How does financing Medicaid work?

Part 1 of this series provided independent voters a basic overview of Medicaid. In Part 2, we discuss how Medicaid is financed.

Medicaid in the News

Just as a reminder, courtesy of the Congressional Research Service, "Medicaid is a means-tested entitlement program that finances the delivery of primary and acute medical services as well as ‘long-term services and supports’ (LTSS). Medicaid is a federal and state partnership that is jointly financed by both the federal government and the states."

We briefly mentioned in Part 1 that Medicaid is a partnership between the federal government and the states. However, we didn't cover financing in detail and would like to explore this topic further in this section.

Medicaid is in the news right now primarily because of the recently signed One Big Beautiful Bill Act (OBBBA). There are certainly changes to the program in the OBBBA, but breaking those changes down is beyond the scope of part 2 of this series. It's essential to discuss the numbers because National Healthcare Expenditures in 2023 totaled $4.9 trillion, accounting for 17.6% of GDP. The Medicaid share was $871.7 billion.

Now, Let's Talk About the Dollars and Cents

As a partnership between the federal government and the states, Medicaid is funded by both levels of government. According to research by the National Conference of State Legislatures (NCSL), "State Medicaid financing is an open-ended reimbursement categorical grant where the amount of federal funding fluctuates to cover actual program costs based on the number of program participants. These costs are shared between the federal and state governments pursuant to Section 1903 of the Social Security Act."

FMAP, or the Federal Medical Assistance Percentage, is a key component in understanding how this partnership functions. By design, the federal share of state Medicaid expenses is at least 50%. However, that does not mean that all states split their Medicaid costs 50/50. FMAP is dynamic and based on the state's per capita income compared to the national per capita income. Specifically:

𝐹𝑀𝐴𝑃=1−(((𝑆𝑡𝑎𝑡𝑒 𝑃𝑒𝑟 𝐶𝑎𝑝𝑖𝑡𝑎 𝐼𝑛𝑐𝑜𝑚𝑒2÷𝑈𝑆 𝑃𝑒𝑟 𝐶𝑎𝑝𝑖𝑡𝑎 𝐼𝑛𝑐𝑜𝑚𝑒2))×0.45)FMAP=1−State Per Capita Income2÷US Per Capita Income2×0.45

In simpler terms, this equation ensures that no state is responsible for more than half of its Medicaid spending. Additionally, states with per capita incomes that are lower than the national average receive progressively more assistance. Ten states have the statutory minimum FMAP rate of 50.00%, and Mississippi has the highest FMAP rate of 76.9%.

To draw down these matching funds, states must first make Medicaid expenditures. Once a state makes a payment on behalf of a beneficiary, the state can then draw down federal funds. This reimbursement operates in a non-traditional way, where states can draw down federal matching funds in real-time "through commercial banks and the Federal Reserve System against a continuing letter of credit certified by the Secretary of the Treasury in favor of the state payee." States get the added benefit of real-time reimbursement for the federal share. In the meantime, the Centers for Medicare and Medicaid Services (CMS) will reconcile the balance sheet each quarter using a combination of the estimate state’s supply and the actual expenditures submitted.

Is Medicaid an Entitlement Program?

You might think that because Medicaid is an entitlement program, it would be part of the mandatory spending side of the federal budget, like Medicare or Social Security, and program funds bypass the appropriations process. That would be incorrect. Technically, Medicaid is an appropriated entitlement program and undergoes the annual appropriations process each year. Importantly, even though Medicaid is an appropriated entitlement, it is not subject to the whims of the Appropriations Committee. Instead, the committee is bound by law to appropriate funds based on benefit eligibility and program criteria to project the following year's program needs.

For a state's share of Medicaid funding, that funding can come from a variety of sources. States can fund their share through general funds, other state funds, tobacco settlement funds, or even local government funds. This funding approach is another example of the laboratory of the states trying out different policy proposals to find what works best for their specific situations. While states have broad flexibility in funding their programs, there is a prohibition on using federal funds to cover the state's share of the program. States can tax all healthcare providers and long-term care service providers, regardless of their participation in Medicaid, and use the revenue to cover the state's share of the costs.

County or municipal hospitals, or any government provider that pays for eligible services, engage in what is called a certified public expenditure (CPE). The state can use the costs associated with CPEs to support the state’s share. Finally, intergovernmental transfers, transfers from local government entities to the Medicaid agency before costs are incurred, can also be used to support the state’s share.

Medicaid Expansion

Medicaid Expansion under the Patient Portability and Affordable Care Act (PPACA, commonly referred to as the Affordable Care Act or Obamacare) offered a different FMAP percentage for states that expanded Medicaid to cover able-bodied adults whose incomes are at or below 133% of the federal poverty level. For these "newly eligibles," the FMAP was initially 100% to be drawn down to 90% by 2020. Additionally, for states that had utilized waivers to cover many of the newly eligible individuals, there was a range of FMAP increases that would eventually settle at 90% by 2020. Finally, the American Rescue Plan Act added incentives for states that hadn't expanded Medicaid. These states were offered two years with a 5% FMAP increase to incentivize expansion during the COVID-19 Pandemic.

States are required to make regular payments to hospitals that see a higher proportion of low-income patients, as these patients are more likely to be uninsured or on Medicaid. These payments are called Disproportionate Share Hospital (DSH, pronounced 'dish') payments. DSH payments exist to recognize that by taking on more care of uninsured and Medicaid patients, hospitals are taking on more financial risk, as Medicaid reimburses at lower rates than Medicare or commercial insurance, while uninsured patients often yield no payments. Unlike other Medicaid expenditures, DSH payments are capped at the state's previous year's DSH payments or 12% of the state's total Medicaid expenditures.

Medicaid is a complex program, and no two state programs are the same. While the federal share is easily identified by statutory requirements for the Appropriations Committees to fund, the state share can vary in its sources as widely as the number of states' Medicaid programs. This flexibility leads to experimentation, as well as the sharing of best practices among states, all while allowing them to meet their unique needs.