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Federal Reserve Bank of St. Louis

REGIONAL ECONOMIC
DEVELOPMENT
VO LU M E 3 , N U M B E R 1

2007

Medicaid Financing:
Challenges for Missouri and the Nation
Selected papers of a conference co-hosted by
the Federal Reserve Bank of St. Louis;
the Weidenbaum Center on the Economy, Government,
and Public Policy at Washington University in St. Louis;
the Center for Health Policy at Washington University in St. Louis;
and the Missouri Foundation for Health
June 8, 2007

Medicaid in the United States
Tommy Thompson
Medicaid—The Need for Reform
John Holahan and Alan Weil
Commentary
James W. Fossett
Mandatory and Affordable Health Insurance
Len M. Nichols
Commentary
Thomas Stratmann

Medicaid Financing:
Challenges for Missouri
and the Nation

REGIONAL ECONOMIC
DEVELOPMENT

1
Director of Research

Editor’s Introduction

Robert H. Rasche

Thomas A. Garrett

Deputy Director of Research

Cletus C. Coughlin

4

Editor

Thomas A. Garrett

Medicaid in the United States
Tommy Thompson

Center for Regional Economics—8th District (CRE8)

12
Director

Howard J. Wall

Medicaid—The Need for Reform
John Holahan and Alan Weil

Subhayu Bandyopadhyay
Cletus C. Coughlin
Thomas A. Garrett
Natalia A. Kolesnikova
Rubén Hernández-Murillo
Michael R. Pakko
Christopher H. Wheeler

22
Commentary
James W. Fossett

24

Managing Editor

George E. Fortier
Editor

Lydia H. Johnson

Mandatory and Affordable
Health Insurance
Len M. Nichols

Graphic Designer

Donna M. Stiller

29
The views expressed are those of the individual authors and
do not necessarily reflect official positions of the Federal
Reserve Bank of St. Louis, the Federal Reserve System, or the
Board of Governors.

F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E G I O N A L E C O N O M I C D E V E LO P M E N T

Commentary
Thomas Stratmann

V O LU M E 3 , N U M B E R 1

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i

Regional Economic Development is published occasionally by the Research Division of
the Federal Reserve Bank of St. Louis and may be accessed through our web site:
research.stlouisfed.org/regecon/publications/. All nonproprietary and nonconfidential
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published in Regional Economic Development also are available to our readers on this
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providing U.S. economic and financial data and regional data for the Eighth Federal
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© 2007, Federal Reserve Bank of St. Louis.
ISSN 1930-1979

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F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E G I O N A L E C O N O M I C D E V E LO P M E N T

Contributing Authors
James W. Fossett
Rockefeller Institute
fossettj@rockinst.org

Thomas Stratmann
George Mason University
tstratma@gmu.edu

Thomas A. Garrett
Federal Reserve Bank of St. Louis
tom.a.garrett@stls.frb.org

Tommy Thompson
Akin Gump Strauss Hauer & Feld LLP
tthompson@akingump.com

John Holahan
Urban Institute
jholahan@ui.urban.org

Alan Weil
National Academy for State Health Policy
aweil@nashp.org

Len M. Nichols
New America Foundation
nichols@newamerica.net

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Editor’s Introduction
Thomas A. Garrett

T

he Federal Reserve Bank of St. Louis
co-hosted a one-day conference on
Medicaid finance on June 8, 2007.
Co-hosts included the Weidenbaum
Center on the Economy, Government, and Public
Policy at Washington University in St. Louis, the
Center for Health Policy at Washington University
in St. Louis, and the Missouri Foundation for
Health. Titled “Medicaid Financing: Challenges
for Missouri and the Nation,” the conference
intended to provide attendees with a nontechnical
description of the major issues surrounding
Medicaid financing in Missouri and the nation.1
The conference coincided with pending legislation
in the Missouri legislature (SB 577) that would
modify various provisions relating to Missouri’s
medical assistance program. The Missouri Health
Improvement Act of 2007 was signed into law by
the governor of Missouri on July 2, 2007.
To provide diversity of views and experiences,
the conference brought together physicians, hospital administrators, state health officials, and
nationally recognized academic scholars and policymakers. The conference format consisted of presentations by academic scholars as well as several
panel sessions involving health officials, physicians,
and hospital administrators. This issue of Regional
Economic Development contains selected papers
from the conference.
1

More information on the symposium can be found at
http://research.stlouisfed.org/conferences/medicaidconf/index.html.

MEDICAID IN THE UNITED STATES
Tommy Thompson, former Governor of
Wisconsin and former U.S. Secretary of Health
and Human Services, provided the keynote
address. Governor Thompson discusses three
major problems facing the future of Medicaid and
the U.S. health care system: The rising costs of
health care and its effect on America’s competitive
position in the global economy, a decrease in the
number of companies offering health insurance,
and the inability of the federal government to prevent the insolvency of Medicaid in the coming
years. Governor Thompson outlines several solutions to the problems facing Medicaid and the U.S.
health care system. The first is that of prevention
and education versus treatment—because preventing an illness is cheaper than treating it. Governor
Thompson outlined several key areas for prevention dollars: tobacco use, diabetes, and obesity. In
addition to prevention, Governor Thompson argues
that more funding should be used for medical
technology that would reduce medical errors in
the treatment of patients.

MEDICAID—THE NEED FOR
REFORM
In the first paper of the conference, John
Holahan and Alan Weil outline the major issue
facing Medicaid—rising costs—and argue that
recent policy initiatives will not significantly curb
Medicaid spending. Reasons cited by the authors
include moral hazard, excessive benefits packages,

Thomas A. Garrett is an assistant vice president at the Federal Reserve Bank of St. Louis.
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 1-3.

© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
only with prior written permission of the Federal Reserve Bank of St. Louis.

F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E G I O N A L E C O N O M I C D E V E LO P M E N T

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Garrett

and rapid enrollments due to the decrease in
employer provided insurance.
The authors present four options for Medicaid
reform, each that would, the authors argue, ensure
the sustainability of the Medicaid program. One
reform would require states to increase coverage
to certain income levels for parents and childless
adults, with the aim of establishing uniform coverage across states and reducing the number of
uninsured. Another reform would increase federal
matching rates or services for selected populations
or services. A third reform plan would shift responsibility for some services or populations wholly
to the federal government while shifting others
wholly back to the states. The final reform plan
would end the Disproportionate Share Hospital
Program. Holahan and Weil provide cost estimates
for each reform option.
In his discussion, James Fossett focused on
health care politics and choices that federal and
state governments are going to be able to make in
the near term. He acknowledges the rapid growth
in health care spending but argues that state and
federal governments will be unable to devise any
reform plans, including those proposed by Holahan
and Weil, to deal with Medicaid and health care
in general. Specifically, Fossett argues that military
spending, the federal budget, and weakening state
revenue growth all limit the chances that any
Medicaid reform will be achieved in the next
several years.

erage, Nichols argues that any reform should create
an effective health insurance market, all individuals
should be required to purchases health insurance,
and there must be substantial subsidies for lowincome individuals and families, among others.
Nichols then suggests that the success of any health
care system is dependent upon the delivery system.
He outlines three elements of an effective delivery
system.
In his discussion, Thomas Stratmann argues
that more free market solutions to health care
should be considered by policymakers, and he
points out several problems with the current system. Subsidization of health care creates an overuse
of health care services, thus driving up costs. In
addition, the expected treatment of illness creates
an incentive for individuals to participate in behavior that is conducive to ill health, such as drug
abuse, smoking, etc. Stratmann argues that the
uninsured in the United States are primarily healthy
and young, so their need for health insurance is
relatively low and forcing insurance upon these
individuals would create extra costs. Finally,
Stratmann argues that catastrophic health insurance should be mandated. The costs of such a
reform would be relatively low because catastrophic
events are infrequent, and no additional funds
would be needed to finance such coverage for those
with lower incomes because they are covered by
Medicaid.

MANDATORY AND AFFORDABLE
HEALTH INSURANCE

PANEL DISCUSSIONS

Len Nichols argues that a reformed health care
system in the United States should provide universal coverage and a more efficient delivery system.
Nichols stresses, however, that universal coverage
does not imply only government provision of
health care, but rather cooperation between the
public and private sectors to provide health care
to all citizens. He outlines several universal financing arrangements that support tax-financed, singlepayer (or Medicaid for all) programs, as well as
mandates on employers and employees to purchase
private health insurance. To ensure universal cov2

V O LU M E 3 , N U M B E R 1

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In addition to the two academic papers, two
panel discussions (not included here) were also
held during the conference. For the first, two hospital administrators and two physicians from
Missouri discussed their ideas for Medicaid reform
and why such reforms are needed. The last session
of the day consisted of a panel of health policy
experts and state administrators who discussed
the future of Medicaid. Panelists shared their
views on likely reforms in Missouri as well as the
nation. Each panel session provided the audience
an opportunity to understand the highly political
nature of Medicaid financing in Missouri.

F E D E R A L R E S E R V E B A N K O F S T. LO U I S R E G I O N A L E C O N O M I C D E V E LO P M E N T

Garrett

ACKNOWLEDGMENTS
I thank the authors, discussants, and panelists
for their participation. I also thank the Weidenbaum
Center at Washington University in St. Louis, the
Center for Health Policy at Washington University,
and the Missouri Foundation for Health for their
professional partnership in organizing this event.

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Medicaid in the United States
Tommy Thompson

T

hank you very much and good morning.
Ladies and gentlemen, if we want to
understand Medicaid, we must look at
the overall picture. We can’t do it in isolation. What I would really like to have you do is
to think about how you could change the system
because the system has got to be changed dramatically to survive.
Health care in America, I believe, is the best in
the world. Now, you can find countries that do
better in prenatal care. You can find a country that
does better on longevity or on mental disease and
defect. In any one area of health care, you can find
a country that is probably doing something better
than the United States. But overall, holistically, if
you are going to become sick, you will want to
receive care in a U.S. city such as St. Louis because
you have got an outstanding, outstanding health
care system here. You’ve got some of the best
researchers, some of the most talented people in
the world right here in St. Louis. So if you are
going to get sick, no matter where you are in the
country, you will want to get back to St. Louis to
be taken care of. I think it is pretty common for
Americans to feel this way. If our health care system
is this good, we surely want to preserve it.
The health care system in America is under a
great deal of stress and strain. It’s not only Medicaid,
it’s the total system. Right now we are spending
$2 trillion on health care. You may want to take
some of these figures down because I think they
are really relevant. Two trillion dollars is what we
expend now on health care. That’s 16 percent of

our gross domestic product (GDP). And within
seven years that’s going to double to $4 trillion and
that’s going to go to 21 percent of GDP in America.
When you reach this level, you put a lot of companies in St. Louis and in the Midwest out of any
kind of competitive advantage in the international
arena, because health care costs for countries
around the world are much smaller percentages
of GDP than those in the United States.
For instance, Japan is the second largest economic power right now, soon to be overtaken by
China. Right now, Japan is spending about 7 1/2
percent of GDP on health care and may reach 8
percent when we reach 21 percent here in the
United States. If we are going to be competing
against Japan, we are going to see what is already
taking place in the automobile sector: At the beginning of this year, General Motors was the largest
automobile manufacturer and seller of cars in the
world. They pay $1,725 per automobile to sustain
their employee health care system. Toyota, a
Japanese company, spends $225 dollars per automobile. So every car that General Motors sells costs
an extra $1,500 for the company to produce.
We have seen the toll this has taken on General
Motors and Ford. According to business projections,
Toyota was not supposed to overtake Ford until
the end of this year; they overtook Ford in January
of this year. They were not supposed to overtake
General Motors until the middle of next year; they
overtook General Motors and became the largest
automobile manufacturer in the world in April of
this year. This is indicative of the challenges that

Tommy Thompson is a senior partner at Akin Gump Strauss Hauer & Feld LLP, former governor of Wisconsin, and former U.S. secretary of
Health and Human Services.
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 4-11.
© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
only with prior written permission of the Federal Reserve Bank of St. Louis.

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Thompson

the high price, high cost of health care will impose
upon all manufacturers and firms that sell internationally—especially over the next seven years,
with the doubling of our health care costs. If you
are in business or if you are in the Federal Reserve
System, you have got to be concerned about the
terrible cost of health care and how you are going
to be able to allow America to continue to compete internationally, especially with the Chinese.
So it is an immediate problem.
The second immediate problem involves
employer-provided health care coverage: During
and after the second World War there was a law
passed that enacted rules and regulations preventing businesses from increasing wages. Companies,
in order to keep their best employees and continue
to recruit good employees, offered health insurance.
A lot of companies started offering first-dollar
coverage, which means that all of an employees
health care was paid for by company health insurance, which was sponsor owned and negotiated
by the employer. Over the years, insurance costs
have gone up and companies have started to withdraw from comprehensive employee coverage,
especially in the past 10 years. The 82 percent of
employees who have historically been covered by
company health care plans has been declining to
about 60 percent. It’s probably on its way down
to 45 percent. For companies with 50 or fewer
employees, it’s already in the low 50s.
As coverage by employers decreases, there
will be more pressure on Medicaid—more uninsured and more government control of health care.
And because the cost of health care is going to
continue to rise, the problems are going to get
worse: Fewer people are going to be covered by
employer-provided health insurance, and co-pays
are going to increase. The good side of that is that
there has been an upsurge of attention and interest
across America in consumer health care. For the
first time, higher co-pays and/or less employer
contributions to health insurance are prompting
health care questions: How much is this procedure
going to cost? Do I need this patented drug or can
I get a generic drug? For the first time in America
we are starting to educate ourselves about health
care and we are starting to ask questions, which I
think is extremely positive. Even though the

employers are backing off, the fact of the matter is
that this employer withdrawal is starting to make
employees and consumers much more knowledgeable about health care.
The third big driver that you have to take into
consideration is going to directly impact Medicaid
because so many states and so many policymakers
are expecting the federal government to take over
Medicaid. What I am going to tell you is going to
point out that Medicaid is not going to be helped
by the federal government. The reason being is that
by the year 2014, seven years from now, Medicare
starts to go broke. Medicare right now takes up 21/2
to 3 percent of GDP. In 75 years that’s going to
jump to 15 percent, and the unfunded liabilities
of Medicare in 75 years are going to be $68 trillion
dollars. To put this number in it’s proper perspective, the entire GDP in America right now is a little
under $13 trillion. So this surge in costs is huge,
and Medicare is going to start going bankrupt in
the year 2013 or 2014.
Congress has been taking the money out of
Medicare. And, likely until 2013 or 2014, Medicare
will continue to shed an excess of funds. That
excess money has gone into the United States
Treasury. Do you know what happens to money
that goes into the United States Treasury? It’s spent.
Congress has spent this money and continues to
do so. Come 2014 there will be no more excess
money coming in, and Medicare is going to come
over and say, “Pay us: Those IOUs that you have
been giving out for 28 years...Write us a check.”
Congress will say, first off, that they don’t have any
excess money coming in. Moreover, the Medicare
surpluses were being used to fund other government programs. The first thing Congress will have
to do is to take other taxpayer monies to supplant
the money that Medicare was funding in those
programs. Secondly, on those IOUs to Medicaid,
they won’t have any money to pay them. The Iraq
War has cost us $8.5 billion per month and that’s
not going to be paid off for many years, even if we
stop the war this year. Medicare has got the first
draw on those IOUs that the government has sent
and Congress doesn’t have the money.
In 2014, Congress is going to be faced with
three objectives, I believe. They are going to have
to first come up with the money, and there are

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Thompson

several ways to do this: They could go to a complete
price control system and a rationing of health care
on elective surgeries, on elective appointments to
your doctor—which they can do—and ratchet down
the cost. But Washington University in St. Louis,
for instance, is going to be adversely impacted
because there will be no money coming in. Or they
could go to a government-controlled, nationalized
system, which some of you in this room support.
I don’t. The reason I don’t support it is because it
will stifle innovation completely. I want to find a
cure for breast cancer because my mother-in-law
died from it, my wife had it, and my younger
daughter had it. I want to find a cure for breast
cancer, and I don’t want to stifle innovation, so
I’m not for a nationalized health care system.
Another option is to raise huge amounts of
taxes. Congress could roll back all of those tax
breaks we’ve been given. If they were to reinstate
those taxes and then double them, that would
stabilize Medicare. That’s the background. Those
governors and state legislators that believe that
Washington is going to fix Medicaid by coming in
with new dollars—well, it’s not in the cards.
I ask you now to put your hat on and say you
are a governor. You’re the governor of Missouri,
and you want to be able to fix Medicaid and take
care of the uninsured and underinsured in this
state. Let’s take a look at Medicaid. Medicaid is a
combination program. It was instituted as a result
of Medicare, to follow it and supplement it. To fill
in the gaps. It was sort of a strange phenomenon.
The federal government pays about 55 percent on
average of state Medicaid costs. But that percentage
varies by state. Some states get 70 percent, other
states get 50 percent, but on average it’s 55 or 45
percent. The federal government pays 55 percent
and for that payment they say there are 32 programs
or policies that states can add on and have complete discretion over and we will fund 55 percent;
but there are some mandatory programs for children and mothers that we are going to require every
state to have and we are going to set those rules.
Medicaid is a partnership between the federal
and state governments in which states have the
option of putting in voluntary programs, which
every state has a portion of. My home state of
Wisconsin has got the maximum. Other states do,
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too. Missouri does not. Anyway, you can put in
these voluntary programs, which the federal government will fund at 55 percent on average, and you
have to fund all the mandatory programs put out
by the federal government as well. With that as a
background, then, how do we fix the system and
how do we change health care and at the same
time specifically fix Medicaid?
I tell governors, think boldly. Be bold and
courageous. Because, just stop and think practically, if you have an entity and you are in business
and somebody comes up to you and says I will give
you 55 percent of your cost and all you have to do
is come up with 45 percent, how much of that
money will you take? Me, I would take as much as
I could get. I would put every voluntary program
in. I would put in as courageous and as aggressive
a program as I could have for my state because the
federal government is going to pay 55 percent.
The federal government quakes when I say
this because they don’t want states to think that
way. But if you stop to think about it, if you are a
banker or in a business and somebody comes in
and says if you want to expand your business I’ll
give you 55 percent and all you have to come up
with is 45 percent, wouldn’t you take as much as
you could get? It’s an open-ended proposition on
Medicaid, and that’s why I don’t understand the
timidity of governors. It’s a blank check, and if you
consider health programs for children, it’s even a
better deal. The federal government will give you
70 percent for those, and all you have to come up
with is 30 percent. If you want to go into technology, there are some programs for which the federal
government will give you 90 percent and all you
have to come up with is 10 percent. I, for the life
of me, do not understand why states don’t completely bankrupt the federal government. It’s a
wide-open thing.
I tell you this as a background, and then I look
at welfare reform because I started welfare reform
in this country. What I did is I brought welfare
mothers into the governor’s residence in Madison
and I asked them why they didn’t work. They said,
“If we go to work we lose our health insurance.” I
said, “If I give you health insurance will you go to
work?” They said, “Yes, but if I go to work who is
going to take care of my children?” I said, “If I pro-

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vide you with day care will you go to work?” They
said, “Yes, but I dropped out of school when I was
thirteen and I have no job skills.” I said, “If I give
you job skills, day care, and health care, will you
go to work?” They said, “Yes, but most of the jobs
are in the suburbs and I live in the central city.” I
said, “I’ll provide you transportation. Will you go
to work then?” They said, “Yes.”
And welfare reform was born. When I started
welfare reform, governors and policymakers in this
country said it couldn’t be done: “Welfare reform
cannot take place. It’s a way of life and you are just
going to get hurt, Tommy.” I said, “No, I’m going
to try it because I want to give people a chance to
get out of poverty, and the only way to get out of
poverty is by working.” I didn’t want to be cruel. I
wanted to be compassionate and give people the
assistance to help themselves. It was born at the
dinner table at the mansion in Madison with the
welfare mothers.
Once I started, the governors who originally
told me not to do it saw that I was getting some
success and they started copying me. John Engler
said, I’m smarter than Tommy Thompson. If he
can do it, I can do a better job. Then Arnie Carlson,
then Terry Branstad, and it spread across the
country. Then the federal government noticed the
states were getting good recognition and reducing
welfare and decided they had better get into the
act. They would have never done it except for the
fact that the states had done it.
Why do I tell you that story? I tell you that
story because when I was secretary of Health and
Human Services, Mitt Romney came to me from the
state of Massachusetts, and Ted Kennedy, too, and
said if you could give us a waiver, Tommy, so that
we could use our disproportionate share money,
the federal dollars that come back to the federal
government, we can set up a health insurance program that will cover under Medicaid all of the uninsured in Massachusetts. I jumped at it. I didn’t
know he was going to be my opponent. I jumped
at giving him the waiver, so that he could try something, because in the back of my mind I knew what
was going to happen. It was the last waiver that I
handed out. Then I went on the speaking circuit
on health care.

I always put this out as a bet. I bet anybody in
the audience $100 to $5 that there will be 25 states
this year that are going to offer some kind of solution on health care on the uninsured and Medicaid.
The reason I was so sure on this is because of my
experience on welfare. I knew that once a governor
does something and gets some good public recognition and publicity, others are going to copy it.
Governors love to go to conferences. I did the same
thing. I was a governor for 14 years. You go to a
conference, you find out what’s the best program
out there that’s working, and then you run back to
your home state, change a couple of things, and
take credit for it. I knew that’s what happened on
welfare. I knew that’s what would happen in health
care, and that’s exactly what’s happening across
America: Massachusetts, Vermont, New Hampshire,
California, Missouri, Wisconsin, Michigan, Illinois,
Minnesota—you name it—Iowa—they are all trying
something new. Because one state started it, it’s
starting to spread.
Ladies and gentlemen, the beauty of this is that
great opportunities exist. Come 2008, the presidential election is going to take place. Democratic
candidates are talking about a single-payer nationalized system. Republicans, except for me, are talking about putting a tourniquet on health care. I’m
talking about a complete transfusion and transformation, and that’s where you come in today. We
are here today to talk about Medicaid. I’m trying
to set the stage for you so that you do know now
that we have problems facing us in 2014. The federal government is not going to fix them, but the
federal government’s got a piggy bank and there is
no limit to what you can do innovatively in your
state to pull in federal dollars to help you fix your
problems in Missouri.
So let’s get started. Now we look at health care
and at the fact that you have a responsibility as
the governor of Missouri to make your health care
system effective, efficient, and expanded to cover
the underinsured and uninsured. Currently, $2
trillion is spent on healthcare, and Medicaid is 20
percent of your Missouri budget. You’ve got to
realize that, for every $1 in Medicaid costs, as a
governor you pay only 45 cents. A governor has to
think, I have a real opportunity here. You look at
health care and you find out that 93 percent of

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that $2 trillion is spent on patients who go to their
doctor or the hospital after they’re already sick. It
is called a curative system. The money is spent to
get you well after you get sick. That isn’t health
care. Consider your car: After so many miles, you
take it in for an oil change, grease job, etc. But you
don’t take your own body in for maintenance. You
wait until it collapses and go to the hospital;
you’ve got cancer and then it costs a heck of a lot
more money to get you well. There’s hardly any
money, only 7 percent of that $2 trillion, that is
used to keep you well. So don’t you think the first
thing we should do is have a transformation and
put the emphasis on wellness? Let’s see if we can
keep some individuals out of the hospital.
So, after transforming the system, after trying
to transform the curative system to a wellness and
prevention system, you look at the next big challenge. And the biggest area, especially for poor
people, is chronic illness. Seventy-five percent of
the cost of health care, including costs for Medicaid
(in fact, especially costs for Medicaid) is for chronic
illnesses. When Willie Sutton and Jessie James were
asked why they robbed banks, they said, because
that’s where the money is. So if we want to fix
Medicaid, we want to be able to put the emphasis
on wellness but most importantly on education and
getting people to understand chronic illnesses
because that’s where the big money is. You want
to change that. You want to have the best system
and the healthiest people in Missouri so you can
go brag about it.
The first thing you want to do is address the
biggest health care issue, which is tobacco use.
People don’t understand this, that tobacco use is
still the biggest problem related to chronic illnesses
in America. Four hundred and forty-three thousand
Americans died last year of tobacco-related illnesses. Just as I did when I was secretary, when I
was governor of Wisconsin I went around in the
morning and took cigarettes out of my employees’
mouths as they were smoking outside the door.
Sometimes I got slapped. Sometimes I got cussed.
One day I walked around and an elderly gentleman
was taking a drag and didn’t know what to do with
his cigarette when he saw me coming. So he put
it in his pocket. It caught his shirt on fire, but he
stopped smoking. Then I got so irritated that I
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banned all the smoking on all of the property
owned or leased by HHS. I made any employee
who wanted to smoke go over to EPA and smoke.
A complete embarrassment.
Let’s return to our imagined role as governors
now. Here’s what I would do if I were governor of
Missouri. I would put a dollar tax on every pack
of cigarettes sold, and I’m a Republican. That’s a
tax, ladies and gentlemen, but I wouldn’t let the
government have the money because 70 percent
of smokers want to quit. Which is a tremendous
opportunity, ladies and gentlemen, to put that
dollar-a-pack tax into a fund only for smokers to
draw down to quit. Can you imagine the change,
the transformation of public health if you did that,
for patches, for counseling, for doctors? And you
would be able to have a huge impact. On the federal
government level, I would require nicotine to be
regulated by the FDA. Baby aspirins: How many
of you take a baby aspirin every day? I do. Baby
aspirins have to be regulated by the FDA, and baby
aspirins are used to improve your health and circulation system, while nicotine isn’t regulated
and it killed 443,000 Americans last year. Does
that make any sense to any rational person in the
public arena? So then we take care of tobacco.
The next big health issue is diabetes. Diabetes
is just huge. Eighteen million Americans last year
had type II diabetes, a lot of those in the Medicaid
arena. This year, 21 million. One year later and
it’s 21 million Americans. Costs went from $135
billion to $145 billion in both direct and indirect
cost for the health care system. There are 41 million more Americans, ladies and gentlemen, some
in this room that are walking around that are prediabetic and within five years will be diabetics,
and then the cost will go to $400 billion. One out
of every five dollars going into the health care system will be needed for diabetes if we don’t make
changes.
Dr. Peck has spoken about the National
Institutes of Health (NIH). The NIH is a great
research engine for the world, and we should
double its funding again, which would achieve
significantly better results than some of the other
programs funded by federal government expenditures. But the NIH did a study that says, if you walk
30 minutes per day and loose 5 to 10 percent of

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your body weight, you reduce the incidence of
type II diabetes by 60 percent. We can walk and
we can watch our body weight, which leads us
then to a third big challenge: obesity. Obesity and
diabetes are epidemic among minorities.
We need to look at obesity. We can look at the
mirror and say chunky is good, but slim is better. I
tell my business clients that have cafeterias, and
you should do it here on the campus of Washington
University, give away salads or subsidize salads,
vegetables, and fruits for a buck a serving. Charge
$5 for hamburgers, $10 for cheeseburgers, and 20
cents per french fry and you will change the eating
habits of your employees. Let’s face it, if you are
able to bring a nutritionist in and start teaching
nutrition at the medical schools and make it a
detailed subject—and especially counsel minorities—you have a tremendous chance to change
Medicaid and health care for the better.
That also leads into cardiovascular disease,
which is the number one killer of both men and
women today in America. Here’s an idea: It is not
radical, but it is common sense. I’ve started a diet
and you don’t have to pay any royalties for using
it. I want you to know that there are no food police
in St. Louis. Although your mother and father and
grandma and grandpa said you have to eat everything on your plate, no law says you have to do that.
Take whatever you want and eat only half and you
will lose weight. This is Tommy Thompson, I’ve lost
15 pounds doing that. I know it hasn’t improved
my looks any, but it has improved my strength and
my ability to work harder. So we must take care of
chronic illness.
This is where governors like you, policymakers,
and businesses like the Centene Corporation come
in. Now, I don’t want you to think that I’m up here
promoting Centene, but I like Centene and it’s a
great company. I want you to know that Centene
manages diseases for Medicaid, and I’m not saying
that just for you to hire Centene. That is not the
thing I’m saying. You, as a governor, look at your
Medicaid population. Twenty-five percent of your
Medicaid population is using anywhere from twothirds to three-quarters of your Medicaid budget.
These are the individuals that are severely mentally
and physically disabled, your diabetes population,
people with severe asthma, and they are using up

two-thirds to three-fourths of your Medicaid budget.
Don’t you think it would be smart for you to
address that problem?
The best way to do it is to manage those diseases. Hire disease managers. Do it yourself. Find
out if individual people on Medicaid are taking
their medicines. I’m going to give you a fact. This
is a Pfizer study, which absolutely amazes me.
Thirteen percent of Americans go in to see a doctor
for a sickness and get a prescription and never take
it to a drug store, never take it to a pharmacist.
Another 14 percent take the prescription to the
pharmacist and never pick it up. Can you believe
that? Twenty-seven percent of people see a doctor
for an illness and never go pick up the medicine.
Another 60 percent, after five months, discontinue
the regular use of medicines. They take it maybe
day after day, for a few weeks, but then stop.
If in fact you were able to manage just the
medicines and to find out whether people are
actually complying with what the doctor said, you
would have a tremendous reduction in cost, especially for that 25 percent who are severely ill. You
have got to realize that you are going to get 55 percent of the cost of hiring disease managers paid
for by the federal government; so, it only makes
common sense, I would think, if you are a reasonable, visionary governor, that this is a great way to
improve the quality of health, the quality of life
of citizens while also holding down cost.
The next thing, ladies and gentlemen, in
Medicaid is the huge problem in information
technology. Doctors at Washington University,
you would not allow a student to enroll in your
school unless they had straight As. You will not
allow a slacker like me, a C+ student, to get into
medical school. Students attending this school
must have excellent grades. You want the best.
You want Dr. Peck to operate on you or Dr. Shapiro.
They’re smart. They’re brilliant. But there is one
subject that those individuals don’t have to get an
A in to be admitted into this wonderful medical
school.
Do you know what that subject is? Handwriting.
And I’ll tell you, Dr. Peck, I don’t know how you
write but I would bet that your handwriting hasn’t
improved a bit in the past 50 years. Ninety-two
percent of doctors still write out prescriptions,

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and one out of five of those prescriptions has to be
corrected at the pharmacy: one out of five. That’s
20 percent. Ninety-eight thousand Americans
died last year—not my figure, but the Institute of
Medicine’s and doctors’ own studies—as a result
of medical mistakes. Fifty percent of those deaths
were caused by the wrong medicine, the wrong
amount, at the wrong time, to the wrong person.
If we had e-prescribing, you could input a
patient’s name and other characteristics into an
electronic system and send and retrieve information. And I know you know what palm pilots are
because I see so many of you looking at them as
I’m speaking. Put your name in, Dr. William Peck
(great guy, a little arrogant) and your whole medical
history could be retrieved, including prescriptions
you’re taking. Let’s say he comes in with a common
cold and Dr. Shapiro examines him and he types
in “common cold,” or the cold that’s going around
in St. Louis now. It immediately comes up with the
three to five drugs that will take care of that, and
immediately any contraindicators will come up
with the medicines he is already taking. Dr. Shapiro
then will press another button and the bill goes to
Centene: no handwriting, just a button. Then he
presses another button and the script automatically
goes down to the pharmacist. For the 13 percent
of patients who don’t take the script down there,
it automatically goes down there. That’s the technology of today, and you would reduce 50 percent
of those error-related deaths overnight. Medicaid
can help pay for that for your doctors, and your
patients will be able to get better quality of care
and therefore better quality of life.
The final aspect of information technology is a
paperless working environment. Do you know what
a 1040 is? Do you know what a W2 is? Large and
small employers all fill out the same form, a W2,
one form. How many forms does it take to file for
Medicaid? How many forms must be filled out to
go see a doctor when you are on Medicaid? How
many forms must be filled out when you go into
the hospital and apply for reimbursement? And
how many of you can even understand what those
forms say once you fill them out? And Medicare is
even worse. If we are smart enough to have the
most complex tax system in the world with one
form and the most complex employment system
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with one form, don’t you think we should be smart
enough to have one medical form or go completely
paperless? We could save 10 percent of the cost of
health care and more than that in Medicaid if we
went paperless.
The final thing on Medicaid is that it is absolutely appalling to me that we walk around in this
country with 47 million Americans that don’t have
insurance, and that’s going to go up to 50 million
unless something happens. You are in the role of
governor now, and you look at this situation, and
you look at the number of uninsured in Missouri,
which is around 1 million. You look at that and
first off you ask where they are going to go for
their health care. Well, they are going to go to the
emergency room. And what’s the most expensive
health care cost in the country? Emergency room
visits, right?
We have 47 million Americans whose first stop
for health care is the emergency room, the most
expensive. Does any rational Missourian think
that that is a smart system? If we go back to what I
originally started with about prevention, wouldn’t
it be nice to have somebody not wait until they have
to go to the emergency room but to be able to go
to a community health clinic in Missouri and
have a procedure, get a test done, or have cervical
and breast examinations? So let’s take a look at it.
Let’s fix this problem.
First let’s make an assessment of the many
uninsured that we have in the state, and a good
share of that percentage of that 1 million are eligible for Medicaid. Instead of sending them to the
emergency room, we can give them a card and the
federal government is going to pay for 55 percent
of the cost. Don’t you think you should go out and
enroll as many of those people that are uninsured
or underinsured that are eligible for Medicaid and
get them on your Medicaid rolls? Governors think
just the opposite. Let’s find ways to get them off, so
let’s send them to the emergency room where its
going to cost more money. Who pays for people to go
to the emergency room? Hospitals, the University,
and everybody that has an insurance policy because
everybody pays for part of the uninsured through
their health insurance.
Let’s be smart. We are governors now. Let’s
make an assessment and put those people in

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Medicaid wherever we can, and then let’s go out
and do something really revolutionary. Let’s put
all of the uninsured into a class. One third of the
individuals that are uninsured are individuals
between the ages of 18 and 33. It’s a good class,
they just don’t want to bother. I’m not going to get
sick, I’m 18 years of age, I’m 21 years of age. I’m
strong. I’m tough. I don’t want to pay a bill. So onethird of them don’t have health insurance. Thirty
percent make over $60,000 per year. Insurance
companies like Centene would salivate over the
fact that they can get a million more subscribers
in Missouri under a managed care system.
Let’s be smart. Let’s tear down all the barriers
on health insurance, and anybody that is licensed
like Centene in Missouri can bid on any group,
require the states to put them up for an insurable
class, and allow the Centenes of the world to bid
on them. Don’t allow the state legislature, your
state legislature, or Congress to put any mandates
on what has to be in that policy. Let the private sector bid on it and you would be absolutely amazed,
ladies and gentlemen, to see how many insurance
companies would come into Missouri, bid against
Centene to cover a million people, like we found
in part D for Medicare. You would be able then to
start covering the uninsured. And I think the uninsured should be required to have health insurance

in the same way we’re required to have automobile
insurance. You would be able to cover the uninsured in this way. I would also put a cap on costs
so you could attract small companies to come back
and offer health insurance, which, in this case,
should be put out for re-insurance.
What I’m telling you, ladies and gentlemen, is
that health care is exciting. It is exciting because
of what we can do. It needs the best minds and the
best ideas for Medicaid and for the total health care
system to have it survive and expand and continue.
But if you use my logic and if you use your own
innovative ideas on these types of programs, we
can cover the people in Missouri and we can make
sure they are covered and that they get the best
health care possible. It can be affordable and accessible for all of your citizens. That’s what we have
to do to save the system and make it better.
Ladies and gentlemen, I want to take your
questions and I’ve already talked longer than I was
supposed to, but I just get pumped up and I’m passionate about the subject. I just want you to know
that it is exciting to be in health care right now,
and the changes with the new innovations, the
revolutions that are taking place in health care,
are so stimulating and exciting that I can’t imagine
that more people are not involved.
Thank you very much.

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Medicaid—The Need for Reform
John Holahan and Alan Weil
Recent administration proposals to address the rising cost of Medicaid will do little to contain costs
or truly reform the program. The primary issues are the large differences among state Medicaid
programs in coverage and benefits and the programs high and rising costs. In this paper, we
describe and develop several options for Medicaid reform that would expand coverage, provide
fiscal relief to states, shift responsibility for some or all of the cost of dual eligibles to the federal
government, and eliminate or restructure the disproportionate share programs. A number of other
issues are addressed, including Medicaid cost containment and the federal matching rate structure.
(JEL I10, I18)
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 12-21.

R

eforming the Medicaid program has
been a major focus of the Bush administration and the Congress. The Deficit
Reduction Act has already put forth
some major changes to Medicaid, and the Bush
administration has also approved several Section
1115 waivers that significantly change the program.
Secretary of Health and Human Services Michael
Leavitt also established a commission to consider
fundamental reforms.
The primary diagnosis of the problem with
Medicaid is the program’s high and rising costs.
Thus, most of the recent reform initiatives attempt
to deal with containing program spending. In this
paper, we argue that these recent policy initiatives
(increased cost sharing, flexibility in benefit/design,
and premium assistance) will not have significant
effects on program spending and are not real reform.
But while we do not believe that these initiatives
will accomplish much, we do believe Medicaid
does need reform for several reasons. We discuss
these reasons and then present four alternative
options as well, as cost estimates, for each. We then

discuss a number of remaining issues that are outside of these options and cost estimates.1
It is important at the outset to note that the
Medicaid program has provided great benefits to
low-income Americans. The program provides
insurance coverage to over 40 million Americans on
a given day and to some 50+ million at any point
during the year. Most of these would not have had
coverage without Medicaid. As a result, the number
of uninsured would have been much higher than the
45 million reported for 2005. Medicaid has been a
major source of health care coverage for low-income
pregnant women and children, and for the disabled.
The program pays for about half of all births in the
United States. It helps low-income elderly and
disabled people pay for Medicare premiums and
cost sharing. It is a major source of support for
safety net hospitals and clinics. Finally, it is the
backbone for the nation’s long-term care system.
The proposals adopted by the Bush administration and the Congress in recent years are not likely
1

This paper was excerpted from a larger version (Holahan and Weil,
2007).

John Holahan is director of the Health Policy Center at the Urban Institute, and Alan Weil is the executive director of the National Academy for
State Health Policy.

© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
only with prior written permission of the Federal Reserve Bank of St. Louis.

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to have significant effects on program costs. The
problem with Medicaid is often identified as one
of moral hazard.2 People face low costs at the point
of service thus tend to overuse services. In addition,
the program is accused of having a “Cadillac” benefit package—benefits far exceed those available to
low-income working Americans.3 The administration and Congress’s solution to these problems is
to provide states with greater flexibility to impose
more cost sharing and to limit benefit packages.
These policies may reduce overall use of program
services but could also do great harm by reducing
use of services that are vitally needed by lowincome populations. The recent proposals also
ignore the fact that Medicaid in essence solves
the rationing problem that cost sharing is designed
to serve by keeping provider payment rates low,
reducing access to providers, and thereby reducing
utilization.
The real reason for spending growth in
Medicaid is primarily due to two things: (i) enrollment growth that can be traced to the erosion of
employer-sponsored insurance, particularly for
low-wage workers, and increases in income
inequality—both have meant that more people
qualify for Medicaid under existing eligibility
standards; and (ii) an increase in the incidence
and recognition of disability resulting in a consistent (approximately) 3 percent increase in the number of disabled enrollees. Finally, the health care
inflation that has plagued the entire health care
system also affects Medicaid (Holahan and Ghosh,
2005, and Holahan and Cohen, 2006).
Recent research (Hadley and Holahan, 2003/
2004) has shown that, on a risk-adjusted basis,
Medicaid costs are not higher than for low-income
people with private insurance (see Figure 1):
Statistical studies that control for disability and
the presence of chronic illness show that private
coverage for the same population would be more
costly. Spending would increase from $719 to
2

3

$795 for children and from $3,145 to $4,410 for
adults (2001 dollars) if people on Medicaid were
given private coverage, not including the likely
increase in administrative costs. Furthermore,
Medicaid costs have not been growing faster than
private insurance (see Figure 2).
But while recent diagnoses and solutions do
seem misguided, we do believe that Medicaid does
need reform. We highlight four reasons.
First, Medicaid costs are a growing burden for
states. Although Medicaid costs per enrollee are
not high in comparison with costs in the private
market, Medicaid enrollment growth coupled with
medical care inflation is clearly forcing health care
spending to increase faster than the rate of growth
in state revenues.
Second, the variation among states in coverage
and provider payment rates is extremely large and
difficult to accept, given the large national stake
in financing the program, i.e., at least half of the
money in each state is federal dollars. Thus, we
believe how these funds are used is a national concern and the variation that we observe is inconsistent with the best interest of the nation (Holahan,
2003, and Spillman, 2000).
Third, a related issue is that eligibility standards are extremely complicated, difficult to
understand, and restrictive—that is, they exclude
populations, including childless adults, that have
very low incomes and are in need of better access
to health care.
Finally, the creative financing arrangements
that states have used over the last 15 years, while
typically legal, have also led to a considerable
amount of mistrust between the federal and state
governments (Coughlin and Zuckerman, 2003, and
Rousseau and Schneider, 2004). They have led to
the transfer of funds to state governments with little
or no state matching payments, a practice that is
clearly inconsistent with the fundamental nature
of the program.

Although not specific to Medicaid, the general case for overuse as a
concern is set forth in Council of Economic Advisors (2006) and
Cannon (2005).

ALTERNATIVE OPTIONS

References by political leaders to Medicaid as a Cadillac program
are legion. For example, see the radio address by Tennessee Governor
Phil Bredesen, June 11, 2005;
http://democraticgovernors.org/news/280 (accessed February 9, 2007).

We propose four options that will address these
problems. All have somewhat different objectives.
All are designed to cost about the same amount to

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Figure 1
Medicaid Costs Are Not Higher Than Private Insurance on a Risk-Adjusted Basis
Per Capita Expenditures (2001 $)
$4,410
Medicaid (actual)
Privately Insured (predicted)

$3,145

$795

$719

Adults
Increase of $1,265

Children
Increase of $76

NOTE: All differences are statistically significant at the 5 percent level. “Adults” include ages 19 to 64. “Children” include ages 0 to 18.
SOURCE: Analysis of Medical Expenditure Panel Survey data from 1996, 1997, 1998, and 1999 are from Hadley and Holahan (2003/2004).

Figure 2
Medicaid Costs Are Not Growing Faster Than Private Acute Care Services, 2000-05 (percent)
2000-02
2002-04

11.9

2004-05

12.5

10.2
9.2
7.6

7.3

7.4

5.6
4.6

Medicaid
Acute Care Spending
Per Enrollee

Health Care Spending
Per Person with
Private Coverage

Monthly Premiums
for Employer-Sponsored
Insurance

SOURCE: Kaiser/HRET Survey of Employer Sponsored Health Benefits, 1999-2006; and Ginsburg et al. (2006).

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the federal government and to provide about the
same savings to states. They each will increase
costs to the federal government more than they
provide savings to the states. The net additional
cost is overwhelmingly due to the coverage expansions that are a part of each option. The key components of reform are as follows:
1. States would be required to increase coverage to certain income levels for parents and
childless adults and be given the option to
offer coverage to individuals at higher income
levels. This would establish a uniform base
of coverage across states and reduce the number of uninsured. It would provide a base to
build upon with other policies such as tax
credits or income-related subsidies as, for
example, has occurred in Massachusetts.
2. Responsibility for some services or populations would shift wholly to the federal government and some would shift wholly back
to the states. In general, this shifting would
involve some or all of the care for “dual eligibles”—those eligible for both Medicare and
Medicaid—who would become the responsibility of the federal government. This would
provide fiscal relief to states and give the
federal government a central role in managing these high-cost cases. With some care
shifted back to states, system efficiency
would potentially improve, which would
offset for the federal government the costs
of their new responsibilities.
3. Federal matching rates for selected populations or services would be increased, e.g.,
“adults,” “acute care,” or long-term care,
depending on the option. This would provide fiscal relief to states and an incentive
to expand coverage—by lowering the costs
to do so. Also, this would allow states to
avoid cutbacks in times of fiscal stress
because the benefits from contractions
would be less.
4. The Disproportionate Share Hospital (DSH)
program would be ended or reformed to
severely curtail the practices of increasing
federal matching payments with no real
state contribution. In the paper, we focus on

DSH payments, but the intent is to include
all similar practices.

Option I
The primary focus of this option is on expanding coverage for acute care services. It would provide a 30 percent enhanced match to cover all adults
with incomes of up to 150 percent of the federal
poverty level (FPL) and allow states to use the
enhanced match to provide coverage to individuals at higher income levels. The State Children’s
Health Insurance Program (SCHIP) would end,
but Medicaid would be altered to have somewhat
similar characteristics. There would be no enrollment caps, but there would be premiums and cost
sharing for children of families with higher incomes,
as in the current SCHIP program. Medicare premiums and cost sharing for acute care services for
dual eligibles would become the responsibility of
the federal government. The current “clawback”
payments would be retained. (These are payments
a state makes to the federal government for the
state’s estimated share of drug payments they would
have had to pay had there been no Medicare drug
benefit.) This option would increase federal matching payments on acute care services by 30 percent.
This would affect acute care services used by adults,
children, and disabled populations who are not
dual eligible. The matching rates for long-term care
would be unchanged. The DSH program would be
eliminated because there would be less of a need
for this residual safety net as coverage expands,
and any additional remaining needs would become
a state responsibility.

Option II
Option II also places a strong emphasis on
coverage expansion and fiscal relief for states, but
extends the financial help to spending for longterm care. Option II would mandate that coverage
be extended to all adults to 150 percent FPL and
provide a 15 percent enhanced match to do so.
Federal matching payments for all services, both
acute care and long-term care, would be increased
by 15 percent; SCHIP would stay a separate program. Federal matching payments for Medicaid
and SCHIP would be 15 percent above the current

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level for Medicaid. This would end the distinction
between SCHIP and Medicaid, where children of
families with higher incomes receive higher federal
payments through SCHIP. It would federalize acute
care services for dual eligibles, including eliminating the clawback payment now made by states.
Option II would also eliminate DSH for the reasons
given above.

Option III
Option III would focus more on long-term care
because it assumes that the primary policy concern
is the impact of an aging population on states.
Option III would mandate coverage of all adults,
but only to 100 percent FPL. There would be no
change in current matching rates for acute care
services. SCHIP would be unchanged and maintain
the current higher federal matching payments. It
would federalize acute care services for dual eligibles and eliminate the drug clawback. The major
focus here would be an increase of 30 percent in
federal matching payments for services for longterm care. This option would also restructure DSH.
Because there is less of a coverage expansion than
in other options, DSH payments would be maintained but redistributed so that the states would
get the same amount per low-income person. This
would deal with the current problem of poor distribution of funds: 10 states now get 71 percent of
DSH payments, 5 states get more than $1,000 per
uninsured person and 16 states get less than $100
per uninsured person.

Option IV
Option IV would be the largest change in current
policy. It would mandate coverage of all adults to
100 percent FPL but there would be no change in
matching rates. SCHIP would be unchanged and
keep the current 30 percent matching rate. The
major focus would be to shift all costs of dual eligibles to the federal government, including costs
for long-term care; responsibility for costs for longterm care for non-dual eligibles would shift back
to the states. This option would also eliminate the
prescription drug clawback payment. Finally, DSH
payments would be restructured as described in
Option III.
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Policy Changes Common to All Options
There are certain provisions that are common
to all options. First, prescription drugs coverage
would become a mandatory benefit. All states currently provide prescription drugs coverage, so this
is not, in practice, much of a change. Second, there
would be increased flexibility in the use of cost
sharing above 150 percent FPL but not below. Third,
there would be increased flexibility on mandatory
benefits for adults but little or no change in benefits
for children or the disabled. For example, benefits
through the current Early Periodic Screening,
Diagnosis, and Treatment Program would remain.
Finally, there would be caps on enrollments in the
new optional programs (i.e., programs beyond
those mandated).

COVERAGE EXPANSIONS
We estimate the impact of coverage expansion
using a detailed spreadsheet model that begins with
the baseline of current coverage. The U.S. population is organized by children, parents, and childless
adults; by income; by current insurance arrangements; and by four geographic regions. We model
current eligibility for public programs in great detail
for each state. We then apply “take-up rates” (the
probability of individuals “taking up” the newly
available coverage) to each group based on the
current research evidence (Selden, Banthin, and
Cohen, 1998; Dubay, Haley, and Kenney, 2002a;
Dubay, Holahan, and Cook, 2007; and Davidoff,
Yemane, and Adams, 2005). We also rely on the
extensive literature on the crowding out of private
coverage by public expansions (Blumberg, Dubay,
and Norton, 2000; Cutler and Gruber, 1996; Dubay,
1999; and Lo Sasso and Buchmueller, 2004). We
base our estimates of Medicaid spending on the
Medicaid Management Information System for
2002, adjusting forward for inflation using several
different sources to obtain 2007 estimates.4 Because
those persons likely to come into the program
through a coverage expansion are likely to be
healthier than those in existing programs, we
4

Congressional Budget Office, March 2006 baseline.

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Table 1
Estimated Cost of Expanding Coverage to 100 Percent and 150 Percent FPL
100 percent FPL

150 percent FPL

Medicaid

7,070

11,117

Employer

–924

–1,861

Nongroup

–967

–1,477

Uninsured

–5,167

–7,779

Change in coverage (millions)

Cost to government (2006 $ billions)

24.1

38.1

Federal

14.0

22.2

State

10.0

15.9

18.2

28.9

5.9

9.2

Regular matching rates

30 percent higher match
Federal
State

make an adjustment for the better health status of
those new enrollees. We also assume a reduced
benefit package for adults and make a downward
adjustment (7.5 percent) to the cost of care for that
population.
Table 1 shows the effect of the coverage expansions on Medicaid enrollment. An expansion to
100 percent FPL would increase Medicaid rolls by
7.1 million and to 150 percent FPL by 11.1 million.
The majority of these new enrollees would be childless adults. The number of uninsured would fall
by 5.2 million with an expansion to 100 percent FPL
and by 7.8 million with an expansion to 150 percent FPL. The cost to the federal government would
be $24.1 billion and $38.1 billion, respectively.
As shown in Table 2, each of the four options
would increase federal spending by between $41.1
and $48.5 billion. At the same time, states would
save between $15.1 billion and $22.6 billion. The
net additional cost to the health care system would
be between $25.8 billion and $29.7 billion. Option
IV has the largest increase in federal spending and
the greatest savings to states. Option I has the greatest net increase in cost to government as a whole.
The biggest impact on costs is the coverage
expansion. For example, in Option I, the expansion
to 150 percent FPL with a 30 percent enhanced
match would increase costs to the federal govern-

Table 2
Change in Spending (2006 $ billions)
Option

Federal

State

Net

I

44.8

–15.1

29.7

II

44.6

–15.6

29.0

III

41.1

–15.3

25.8

IV

48.5

–22.6

25.9

ment by $28.9 billion and to states by $9.2 billion
(see Table 1). The changes in federal matching
payments would shift a substantial amount of
money to the federal government and save states a
considerable amount as well.
After expanded coverage, the next biggest
impact on cost would come from changes in policies affecting dual eligibles. The cost of having the
federal government pick up Medicare premiums
and cost sharing for acute care services and retaining the current policy on the drug clawback would
increase federal costs by $7.5 billion and reduce
state spending by the same amount. Federalizing
acute care for dual eligibles but eliminating the
clawback would increase the federal costs by $14.1
billion and save states the same amount. Shifting
all of the costs of dual eligibles to the federal gov-

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Table 3
Impacts of Proposed Medicaid Reform Options by Region, 2006
Midwest

Northeast
Option

Federal

State

Federal

South
State

West

Federal

State

Federal

State

I

21.1

–16.8

28.4

–12.6

35.8

–11.7

34.0

–8.8

II

22.5

–18.0

29.5

–14.7

33.7

–6.6

35.9

–12.8

III

23.4

–19.8

28.4

–13.9

29.4

–7.3

29.3

–7.9

IV

33.8

–30.7

34.8

–22.3

27.1

–3.3

36.3

–16.7

NOTE: Spending data were adjusted to 2006 using the CMS-64 and Congressional Budget Office projections (March 2006 baseline).
SOURCE: Author’s calculations based on population information from the March 2005 Current Population Survey and spending data
from the 2002 Medicaid Management Information System.

ernment would shift $47.7 billion from the states
to the federal government.
These policies would have different effects
across regions. The coverage expansions would
have the biggest impacts on the south because
coverage levels are currently lower there. The
increases in federal matching rates would help the
northeast the most because Medicaid programs in
that region tend to have broader coverage and richer
benefits than elsewhere in the country. Federalizing
spending for dual eligibles also benefits the northeast the most, again because of broad coverage and
richer benefits, particularly in long-term care. Cuts
in DSH payments would hurt the northeast and the
south the most. DSH restructuring would have an
adverse effect on the northeast but would benefit
all other regions, although not all states within
those regions.
Table 3 shows these effects. For the northeast,
Option IV offers the greatest increase in federal
spending and greatest savings to the states. Because
the northeast spends proportionately more on dual
eligibles than other regions, it would benefit the
most from shifting dual eligibles to the federal
government. In contrast, the south is better off
under Option I because of the increase in federal
payments it would receive for broad coverage
expansion. However, it would gain less from the
increased matching rates because it spends less
on those services currently.
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OTHER ISSUES
There are a number of other issues that are
important for Medicaid reform.

Cost Containment
Cost containment efforts historically have
relied on controls over provider payment rates
and increased use of managed care. Recent initiatives are attempting to introduce more cost sharing
and benefit flexibility. As noted, these initiatives
are likely to have relatively small effects. Rather,
we believe that cost containment should be focused
on the beneficiaries with the highest cost. At present, 7.5 percent of Medicaid beneficiaries account
for two-thirds of Medicaid spending (Sommers and
Cohen, 2006). There is a need for a large federal
investment in both Medicaid and Medicare case
management and care-coordination programs
(Lieberman et al., 2003; and Thorpe and Howard,
2006). There is a need for changes in payment
approaches to provide incentives for physicians
to coordinate and manage the care of patients
with multiple chronic conditions and to expand
Medicaid managed care (with beneficiary protections) to more of the disabled (Anderson, 2005;
Berenson and Horvath, 2003; Wagner, Austin, and
Von Korff, 1996; and Medicare Payment Advisory
Commission, 2006, Chap. 2). This is new territory
to be sure, but clearly this is where the money is
and where the focus of cost containment for spend-

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ing on particularly low-income populations should
be focused.

Provider Payment Rates
We believe the provider payment rates should
be improved. This would improve the image of
the program among providers as well as increase
physician participation rates. Setting minimum
standards and rates could become the responsibility
of the Medicare Payment Advisory Commission.
Medicaid payment rates could gradually be
increased over time, i.e., to a minimum of 90 percent of Medicare rates.

“Creative” Financing
Creative financing, including all practices that
bring in federal monies without real state or local
matching rates, should be eliminated. We have
focused on DSH in the discussion above, but there
are a number of other similar arrangements such
as upper payment limit programs, school-based
clinic programs, and targeted case management
(Allen, 2005; and Coughlin, Bruen, and King, 2004).
These programs added at least $13 billion to federal
outlays in 2005 with unknown state matching
contributions. The federal government should
enforce current rules designed to reduce or eliminate all such practices (Schwartz et al., 2006).

Medicaid Participation
There should be an effort to increase participation rates in Medicaid. In general, participation
rates of those eligible for Medicaid are slightly
above 50 percent. Some states have much higher
participation rates (Dubay, Haley, and Kenney,
2002b). There should be a combination of federal
promotion and advertising as well as federal standards for outreach, income verification, and recertification. Higher participation rates would increase
Medicaid enrollment and spending but also lower
the number of uninsured, reducing the need for
many government programs that support safety
net providers.

Eligibility for Long-Term Care
Long-term care has generally not been discussed in the options presented above. Two areas,

however, are important. While it is important to
deter deceptive practices (e.g., transferring assets
to become eligible for Medicaid), deterrence is not
likely to result in large budgetary savings (O’Brien,
2005). However, under the current requirements,
people must “spend down” (i.e., spend large
amounts of money) before becoming eligible for
Medicaid. Thus, there is a need to permit people
to retain somewhat higher levels of assets and
income. The second issue is the extreme unevenness in the coverage of home and community-based
services for impaired elderly and disabled people.
Efforts should be made to permit states to expand
coverage of home and community-based services
in general and to people with higher income levels.

Change the Federal Matching Fund
Formula
The federal matching formula should be
reformed (Miller and Schneider, 2004). The current
system now recognizes differences in incomes. It
needs to be restructured to recognize differences
in income distribution as well. For example, two
states with the same income level could have very
different proportions of their population in poverty
and thus different needs for federal assistance.
Centering the matching rate on income per person
in poverty would end up shifting dollars to states
with a more skewed distribution of income. If some
of the other changes in matching rates and shifts
in responsibility to the federal government that
have been discussed in this paper were adopted,
then all states would come out as winners, but
some more than others. There is a need to increase
matching rates with rising unemployment on a
timely basis.

CONCLUSIONS
We have identified the following problems with
Medicaid: large interstate variation in coverage,
costs that are increasingly a burden to states, complex eligibility rules, and creative state financing.
To address these problems, we propose to expand
and provide a more uniform base of coverage and
reduce the number of uninsured. These uniform
standards would be easier for the states and federal

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government to build upon, with further reforms
designed to reduce the number of uninsured
Americans. We would also shift more of the financial responsibility for Medicaid to the federal
government and provide fiscal relief to states. We
would give the federal government greater responsibility for managing the care of high-cost patients,
which would also provide a strong incentive for the
federal government to invest in learning how to
manage these high-cost cases. Finally, our proposals
would severely restrain the financial manipulations that are now too great a part of the Medicaid
program.
The nation is now undertaking a new discussion
over universal coverage. We believe Medicaid
reform has to be part of that discussion.

REFERENCES
Allen, Kathyrn G. “Medicaid: States’ Efforts to Maximize
Federal Reimbursements Highlight Need for Improved
Federal Oversight.” Testimony before the Senate
Finance Committee, June 28, 2005.
Anderson, Gerard F. “Medicare and Chronic
Conditions.” New England Journal of Medicine,
2005, 353(3), pp. 305-09.
Berenson, Robert and Horvath, Jane. “Confronting the
Barriers to Chronic Care Management in Medicare.”
Health Affairs, Web Exclusives, January 22, 2003,
w37-53; 10.1377/hlthaff.w3.37.
Blumberg, L.; Dubay, L. and Norton, S. “Did the
Medicaid Expansion for Children Displace Private
Insurance? An Analysis Using the SIPP.” Journal of
Health Economics, 2000, 19(1), pp. 33-60.
Cannon, Michael F. “Medicaid’s Unseen Costs.” Policy
Analysis No. 548, Cato Institute, August 2005.
Coughlin, Teresa A. and Zuckerman, Stephen. “States’
Strategies for Tapping Federal Revenues: Implications
and Consequences of Medicaid Maximization,” in
J. Holahan, A. Weil, and J.M. Weiner, eds., Federalism
and Health Policy. Washington: Urban Institute,
2003, pp. 145-78.

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Coughlin, Teresa A.; Bruen, Brian K. and King,
Jennifer. “States’ Use of Medicaid UPL and DSH
Financing Mechanisms.” Health Affairs, 2004, 23(2),
pp. 245-57; 10.1377/hlthaff.23.2.245.
Council of Economic Advisors. Economic Report of
the President. Washington, DC: GPO, February 2006.
Cutler, David M. and Gruber, Jonathan M. “Does
Public Insurance Crowd-Out Private Insurance?”
Quarterly Journal of Economics, May 1996, 111(2),
pp. 391-430.
Davidoff, Amy; Yemane, Alshadye and Adams, Emerald.
“Health Coverage for Low-Income Adults: Eligibility
and Enrollment in Medicaid and State Programs,
2002.” Kaiser Commission on Medicaid and the
Uninsured, February 2005.
Dubay, Lisa. “Expanding Public Insurance Coverage
and Crowd-Out: A Review of the Evidence,” in
J. Feder and S. Burke, eds., Options for Expanding
Health Insurance Coverage: What Difference Do
Different Approaches Make? Washington, DC: Henry
J. Kaiser Family Foundation, 1999.
Dubay, Lisa; Haley, Jennifer and Kenney, Genevieve.
“Children’s Participation in Medicaid and SCHIP:
Early in the SCHIP Era.” Urban Institute New
Federalism National Survey of America’s Families,
March 2002a, Series B, No. B-40.
Dubay, Lisa; Haley, Jennifer and Kenney, Genevieve.
“Children’s Eligibility for Medicaid and SCHIP:
A View from 2000.” Urban Institute New Federalism
National Survey of America’s Families, March 2002b,
Series B, No. B-41.
Dubay, Lisa; Holahan John and Cook, Allison. “The
Uninsured and the Affordability of Health Insurance
Coverage.” Health Affairs, January/February 2007,
26(1), pp. w22-30; 10.1377/hlthaff.26.1.w22.
Ginsburg, Paul B.; Strunk, Bradley C.; Banker,
Michelle I. and Cookson, John P. “Tracking Health
Care Costs: Continued Stability But at High Rates in
2005.” Health Affairs, November/December 2006,
25(6), pp. w486-95; 10.1377/hlthaff.25.w486.

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Hadley, Jack and Holahan, John. “Is Health Care
Spending Higher under Medicaid or Private
Insurance?” Inquiry, Winter 2003/2004, 40(4),
pp. 323-42.

O’Brien, Ellen. “Medicaid’s Coverage of Nursing Home
Costs: Asset Shelter for the Wealthy or Essential
Safety Net.” Georgetown University Long-Term Care
Financing Project Issue Brief, May 2005.

Holahan, John. “Variation in Health Insurance
Coverage and Medicaid Expenditures: How Much Is
Too Much?” in J. Holahan, A. Weil, and J.M. Weiner,
eds., Federalism and Health Policy. Washington:
Urban Institute, 2003, pp. 111-43.

Rousseau, David and Schneider, Andy. “Current Issues
in Medicaid Financing—An Overview of IGT’s, UPL’s
and DSH.” Publication No. 7071, Kaiser Commission
on Medicaid and the Unisured, April 2004.

Holahan, John and Cohen, Mindy. “Understanding
the Recent Changes in Medicaid Spending and
Enrollment Growth between 2000-2004.” Publication
No. 7499, Kaiser Commission on Medicaid and the
Uninsured, May 2006.
Holahan, John and Ghosh, Arunabh. “Understanding
the Recent Growth in Medicaid Spending, 20002003.” Health Affairs, Web Exclusives, January 26,
2005; 10.1377/hlthaff.w5.52.
Holahan, John and Weil, Alan. “Toward Real Medicaid
Reform.” Health Affairs, March/April 2007, 26(2),
pp. w254-70; 10.1377/hlthaff.26.2.w254.
Lieberman, Stephen; Lee, Julie; Anderson, Todd and
Crippen Dan L. “Reducing the Growth of Medicare
Spending Geographic versus Patient-Based Strategies.”
Health Affairs, November/December 2003, 22(6),
pp. w603-13; 10.1377/hltaff.w3.603.
Lo Sasso, Anthony T. and Buchmueller, Thomas C.
“The Effect of the State Children’s Health Insurance
Program on Health Insurance Coverage.” Journal of
Health Economics, 2004, 23(5), pp. 1059-82.
Medicare Payment Advisory Commission. Report to
the Congress: Increasing the Value of Medicare.
Washington, DC: MedPAC, June 2006.

Schwartz, Sonya; Gehshan, Shelly; Weil, Alan and
Lam, Alice. “Moving Beyond the Tug of War:
Improving Medicaid Fiscal Integrity.” National
Academy for State Health Policy, August 2006.
Selden, Thomas S.; Banthin, Jessica S. and Cohen, Joel
W. “Medicaid’s Problem Children: Eligible but Not
Enrolled.” Health Affairs, May/June 1998, 17(3),
pp. 192-200; 10.137/hlthaff.23.5.39.
Sommers, Anna and Cohen, Mindy. “Medicaid’s High
Cost Enrollees: How Much Do they Drive Program
Spending?” Publication No. 7490, Kaiser Commission
on Medicaid and the Uninsured, March 2006.
Spillman, Brenda C. “Adults Without Health
Insurance: Do State Policies Matter?” Health Affairs,
July/August 2000, 19(4), pp. 178-87.
Thorpe, Kenneth and Howard, David H. “The Rise in
Spending among Medicare Beneficiaries: The Role
of Chronic Disease Prevalence and Changes in
Treatment Intensity.” Health Affairs, September/
October 2006, 25(5), w378-88; 10.1377/hlthaff.25.w378.
Wagner, Edward H; Austin, Brian T. and Von Korff,
Michael. “Organizing Care for Patients with Chronic
Illness.” Milbank Quarterly, 1996, 74(4), pp. 511-44.

Miller, Vic and Schneider, Andy. “The Medicaid
Matching Formula: Policy Considerations and Options
for Modifications.” Publication No. 2004-09, AARP
Public Policy Institute, September 2004.

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Commentary
James W. Fossett

I

’ll try to be brief: We have a saying at my
home base at the Rockefeller Institute that
the ideal conference is nothing but coffee
breaks where people can talk to each other
about what they need to know, and I wouldn’t
want to interfere with that.
Being John Holahan and Alan Weil’s discussant
is a tough job; you basically want to say “what they
said” and sit down. They’ve given you a pretty
good overview of Medicaid’s recent history and
put forward some worthwhile ideas about where
the program should be headed next. Rather than
rehash what they’ve already told you, I’d like to
spend a little time talking about Medicaid and
health care politics and how they affect the choices
federal and state governments are going to be able
to make in the short run. Health policy in general
and Medicaid in particular are as much political
and institutional problems as they are intellectual
ones, and what reforms get passed may be different
from what you might like to see.
Viewed through this lens, there’s not a lot of
cause for optimism. The best sound bite description of the current Washington health policy landscape is “gridlock”—there’s no clear sentiment in
favor of trying to push health coverage or Medicaid
in any particular direction, and most of the major
proposals that have been put forward have attracted
significant opposition. The Bush administration
has resorted heavily to administrative devices—
encouraging certain kinds of waivers, reducing
the use of creative financing techniques, trying to

eliminate graduate medical education—as its main
means of Medicaid policymaking. The governors
have been largely able to block Medicaid changes
that they don’t like—most recently, “block granting” Medicaid—but don’t have a common vision
for where they’d like to take the program beyond
“give us more money and fewer restrictions.” The
most recent legislative success, if you want to call
it that, was the Deficit Reduction Act, which didn’t
move Medicaid in any new directions, but rather
gave the states more flexibility to do a lot of different things, which some of them are doing.
It’s not clear this difficult situation is going to
change very much going forward, even after the
2008 presidential election. It seems likely that the
price of private health insurance and the number of
uninsured will continue to increase. These trends
will make health coverage a popular campaign
issue—several presidential candidates already
have proposals on the table—but there are several
problems that may make major changes in Medicaid
hard to achieve.
The biggest ones are Iraq and Afghanistan.
The next president, no matter who he or she is,
will inherit large, hot, expensive shooting wars in
both those places, which will consume a lot of the
available money and political capital. Second, to
use a highly technical term, the federal budget is
in the toilet and there are large multiple claims
on resources. Even with a Democratic majority,
Congress has been very grudging about smaller
spending such as fully funding the State Children’s
Health Insurance Program and may well balk at the

James W. Fossett is director of Medicaid studies at the Rockefeller Institute and associate professor of public administration and public health at
the Rockefeller College of Public Affairs and Policy at the University at Albany, State University of New York.
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 22-23.
© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
only with prior written permission of the Federal Reserve Bank of St. Louis.

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Fossett

$45 billion to 50 billion in new spending that the
authors want to hand them.
Third, states may be less well-off than they are
now. States have had it pretty good for the past
couple of years where Medicaid is concerned:
Revenue growth has been solid, and the combination of the Medicare prescription drug benefit and
slow enrollment growth has kept Medicaid spending growth, for this year at least, below the level
of growth in state revenues. Some states even have
put their own health reform proposals in effect
and more are considering them.
While things are good for states right now, they
may not be staying that way. My colleagues at the
Rockefeller Institute who follow state finances have
just reported that state revenue growth is slowing
down. Particularly in wealthier states such as mine,
state income tax revenue is driven by the stock
market as much as by the overall economy, and
state sales tax collections have become more unstable as many states have eliminated or reduced taxation on clothing and food. A slide in the stock
market or an overall economic slowdown could
make state revenue pictures look worse in short
order.
This economic vulnerability may mean that
states are not likely to be enthusiastic about the
authors’ proposals to make them spend money by
expanding coverage for adults or cause them to lose
money by eliminating or reducing creative financing techniques such as the Disproportionate Share
Hospital Program or upper payment limits. Expand-

ing coverage for adults is politically more difficult
than for kids. The significant expansion in coverage for kids over the last 20 years has been one of
the major success stories of the American public
health insurance system: We do a much better job
at covering kids than we once did, and disparities
in coverage between states have narrowed dramatically. The politics were successful here—Southern
governors were some of the earliest supporters of
expanding eligibility for pregnant women and
children, and, as Governor Thompson told you
earlier, governors found it easy to campaign on
doing things for kids, so states were competing
with each other to expand coverage.
This model may not transfer well to adults.
Kids are cute, popular, healthy, and cheap to cover;
adults are not cute, not popular, more likely to be
sick, and are decidedly more expensive. Even with
the enhanced match proposed, covering adults to
100 percent of the poverty level or some other reasonable level will cost some states, particularly in
the South, a lot of money that they may not want
to spend.
So my prediction, which I’m making early
enough for you to forget in case I’m wrong, is that
we’re not going to be able to pass major national
changes in Medicaid anytime soon. What we might
be able to do is make it easier for states to cover
more adults and allow states to move ahead as
they’re able to, but large-scale changes in policy
that call for spending a lot of money seem beyond
our reach for the time being.

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Mandatory and Affordable Health Insurance
Len M. Nichols
This paper asserts that America’s health care system is broken and cannot be repaired with timid
half-measures. It suggests that we need both universal coverage and a more efficient delivery
system and that these are not competing objectives: Each is necessary to make the other possible.
It further states that if we do not make health care more affordable and our delivery system more
efficient and sustainable, a majority of Americans will be uninsured in short order. And the persistence of millions of uninsured impairs the efficiency we need to make health care and insurance
affordable for all. Thus, contrary to conventional wisdom, this paper asserts that both universal
coverage and delivery system reform must be pursued simultaneously. (JEL I110, I180)
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 24-28.

H

ealth care costs continue to grow
faster than incomes, and more and
more working families are finding
health insurance unaffordable. Four
million Americans have lost private coverage since
2000, mostly because they cannot afford the contribution their employers require for increasingly
less generous offerings. At this rate, by 2010, fewer
than half of all Americans, the lowest percentage
since 1960, will have employer-sponsored coverage. We may be near the breaking point of our mid20th century employer-based system. Forwardthinking labor leaders, such as Andy Stern, president of the Service and Employees International
Union, are voicing the compelling reality: The
employer-based health insurance system as we
have known it is unsustainable in a 21st century
economy. Understanding their own impotence to
reverse these trends, many employers agree, and
like Lee Scott, CEO of Wal-Mart, are searching for
ways to jump-start a national conversation about
feasible alternatives.
There are only three credible universal financing arrangements: (1) tax-financed single-payer

insurance, or Medicare for all, (2) employer plus
individual mandates to purchase private health
insurance, or (3) individual mandates alone. (Each
of the last two also requires low-income subsidies.)
“Medicare for all” is technically feasible but
requires a level of trust toward government decisionmaking that is simply not present now, nor
likely to spread soon. In addition, most of the efficiencies of a single-payer system could be obtained
within any program of mandatory coverage that
eliminates the profit from avoiding high-risk
patients.
Without purchase mandates, however, no
insurance system can approach the level of efficiency we need; these mandates would prevent
insurers and providers from using many scarce
resources to avoid high-risk patients. So, in addition to the moral case—the Institute of Medicine
estimates that 20,000 Americans die each year
because the lack of health insurance prevents them
from obtaining timely but routine care—there is a
strong economic case for universal coverage.
Among the private insurance alternatives, the
“individual mandate alone” option is by far the

Len M. Nichols is director of the Health Policy Program of the New America Foundation.

© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
only with prior written permission of the Federal Reserve Bank of St. Louis.

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Nichols

most congruent with the 21st century U.S. economy.
That economy must remain flexible and reward
mobile workers, so tying insurance to citizenworkers and not to firms makes perfect sense. At
the same time, the U.S. economy will continue to
generate many jobs with productivity levels that
simply cannot support employer-provided health
benefits plus a market wage. Thus, a mandate on
employers would be counterproductive to efficient
and shared economic growth, for many low-wage
jobs would be lost. Finally, an individual mandate
is consistent with individual responsibility, a central—but by no means the only—element of a new
social contract that can spread opportunity and
well-being through redefined social responsibilities
as well. The New America Foundation will have
more to say about that full social contract soon.
But universal coverage is not enough. Our
health care system is so inefficient and prone to
unsustainable cost growth that to pursue universal
coverage without simultaneously seeking to contain
costs would very soon add to our mounting fiscal
problems.
We spend at least twice as much per capita on
health care as our major trading partners, and we
finance far more of it through employers, which
puts us at a significant competitive disadvantage
in the global economy. This is why health care
system reform has become a “C-suite” issue: CEOs,
COOs, and CFOs are focused on it like never before.
Moreover, the health gains from our spending are
mediocre compared with the rest of the world.
The United States ranks an embarrassing 37th in
the World Health Organization’s evaluation of
health systems worldwide, next to Slovenia and
Costa Rica.
We compare poorly because our three linked
problems—high costs, mediocre quality, and
unequal access—do not yield to the timid, incremental reforms we have tried to date. Despite our
high spending, Americans get appropriate care only
about 55 percent of the time. Individuals at the
higher income levels get appropriate care only 2
percent more often, while individuals at the lowest
income level get appropriate care only 2 percent
less often. Thus, money actually buys very little
quality per se. Geographic variation in the quality
of care is stunning: An individual living in Utah

has a one-third higher chance of surviving cancer
than a person living in North Carolina. Ineffective
care adds unnecessarily to costs, which reduces
coverage and stifles access.
We also suffer over 150,000 unnecessary deaths
each year from avoidable errors and substandard
care. The average person in Canada, Australia, or
France is healthier and will live longer than the
average American. Far more equitable access to
high-quality primary care is a big part of the reason.
There are 46 million uninsured in the United States,
and their lack of timely access results in the lowest
quality of care of all. The total economic costs of
the uninsured—shifted medical costs plus lost
productivity from extra absenteeism and premature
death—have been estimated to be roughly equal
to the public cost of the low-income subsidies
necessary to finance universal coverage in this
country. It is time we made a smarter economic
bargain for health care.
The first step is to recognize that comprehensive health care reform—achieving universal coverage and cost growth containment—is not only
necessary, it is doable. We can provide better care
for more people, we can afford the necessary subsidies for our low-income population, and we
can bridge the divides in our polarized national
debate and politics. It will take leadership, compromise, and hard work, but political leaders in
Massachusetts have shown us that it is certainly
possible. There, a Republican governor and presidential aspirant was willing to use the word “all,”
the Democratic legislature accepted the word
“limit,” and together they are taking a giant step
toward universal coverage.
Politically, the possibilities for national reform
are greater today than ever before, not least because
the barometers of system stress are worse than they
were when Bill Clinton became president and
health reform was on the agenda. In 1992, there
were 33 million uninsured Americans; 13 million
people have been added to the rolls of the uninsured since then. The average family health insurance premium today claims 18 percent of median
family income, compared with 10 percent then.
Three qualitative differences may matter even
more.

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First, employers are increasingly determined
to force politicians to address the question of
reform because high health costs make it harder
for them to compete in international markets.
Second, as cost growth forces companies to
reduce benefits and shift costs to workers, more
and more workers worry about losing coverage
altogether, even in a strong economy. This is a sea
change from the early 1990s, when the fear of coverage loss was recession-based. Now it is based on
cost growth outstripping income growth, with no
end in sight. As presidential aspirants in both parties are learning—in their home districts, in Iowa,
and New Hampshire—voters are deeply worried
about unaffordable health care.
Third, and most importantly, growing public
awareness of the linkages among cost growth,
quality gaps, and losing coverage makes the reform
discussion different this time around. The Clintonera debate was mostly about covering the uninsured
and the income redistribution that would have been
required to accomplish this. That argument was
largely “zero sum”: some would gain coverage, and
others would have to pay higher taxes to finance
it. But if none of us is assured of getting quality
care, and if all of us—including employers—are
vulnerable to rising costs, then there is a positivesum or win-win dimension to comprehensive
reform now that makes it far more likely.

A WIN-WIN FORMULA FOR
REFORM
Positive-sum reform provides something for
everyone and demands shared responsibility as
well. Essentially it entails building a universal
coverage financing system on the backbone of a
sustainable delivery system. Therefore, it must
have numerous elements.
• It must be bipartisan. Effective reform will
require features that moderates in both the
Democratic and Republican parties can
embrace—a program that preserves enough
of the core values of each party’s base to permit each side to recognize its own narrative
in the outcome. To achieve this, there must
be individual responsibility as well as shared
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responsibility, cost-containment as well as
universal coverage.
• It must create an effective health insurance
market. In this market, individuals and
groups without good options today can benefit from administrative economies of scale
and risk pooling. Market rules must be fair
to individuals and reasonable for insurers,
like those that govern very large employers,
employer coalitions, and federal- or stateworker purchasing pools today.
• Individuals must be required to purchase
health insurance. Even with subsidies and
a functioning marketplace, some individuals
will be unlikely to buy health insurance on
their own, thereby shifting costs onto others
in the event of their need for expensive care.
To avoid such “free riding,” individuals must
be required to pay their fair share toward
health access for all. Purchase mandates are
therefore essential under any formula for
achieving universal coverage. Individuals
could purchase insurance through their
employers or efficient purchasing pools.
• There must be substantial subsidies for
low-income individuals and families. A
basic insurance package must be required,
but in exchange it must also be affordable.
This is essential for reasons of equity and
efficiency alike. We cannot force people to
buy policies they cannot afford. Even if this
were politically feasible, it would force them
to forego other necessities, which could have
bad health consequences. If we try to mandate insurance without subsidies, some will
remain uninsured and we will continue to
pay for their late, inefficient care like we do
now. A supplemental benefit package at zero
or low cost is needed to cover cost-sharing
for individuals with very low incomes or
those with substantial health care needs, e.g.,
those who are in households with incomes
below 150 percent of poverty or who are
currently enrolled in Medicaid because of
disability status. The basic package must be
comprehensive (i.e., cover necessary physician, hospital, pharmaceutical, dental, and
mental health services), but still have a cost-

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sharing structure (coinsurance is preferable
to high deductibles) that unsubsidized families could afford.
• Household subsidies should be financed by
a dedicated and limited new tax. These
subsidies can be partially financed, especially
over time, with savings from the reform program, but there will need to be additional
revenues dedicated to them, at least in the
short run. It would be best to fill the gap with
a dedicated stream from a new tax (e.g., a
progressive consumption tax or a progressive
value added tax), which would also serve as
a budget constraint. Budget constraints and
tax rates can and should be revisited over
time as circumstances warrant, but having
annual budget limits on subsidies may be
necessary to construct a majority coalition
for comprehensive reform.
• The new system should be citizen based,
phasing out the employer’s role. There are
a number of options here, but it is important
that employers should be seen as only one
among many possible financing sources for
health insurance coverage, with the understanding that they are not likely to be able
to continue indefinitely in that role. The
goal ought to be to keep current employer
“money” in the game while relieving employers of the burden of negotiating health premium increases every year. A new insurance
market pool and subsidy structure could aid
such a transition. For example, firms might
enroll their workers in a plan through a purchasing pool in year one, while maintaining
their historical premium contribution levels.
In year two, they could give their workers a
raise at least equal to the previous year’s
premium contribution, plus some agreedupon inflation factor, and from that higher
base the workers could be expected to purchase insurance on their own unless eligible
for a subsidy. (Tax preferences could also be
converted at that point, perhaps from the
open-ended exemption for employer-plusemployee section 125 plan tax-sheltered
contributions today, to a fixed tax credit that
might vary by income and/or risk class.)
This transition would keep the “right”

amount of money flowing to health insurance in year two; thereafter, cost growth and
affordability would be settled in the politics
of citizen, state, and health care delivery systems, with the employer out of the picture.
This brings us to delivery system reform,
which is central to the success and sustainability
of the entire reform enterprise. In short, we urgently
need to reorganize our delivery system to yield far
more health “value” per dollar spent. There are
three critical elements to creating a delivery system
with a “culture of value.”
• An electronic health information system.
This would give any clinician anywhere
instant access to a patient’s medical history,
plus diagnosis and treatment options. The
system would include web-based electronic
health records, as well as medical-decision
support tools so that best practices could be
applied to every clinician-patient encounter.
Today, a Las Vegas casino can determine the
precise details of an individual’s credit worthiness in real time, but no emergency room
doctor in that city (or anywhere else in the
United States) can find out what medications
an unconscious person is on (unless that
individual is being treated in the Veterans
Administration system). An electronic information system will help us monitor care,
protect patients, and improve the overall
quality of health care in the United States.
• Turbo-charged incentives. We need a new
set of payment incentives for both patients
and providers. Today, we pay providers for
conducting tests and carrying out procedures
that may or may not be necessary or effective.
And patients are often required to pay no
more for expensive tests and procedures
than for less expensive but equally effective
treatment. This system encourages unnecessary treatments and results in low-value
care. Smarter incentives would encourage
patients and clinicians to use resources
prudently while promoting high-quality,
cost-effective care. Incentives for patients
and providers should be mutually reinforcing, and they can be if they incorporate the
same performance targets. For example,

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HEALTH CARE
FOR ALL AMERICANS
How to Fix Our Broken
Health Care System:
•

Create a health insurance market

•

Require everyone to buy health insurance

•

Subsidize low-income Americans

•

Define a transitional role for employers

•

Improve outcomes using an electronic
information system

•

Offer “turbo-charged” payment incentives
to lower costs

•

Provide high-quality care based on
comparative technology assessment

clinicians should be paid more if diabetics
under their care obtain all appropriate tests
each year, and the patient’s copayment for
such cost-effective, evidence-based tests
should be zero. We will also need to reform
our dysfunctional malpractice legal system.
Evidence-based medicine, i.e., statistically
supported best practices, must be a safe
harbor against spurious malpractice claims.
Guidelines can be developed and disseminated by private specialty societies and
public research agencies to ensure their
effectiveness and a smooth transition to
evidence-based safe harbors.
• Comparative technology assessment.
Advances in medical technology have saved
lives and improved the quality of life for
many, and future advancements are likely
to have possibilities nothing short of breathtaking. However, the overuse of new technology has been the main culprit in driving
up costs. Future advancements are likely to
drive up costs even further, to the point of
their being potentially catastrophic for the
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added of new technologies compared with
existing treatment or diagnostic options prior
to their widespread adoption and use. The
FDA’s drug approval process is a case in
point. Today, to get a drug approved for a
specific use, a manufacturer must simply
prove that the proposed new drug did not
manifest serious side effects and is more
effective than a placebo. We should require
a higher standard for approval: New and more
expensive drugs should be shown to be better
than the best existing treatment for any given
patient subpopulation. To compensate for
the longer and more expensive trials this
would require, we would probably need to
lengthen the life of drug patents. We should
apply the same logic to medical devices and
new diagnostic or surgical techniques. Then
we can become far smarter purchasers of
costly new technologies.

THE POLITICAL GROUNDWORK
IS BEING LAID
The good news is that a critical mass of stakeholders, opinion leaders, CEOs, union officials,
and politicians agree that our health care system
is on an unsustainable trajectory and must be
reformed. Massachusetts has shown that comprehensive and bipartisan compromise is possible,
and the American Medical Association’s recent
call for an individual mandate approach to universal coverage is proof that former adversaries of
wholesale reform now see its necessity.
The coming presidential campaign season
will be an opportune time to debate larger visions
about necessary and wise changes to our existing
health care system. Large majorities of the electorate support and are willing to pay to ensure that
all Americans have access to at least basic health
insurance. Announced and potential presidential
candidates have heard the rumblings of discontent
and fear among the electorate. Our political system can find a bipartisan way for those fears to be
addressed and the public’s preferences to be translated into affordable and effective heath care for
all Americans. The leaders that facilitate this transformation will be highly regarded indeed.

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Commentary
Thomas Stratmann

L

en Nichols identifies a number of problems in the current health care system.
They include the rising cost of health
care, the poor quality of services in the
United States relative to some other countries, the
possibility that employer-provided health insurance puts American employers at a competitive
disadvantage in the global economy, and that
many individuals are uninsured. I will discuss
these issues in turn. I will then make some suggestions for improving the current health care system.
Contrary to Len’s proposal, I suggest making only
some coverage compulsory—namely, catastrophic
health insurance—and to not rely on extra taxes
to finance health care services.
Currently the United States spends $2 trillion
on health care. The fraction of gross domestic
product spent on health services has increased over
many years, totaling now one-seventh of gross
domestic product. Health care spending has risen
because, on the supply side, quality of care has
increased and often higher quality is associated
with higher prices. But demand for health care
services has also increased because of improved
quality of health services and longevity. People live
longer and thus demand more health care to maintain a high quality of life. Further, technological
advances have given people more options for highquality care. Treatment for ailments in the health
care sector has a large discretionary component.
Some people opt to be treated for mild depression,
decreased mobility, cosmetic concerns, etc., others
do not. As the quality of life-improvement services

increases, more people take advantage of these
new options, as expected when quality of services
rises faster than its price. This sum of circumstances
can explain much of the increase in health care
spending. At the same time, it would be interesting
to know what would happen to demand if more
patients were paying out of pocket.
To spend more on medical services and less
on food or housing is an individual’s choice, and
from an economic perspective this is no problem
if choices are not distorted, as for example through
public subsidies. As we get richer as a nation, we
may decide to devote more and more resources to
health care, because our basic needs for food and
housing are fulfilled, to further improve our quality of life.
An economist always thinks about so-called
opportunity cost, that is, the value of a resource
in an alternative use. Thus, from an economist’s
perspective, the question is not whether we spend
too much on health care, but whether we can
find some better ways to spend the $2 trillion,
either in the health care sector or in some other
way.
Many of the improvements in longevity over
the past century are attributable to improvements
in health care. A recent article in the Journal of
Political Economy by Kevin Murphy and Robert
Topel (2006) has put a number on the value of this
increased longevity: Between 1970 and 2000, the
added value of increased longevity, after subtracting out the $35 trillion in health care spending in
this 30-year span, is over $60 trillion. This shows

Thomas Stratmann is a professor of economics at George Mason University.
Federal Reserve Bank of St. Louis Regional Economic Development, 2007, 3(1), pp. 29-31.
© 2007, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in
their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made
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that, at least in an absolute sense, our health care
sector performs well.1
But do we fare well when we compare the
performance of our health care sector with that
for other countries? It may be the case that other
countries that have comparable or higher rates of
longevity, and at the same time spend less on health
care, have a more efficient health care system. But
there are several reasons that this is not necessarily
the case. First, many other countries ration qualityof-life improvements, such as knee replacement,
preventive angioplasty, back surgery, and breast
reconstruction after breast cancer, and this rationing involves significant costs because patients have
to wait for a long time for treatment, as for example
in Great Britain. Longevity is only one part of measuring the performance of health care systems, and
when it comes to quality-of-life improvements, it
is not obvious that other countries do better than
the United States. Second, another indicator that
the quality of U.S. health care services is high comes
from the fact that the United States is a leader in
medical research. In fact, many citizens from other
countries come to the United States seeking medical treatment. Finally, cross-country comparisons
are difficult to make because individuals change
their behavior in response to medical progress. In
my own studies, I have shown that individuals
engage in more risky behavior when they expect
to be treated for diabetes and drug abuse (Klick and
Stratmann, 2006 and forthcoming). So if there are
medical advances in some countries that treat the
consequences of obesity (such as diabetes), some
people in this country will be less vigilant in their
diets because they know that they can take advantage of the treatment options if they gain weight and
become diabetic. The resulting increase in obesity
will therefore somewhat offset the benefits of technological progress. Because technological progress
changes people’s behavior and because countries
differ in their medical progress, sometimes meaningful cross-country comparisons of health indicators are difficult to make.
Is employer-based health insurance making
U.S. firms less competitive in the global market?
1

In these comments I draw on www.becker-posner-blog.com/, as
well as the works cited at the end of this article.

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Employer contributions to workers’ health insurance premiums increase the total cost of labor. The
fact that employers pay some of workers’ health
insurance does not mean that they pay the premiums on top of wages. Employers pay workers less
than they would have if employers had not paid
the workers’ health insurance premiums. So, in the
end, workers pay for health insurance premiums
through lower wages. Some may argue that this
occurs only in the long run, but in this case, the
long run is probably not so long. Clearly, when
health insurance premiums increase, employers
may not be able to reduce workers’ wages immediately. But it may be enough to pay for the increased
premiums by giving workers a lower increase in
wages. Wages have been fairly flat over the past
decades, suggesting that employers might have
paid for the increased premiums by not increasing
wages. So, the time lag to pass on premiums is
not necessarily very long. And this means that
the argument that employer contributions make
employers less competitive in the market place is
incorrect, as workers bear the burden through
lower earnings.
Clearly, many CEOs complain about high health
insurance premiums, but that does not mean that
this is the true underlying cause of their failure to
successfully compete. For example, the Detroit car
manufacturers do not have competitive problems
because of health insurance premiums. Foreign
car manufactures in the United States are also
paying health insurance premiums and are doing
quite well in the United States. The problem for
the Detroit car manufacturers can be traced to past
promises they have made to their workers, not their
current payments of health insurance premiums.
What are the economic reasons for the concern
that 16 percent of the current U.S. population is
uninsured, besides possible humanitarian concerns? The uninsured are primarily healthy and
young. So it is possible to view their decision not
to take up medical insurance as their free and legitimate choice. The argument most often advanced
against this view is that this is not their free and
legitimate choice because the uninsured impose
costs on the insured. This is because emergency
rooms are required to treat every person, and if
the uninsured do not pay their bills, then hospitals,

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taxpayers, or other insured people will pay for the
costs of treatment. So, some individuals may decide
not to become insured, because they know of the
“free” emergency room treatment option. However,
an article by Weber et al. (2005) in Annals of
Emergency Medicine found no evidence that the
uninsured are disproportionately visiting the emergency room. This study was based on interviews
of 50,000 individuals who had visited the emergency room. The findings in this study may be due
to the fact that the uninsured tend to be the young
and healthy who have fewer reasons to visit the
emergency room than the insured unhealthy individuals. Further, the incentive to visit the emergency room is not so strong, given that going to
the emergency room is not particularly enjoyable,
nor always the most appropriate treatment option
for ailments.
Currently, those with employer-based insurance
are subsidized by the government because workers
do not have to declare the portion of the health
insurance premium paid by the employer as taxable income. One problem with this arrangement
is that it encourages workers to take, and employers
to offer, more elaborate and expensive plans just
because workers do not pay the full cost, for the
tax deductibility benefits. Another problem is that
this arrangement distorts the playing field between
those who purchase insurance as individuals as
opposed to through employers. One way to address
this issue is to eliminate the tax exemption of
employer-based plans. But if the goal is to get more
people insured, it would make sense to extend the
tax deductibility, up to a cap (to reduce the incentive to purchase expensive plans that offer little
extra health benefits but are purchased only because
they are subsidized) for individual plans. This tax
deductibility would reduce the cost of individual
plans, encouraging some of the currently 46 million
uninsured to purchase health insurance.

Finally, it would make sense to mandate catastrophic health insurance. Catastrophic insurance
covers events such as long-term illnesses that
would deplete an individual’s or family’s resources.
Compulsory catastrophic health insurance would
reduce the likelihood that the uninsured free ride
and push their costs of treatment off onto the
insured and taxpayers. The cost of this policy
would be low, because catastrophic events do
not occur often. No additional subsidy would be
required to help lower-income people to pay for
this insurance, because they are already covered
though Medicaid.

REFERENCES
Klick, Jonathan and Stratmann, Thomas. “Subsidizing
Addiction: Do State Health Insurance Mandates
Increase Alcohol Consumption?” Journal of Legal
Studies, January 2006, 35(1), pp. 175-98.
Klick, Jonathan and Stratmann, Thomas. “Diabetes
Treatment and Moral Hazard.” Journal of Law and
Economics (forthcoming).
Murphy, Kevin M. and Topel, Robert H. “The Value of
Health and Longevity.” Journal of Political Economy,
October 2006, 114(5), pp. 871-904.
Weber, Ellen J; Showstack, Jonathan A.; Hunt, Kelly A.;
Colby, David C. and Callaham, Michael L. “Does
Lack of a Usual Source of Care or Health Insurance
Increase the Likelihood of an Emergency Department
Visit? Results of a National Population-Based Study.”
Annals of Emergency Medicine, January 2005, 45(1),
pp. 4-12.

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