If state officials administering Medicaid were given the option to give up substantial control in exchange for financial relief, it is likely that most would decline. They do not want to forfeit the power that comes with running such an important program. Medicaid is among the largest line items in every state’s budget and affects millions of households. Its size also gives the states influence over the operation of the broader health system.
But wanting a large say in Medicaid is not the same as being eager to pay for it, and therein lies much federal-state tension.
Medicaid is expensive. The federal government alone spent 2.3 percent of GDP on the program in 2023, up from 0.7 percent in 1990. A major factor is surging enrollment. In 2021, there were 85 million program participants, or 60 million more than was recorded in 1990.
From the beginning, Medicaid’s costs have been divided between the states and the federal government (in some states, local jurisdictions also play a role). The basic formula splits the bill using a comparison of state per capita incomes relative to the national average. The result is state-specific federal medical assistance percentages, or FMAPs, which tilt in favor of the jurisdictions with the lowest incomes. For instance, in 2024, the FMAP for West Virginia is 74.1 percent, while states closer to the national average, such as Rhode Island, get an FMAP of 55 percent. The law also established an FMAP floor of 50 percent for higher-income states like California and New York.
Medicaid law sometimes sets aside the standard FMAP. For instance, the Affordable Care Act (ACA) requires the federal government to pay 90 percent of the costs for the law’s enrollment expansion.
Across the entire program, the Congressional Budget Office (CBO) estimates the federal government pays for about 65 percent of total Medicaid spending, which was $806 billion in 2022 according to National Health Expenditure (NHE) data. The implied state share—35 percent—is not quite what it seems, though, as outlined in a recent report chapter from the Medicaid and CHIP Payment and Access Commission (MACPAC).
Beginning in the late 1980s, states discovered that they could ease the burden on their taxpayers by partially paying for Medicaid with tax assessments applied to hospitals and other service providers. The key is to pair the tax with an increase in Medicaid spending that fully or partially covers the costs of the tax payments. This two-step process sometimes must be accomplished through various indirect methods, such as intergovernmental transfers tied to publicly-owned health care facilities, to avoid running afoul of federal rules that have been promulgated in the years since these schemes first appeared.
As shown in the MACPAC chapter, these provider-centric financing methods are now a major factor in paying for Medicaid. Across all states, 17 percent of state-associated Medicaid spending is financed by “provider taxes and donations” and another 12 percent comes from transfers from local governments. Most of these payments can be traced back to health care providers (like public hospitals) that have the money returned with separate payments from Medicaid. Many of the schemes also involve lump-sum payments to providers that are severed entirely from specific patient services. The net effect is a win for the states because it reduces the need to impose unpopular general taxes on their citizens, and also a win for providers that receive higher Medicaid payments.
States remain creative in their search for ways to get around federal rules designed to prevent abuses. As recently highlighted by Bill Hammond in the Wall Street Journal, California seems to have struck gold with a new tax that applies only to managed care plans. The scheme is expected to produce billions of dollars in added federal payments to California even as the state tax triggering the new payments receives minimal resistance from the affected plans. The federal agency in charge of Medicaid, the Centers for Medicare and Medicaid Services, is signaling it will try to close off this option before it becomes a national trend (New York is eyeing a similar maneuver).
MACPAC seems aware of the potential for a backlash if these practices get out of hand. It recommends changing Medicaid law to require states to submit annual reports detailing precisely the sources of their required shares of program costs. With more clarity on what is taking place today, the next step would be to close off the worst abuses.
That won’t be easy though, in part because the battle lines aren’t partisan. State officials of both parties tend to agree that the best combination in Medicaid is maximum administrative flexibility and an unlimited federal checkbook.
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