Marc Joffe and Krit Chanwong
Federal reforms in 2025 may give states both the flexibility and incentives they need to rein in spiraling Medicaid costs. As we discussed in a February 2024 Cato Policy Analysis, the Biden administration gave states few opportunities to improve the cost-effectiveness of their Medicaid programs, but this is likely to change under the second Trump administration.
And such a change is sorely needed. According to the Medicaid and CHIP Payment and Access Commission (MACPAC), Medicaid spending totaled $900 billion in Federal Fiscal Year 2023. This number includes costs incurred by federal, state, and territorial governments. It is up dramatically from the $498 billion the same entities spent in FFY 2014.
At the most aggressive end of potential federal reforms on tap for next year would be the conversion of Medicaid from an entitlement to a block grant program. Currently, states receive a federal match for all medical provider expenses they incur on behalf of Medicaid beneficiaries. During FFY 2025, this Federal Medical Assistance Percentage (FMAP) ranges from 50 percent in affluent states such as California and New York to 76.90 percent in Mississippi, and to 83 percent in some smaller overseas territories. The block grant proposal would replace this variable match with a fixed stipend.
Such a change could be scary for state governments because it would make them fully responsible for each incremental dollar of Medicaid spending, whereas now their share of this additional spending is half or less. But assuming the block grants come with limited strings attached, states will gain considerable new flexibility to control costs, including setting their own eligibility requirements.
Given concerns about low-income individuals losing coverage, federal policymakers may choose an alternative to block grants known as per capita caps. Under this policy, the federal government would pay each state no more than a certain amount per Medicaid beneficiary per year. Caps may vary by category because it costs much more to cover a senior in a skilled nursing facility than a healthy young adult. With per capita caps, states would be at less risk from enrollment growth, but they could lose out if per-beneficiary spending exceeds the federal cap.
But assuming per capita caps are coupled with delegation of control over program structure, states should be able to avoid this outcome. For example, states could impose significant copayments to dissuade the use of emergency rooms for non-emergency purposes. Under current law, such copayments are limited to $8. States could impose copayments on other services to discourage their overuse as well.
States could also encourage beneficiaries to use lower-cost alternatives compared to in-person physician visits, such as nurse practitioner services and telemedicine. To derive cost savings from these options, states will have to establish lower reimbursement rates for them.
Assuming they have greater flexibility, states can also save money by curtailing Disproportionate Share Hospital (DSH) payments to hospitals that do not require them. As we discussed in our Policy Analysis, many large hospital systems realize significant net revenues, offer costly executive compensation packages, and/or employ excessive administrative staff. States could reduce or eliminate Medicaid supplemental payments to these institutions without compromising the quality of patient care.
Finally, states should reexamine their relationships with Medicaid Managed Care Organizations. Under current Medicaid program constraints, MCOs generally lack the flexibility to realize the cost savings necessary to justify their substantial overheads. If the administration does not provide more flexibility, it may be best to phase out managed care arrangements and revert to fee for service. But, if the federal government creates the opportunity to really manage costs, MCOs may become an attractive option if state Medicaid agencies aggressively negotiate rates.
In the long term, the federal government should give the states full responsibility for Medicaid by eliminating federal Medicaid spending while concomitantly cutting federal taxes.
Enthusiasm over Medicaid reform may be premature. Republicans will have a very narrow House majority and so a budget reconciliation process that significantly reforms Medicaid may prove impossible. In that event, the administration could still make more modest regulatory reforms, such as ending the Biden administration’s ban on Medicaid beneficiary work requirements, but the opportunities for savings will be limited. Further, Medicaid regulatory changes will not impact the FMAP system, so the fiscal upside to state reforms will be limited. For now, state Medicaid administrators will have to monitor developments at the federal level to see what will be possible.