Bring Medicaid Spending Under Control

Medicaid’s runaway costs are ravaging federal and state budgets. The program is expected to cost $338 billion in the current fiscal year, up $80 billion, or about 31%, in just the last three years.

The feds pay about 57% of the program’s costs, the states the rest. The Congressional Budget Office says that Medicaid will be one of the main causes of the looming explosion in federal spending over the next few decades. If current trends continue, federal Medicaid spending alone will grow from 1.5% of GDP today to about 4.5% by 2050.

State Medicaid spending has now grown to almost one-fourth of total state budgets—more than state governments spend on education.

Conservatives who believe in smaller government must lead reform of this program to stop these exploding costs. Fortunately, practical and feasible reforms have already been developed that would achieve precisely this.

Block Grant Approach

The model is the mid-1990s reform of the old Aid to Families with Dependent Children (AFDC) program. Following that model, federal Medicaid spending would be replaced by block grants to each state for their own programs for the poor. The state programs would have to be based on a work requirement for able-bodied recipients for the state to receive the federal funds.

After such reforms, the number of recipients in the old AFDC program dropped by over 50% nationwide, with states with the strictest work requirements reducing their rolls by close to 80%. The reforms succeeded because they changed the incentives for the states as well as the recipients.

As with Medicaid today, the states received a dollar or more in federal funds for each dollar they spent on the old AFDC program. So the states had the incentive to sign up more welfare recipients, bringing more federal money to the state.

But the reforms provide for a fixed block grant amount for each state, regardless of how much the state spends on its program. Any excess costs the states incur under their programs are now paid by each state alone. Moreover, any savings each state achieves under its program is kept by the state, freeing up state funds for other uses.

With these reversed incentives, the states moved aggressively to get recipients off welfare, and limit assistance to new applicants who were truly needy. The states were helped in this because work requirements for the able-bodied eliminated incentives to go on welfare. If you have to work anyway to receive assistance, then you may as well take a job in the private sector, where you can get raises and promotions over time.

These same reforms adopted for Medicaid would again produce major savings. Yet, even keeping total federal spending on the block grants at the current level of federal Medicaid spending, with no federal reductions for the state savings, would still save the Feds almost a trillion dollars over the next 10 years in increased Medicaid spending that would have otherwise occurred without the reforms.

After that first 10 years, the federal block grants could be limited to grow no faster than GDP. Medicaid would then not cause any future increase in federal spending relative to GDP.

As an added benefit, such Medicaid reform would also make Social Security reform involving large personal accounts more feasible. The enormous long run federal saving would be more than enough to cover the transition to large personal accounts as proposed by Rep. Paul Ryan (R.-Wis.) and Sen. John Sununu (R.-N.H.). Those large personal accounts, averaging roughly the employee share of the Social Security payroll tax, would in turn make Medicaid reform more feasible. With workers saving and investing in such large personal accounts over their lifetimes, they would each retire with several hundred thousand dollars in their accounts in real terms, close to a million or more for average, two-earner couples.

If conservatives want to reduce big government, rather than see it explode into full grown, old-fashioned, Scandinavian socialism, then such Medicaid reform needs to be an urgent priority.