Medicaid Financing

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Combined federal and state spending on the Medicaid program currently exceeds $300 billion
each year. It is the largest or second-largest item in state budgets, and is second only to Medicare
in terms of federal spending on health care. In 2007, Congress placed temporary moratoriums on
the implementation of four controversial regulations that anticipate large reductions in federal
spending for Medicaid. A war supplemental spending bill enacted in 2008 (P.L. 110-252) further
delayed implementation of these regulations and two others until April 1, 2009. Most recently,
debate has focused on the downturn in the U.S. economy and whether increases in the federal
medical assistance percentage (FMAP, which determines the federal share of most Medicaid
costs) should be included as part of a stimulus package. Stimulus bills containing a temporary
increase failed a motion to proceed in the Senate (S. 3604) and passed the House (H.R. 7110) in
September, and another was introduced in November (S. 3689). Over 10 years, the bills would
increase Medicaid spending by an estimated $19.6 billion, $14.7 billion, and $37.8 billion,
respectively. Additional legislation that would provide a temporary Medicaid FMAP increase was
introduced earlier in 2008 (S. 2586, H.R. 5268, S. 2620, S. 2819).

Financing for the Medicaid program is shared by the federal government and the states. States
incur Medicaid costs by making payments to service providers (e.g., for beneficiaries’ doctor ¹
visits) and performing administrative activities (e.g., making eligibility determinations). They
then submit quarterly expense reports in order to receive federal reimbursement for a share of ²
these costs.
The federal share for Medicaid administrative costs does not vary by state and is generally 50%.³
The federal share for most Medicaid service costs is determined by the federal medical assistance
percentage (FMAP), which is based on a formula that provides higher reimbursement to states ⁴
with lower per capita incomes relative to the national average (and vice versa). FMAPs have a
statutory minimum of 50% and maximum of 83%. Some Medicaid services receive a higher
federal match, including those provided through an Indian Health Service facility, to certain
women with breast or cervical cancer, for family planning, or under the Qualifying Individuals ⁵
(QI) program that pays Medicare Part B premiums on behalf of certain Medicaid beneficiaries.
Exceptions to the FMAP formula have been made for certain states and situations. For example,
the District of Columbia’s Medicaid FMAP is set in statute at 70%, and the territories (Puerto
Rico, American Samoa, the Northern Mariana Islands, Guam, and the Virgin Islands) have
FMAPs set at 50%. Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-
27), all states received a temporary increase in Medicaid FMAPs for the last two quarters of
FY2003 and the first three quarters of FY2004 as part of a fiscal relief package. In addition, the
Deficit Reduction Act of 2005 (P.L. 109-171) allowed an increase in the federal share for certain
Medicaid and State Children’s Health Insurance Program (SCHIP) costs in the wake of Hurricane
Katrina.
One goal of the FMAP formula is to narrow differences in states’ ability to fund Medicaid
services, defined in some studies as a state’s total taxable resources (a specific measure produced
by the U.S. Department of Treasury) relative to its number of low-income people. Although the ⁶
Government Accountability Office (GAO) and others have found that it does not always do so, a
primary obstacle to altering the FMAP formula is the potential creation of winners and losers
among states that fare well under the current system and those that would do better under another.
In FY2006, Medicaid spending on services and administrative activities in the 50 states and the
District of Columbia totaled $314 billion, with a federal share of $179 billion and a state share of ⁷
$135 billion. As with overall health care spending, Medicaid is expected to consume a growing

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share of the U.S. economy in the future, mostly because of increases in costs per person (driven ⁸
by medical technology and other factors) and to a lesser extent because of population aging.
Federal spending levels for Medicaid are largely determined by the states, which generally
receive open-ended funding as long as they operate their programs in compliance with federal
law. Exceptions for which federal funding is capped include the territories, disproportionate share
hospital (DSH) payments made to hospitals serving a large number of Medicaid or low-income
patients, the QI program mentioned earlier, and waivers that allow states to operate outside of ⁹
normal federal rules (which are subject to aggregate budget caps or cost-per-beneficiary caps).
The annual appropriations process also provides an opportunity for Congress to place limitations
on specified activities, including the circumstances under which federal funds can be used to pay
for abortions.
Unlike Medicare and Social Security, federal funding for Medicaid comes entirely from general
revenues, rather than a dedicated account or trust fund within the U.S. Treasury. It represents a
growing portion of the federal budget, having increased from 2% of federal outlays in FY1975 to ¹⁰
an estimated 7% in FY2008.
States generally control their own Medicaid spending levels by altering eligibility, covered
services, cost-sharing and premiums paid by beneficiaries, provider reimbursement rates, and ¹¹
other aspects of the program within broad federal guidelines. Funding for the nonfederal (i.e.,
state) share of Medicaid costs comes from a variety of sources, but at least 40% must be financed
by the state, and up to 60% may come from local governments. In state fiscal year (SFY) 2006,
states reported that about 80% of the nonfederal share of their Medicaid costs was financed by
state general funds (most of which are raised from personal income, sales, and corporate income

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taxes). The remaining 20% was financed by other state funds (including local funds, provider ¹²
taxes, fees, donations, and assessments, and tobacco settlement funds).
Although financing for the Medicaid program is a shared responsibility, GAO and others have ¹³
reported on mechanisms used by states to inappropriately increase their federal share. For
example, a state with a 50% FMAP might make a $10 million payment to a hospital that returns
$9 million to the state, netting $1 million for the hospital and $4 million for the state at the ¹⁴
expense of the federal government. Limits have been placed on these financing mechanisms
over the years, primarily through changes to DSH and upper payment limit (UPL) rules that allow
states to make supplemental payments to certain providers, as well as intergovernmental transfer
(IGT) and provider tax and donation rules that allow them to collect revenues from providers.
Medicaid is the largest or second-largest item in state budgets, depending on how it is measured.
Looking at SFY2006 expenditures from all revenue sources (including federal funds), Medicaid
made up the largest share (21.5%), closely followed by elementary and secondary education
(21.4%). Looking only at SFY2006 expenditures from state revenue sources (general, other state,
and bond funds), elementary and secondary education made up the largest share (24.9%), ¹⁵
followed by Medicaid (13.0%). State-funded Medicaid spending as a share of state-funded total
spending has more than doubled since SFY1989 (when it was 6.3%), with major growth in the
early 1990s fueled by an economic downturn, high growth in medical costs, and the use of
financing mechanisms described earlier that can effectively recycle federal funds into state ¹⁶
funds.
A number of controversial regulations affecting Medicaid financing and federal funding have ¹⁷
been proposed or finalized recently, including some that would:
• restrict the use of IGTs between state governments and public providers for ¹⁸
purposes of Medicaid, as well as UPL payments to these providers;

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• align the Medicaid definition of outpatient hospital services more closely to the ¹⁹
Medicare definition for purposes of calculating Medicaid UPLs;
• implement Medicaid provider tax provisions in P.L. 109-171 and P.L. 109-432 ²⁰
and clarify rules for approving these taxes;
• clarify that graduate medical education (GME) payments are not federally ²¹
reimbursable under Medicaid;
• restrict federal reimbursement under Medicaid for certain school-based ²²
administrative activities and transportation services;
• implement a Medicaid targeted case management (TCM) provision in P.L. 109-²³

171 and clarify rules for claiming these services;

• clarify what may be claimed as Medicaid rehabilitation services;²⁴ and
• implement Medicaid prescription drug provisions in P.L. 109-171.²⁵
Some of these regulations anticipate large reductions in federal spending for Medicaid. For
example, the final rule on IGTs alone was expected to result in federal savings of $3.87 billion ²⁶
over five years by restricting states’ use of certain financing mechanisms. In four cases (IGTs,
GME, school-based administration and transportation, rehabilitation), Congress placed temporary
moratoriums on implementation until May or June of 2008. A war supplemental spending bill
enacted at the end of June (P.L. 110-252) further delayed implementation of these regulations and ²⁷
two others (provider taxes and TCM) until April 1, 2009.
Another area of concern for Medicaid is the U.S. economic downturn, which has the potential to
increase enrollment at a time when state revenues might be stagnant or falling. Stimulus bills
containing a temporary Medicaid FMAP increase failed a motion to proceed in the Senate (S.
3604) and passed the House (H.R. 7110) in September, and another was introduced in November
(S. 3689). Over 10 years, the bills would increase Medicaid spending by an estimated $19.6 ²⁸
billion, $14.7 billion, and $37.8 billion, respectively. Additional legislation that would provide a

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²⁷^O^t^he^r^le^gⁱ^s^l^a^tion^{to f}^u^r^t^he^r^de^la^y^im^plem^eⁿ^ta^{tion w}^a^s^pa^s^s^e^{d b}^y^the^H^ous^e⁽^H^.R^.⁵⁶¹³⁾^,^pa^s^s^e^{d by}^the^Se^na^te⁽^S^.
¹²⁰⁰⁾^,^intr^od^uc^e^dⁱⁿ^b^o^t^h^c^h^a^m^be^r^s⁽^H^.R^{. 4}³⁵⁵^{, S}^.²⁴⁶⁰^{, H}^.^R^.⁵¹⁷³^,^S.²⁵⁷⁸^{, S.}²⁸¹⁹⁾^,^aⁿ^{d a}^c^k^now^le^dg^e^d^w^{ith de}^fⁱ^c^it-
^ne^utr^a^{l r}^e^s^e^r^v^e^f^unds^{in t}^h^e^H^o^us^e^,^Se^na^te^{, a}ⁿ^d^c^onf^e^r^eⁿ^c^e^a^g^r^e^emeⁿ^{t v}^e^r^s^ions^of^the^FY²⁰⁰⁹^b^udg^e^t^r^e^s^o^luti^on
^(H.^C^oⁿ^.^Res.³¹²^,^S^.^Con^.^Res.⁷⁰^,^an^d^H.^Rep^t^.¹¹⁰^-⁶⁵⁹^acco^m^p^an^yⁱⁿ^g^S^.^Con^.^Res.⁷⁰^).
²⁸^Fo^r^d^e^{tails, see CRS Rep}^o^{rt RL}³²⁹⁵⁰^,^Medⁱ^c^aⁱ^d^:^T^h^{e F}^e^d^e^ra^l^Medⁱ^ca^l^A^ssi^st^aⁿ^{ce P}^e^rcen^t^a^g^e⁽^F^M^A^P⁾^{, by}^A^p^ril
^Gr^a^d^y.

temporary Medicaid FMAP increase was introduced earlier in 2008 (S. 2586, H.R. 5268, S. 2620,
S. 2819).
FMAP increases would reduce the amount of state funding that is required to maintain a given
level of Medicaid services. For states that are contemplating cuts to Medicaid (which can take
many forms), increased federal funding could enable them to avoid those cuts. For others, the
state savings that result from an FMAP increase could be used for a variety of purposes that are ²⁹
not limited to Medicaid.
^A^p^r^{il Gr}^ad^y
^Aⁿ^a^l^ystⁱⁿ^H^e^a^l^t^h^Ca^r^e^Fi^na^ncⁱ^ng
^ag^rad^y^@^c^r^s^.l^oc.g^ov^{, 7-}⁹⁵⁷⁸

²⁹^Ibid^.