify what the individual’s responfor corporate income taxes paid. It is
sibility is for paying for long-term care. estimated that this will raise $6 billion.2
Hughes also noted that the act requires
Eugene Gessow, Medicaid director, Iowa
improved enforcement of documentation
Department of Human Services, talked
of citizenship for Medicaid applicants.
about Iowa’s innovative approach to
managing its $2.6 billion Medicaid budState perspective
get. Iowa has developed a system to track
Barry Maram, director, Illinois Departthe type of health service the individual
ment of Healthcare and Family Services,
receives by using standard medical and
described Illinois’s past efforts to expand
billing codes in order to place Medicaid
health care coverage and Governor Rod
in the context of the broader health
Blagojevich’s recent proposal to provide
care system. The system generates instatewide coverage. During the goverformation that is easily accessible and
nor’s administration, Maram said, the
can be used by multiple audiences.
state’s health insurance rolls have inSystem users can examine which procreased by 560,000 individuals. The
gram costs are controllable and whethstate’s fiscal management of Medicaid
er the health needs of enrollees are
has also improved, according to Maram.
being met. It also allows for closer exThe backlog of bills has been cut from
amination of who is providing health
$2.2 billion to $1.1 billion by FY2007,
care and what treatment is being received.
and the payment cycle has been reduced
Iowa’s system provides some interestfrom 125 days to 50.
ing findings. For example, the use of
The governor’s new universal health care
emergency services is often cited as a
initiative, Illinois Covered, will offer
significant cost to Medicaid programs.
guaranteed, affordable private health
Yet, in Iowa, emergency service costs in
plans to small businesses and individu2006 totaled only $11 million out of a
als, and it will also give rebates toward
budget of $2.6 billion. In addition, 50%
the purchase of employer-provided
of the expenditures for emergency
health insurance to some families.
No. of visits to emergency
room past 12 months

In a keynote address at the forum,
Tommy Thompson, independent
chairman, Deloitte Center for Health
Solutions, provided a structure for health
care and Medicaid reform. Thompson
is a former U.S. Secretary of Health and
Human Services and four-term governor of Wisconsin. In his view, the U.S.
health care system will reach a crisis by
2013. By that time, he said, health care
spending will have doubled from current
levels and will consume 21% of gross
domestic product. At this level, U.S.
businesses will not be able to compete
because their health care burden will
far outweigh that of their foreign competitors. For example, Thompson noted
that even today General Motors’ cost
of health care is nearly $1,700 per car
produced versus Toyota’s cost of $225.
In addition, by 2013, the Medicare system will start to go broke. Currently,
Medicare runs a surplus and makes
an annual contribution to the U.S.
Department of the Treasury. This will
not be the case starting in 2013.

Michael H. Moskow, President; Charles L. Evans,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Jonas Fisher,
Economic Advisor and Team Leader, macroeconomic
policy research; Richard Porter, Vice President, payment
studies; Daniel Sullivan, Vice President, microeconomic
policy research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Kathryn Moran, and Han Y. Choi, Editors; Rita
Molloy and Julia Baker, Production Editors.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2007 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
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and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Chicago Fed
Letter and other Bank publications are available
on the Bank’s website at
ISSN 0895-0164

Thompson argued that instead of resorting to traditional options, such as price
controls, one-payer government health
systems, or tax increases, the health care
system should be transformed to promote healthier lifestyles and slower cost
growth, with the following specific goals:
• Create a wellness system that encourages preventive health care and better lifestyles;
• Reduce chronic illness by changing
human behavior. In particular, reductions in tobacco use, diabetes, and
obesity would be targeted, with incentives for good health practices and disincentives for poor health practices;
• Improve management of the care of
people who are really sick; and
• Adopt uniform standards for medical records (requires action by the

federal government) and create a
funding stream to pay for technology
infrastructure. This would facilitate
the development of electronic medical records that are portable and easily accessible to medical professionals,
resulting in reductions in medical mistakes as well as administrative costs.
Thompson said state experimentation
with Medicaid programs offers great
promise. He suggested it may make
sense to create an “uninsured” class of
people and then allow private health
insurance companies to bid to serve this
population. Federal and state responsibilities should be split, he added, with the
federal government providing for elderly and institutional care and the states
providing acute, family, and wellness
care. This would allow state Medicaid
programs to focus more on preventive
health care.


Medicaid costs will continue to be a front
burner issue for the states for some time
to come. Driven by escalating health care
costs and unfavorable demographics, the
gap between states’ revenue growth and
Medicaid expenditure growth will persist
without significant reform. At the same
time, as fiscal pressures are being recognized, Medicaid is also being used in
many states as the platform to promote
universal health coverage, which will likely lead to even greater funding pressure.

The Medicaid program is jointly funded by
the states and the federal government. The
amount of federal funds each state receives
depends on its own Medicaid spending and
its federal medical assistance percentage
(FMAP). For more details on the FMAP,


These details are from the proposal in
Governor Blagojevich’s budget address
of March 7, 2007. The proposal has since
been revised.

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