Feb 22, 2021

Medicaid is a joint federal-state program that provides health insurance targeted to lower-income recipients. The program plays a significant role in the U.S. health system, providing medical care for about 22 percent of the population.

As a key part of the safety net, Medicaid is designed to be countercyclical, meaning that it expands to meet rising needs during economic downturns when people lose their jobs and job-based health coverage. It also represents a major source of both revenues and expenditures in state budgets, since states receive a portion of funding for the program from the federal government. During the COVID-19 pandemic, increased enrollment in and additional federal funding for the program are significant drivers of uncertainty for state budgets.

Overview of Medicaid Financing

Each state’s Medicaid expenditures for healthcare services are matched by federal funds according to various formulas. The formula that governs the majority of government funding takes into account differences in per capita income among the states and is called the federal medical assistance percentages (FMAP). The FMAP ranges from a minimum of 50 percent in wealthier states such as California to 78 percent in Mississippi. The matching structure provides states with resources that automatically adjust for demographic and economic shifts, healthcare costs, public health emergencies, and natural disasters.

INTERACTIVE MAP

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In addition to funds governed by the FMAP, the federal government provides enhanced matching rates for select services, providers, or groups of beneficiaries. The most prominent example stems from the Affordable Care Act (ACA), which expanded the Medicaid program to cover individuals with incomes up to 138 percent of the poverty level; the federal government covers nearly all the cost of coverage for the expansion population.

Remaining Medicaid expenditures are referred to as the nonfederal share, and federal law requires that states finance at least 40 percent of their share of total Medicaid expenditures through state funds. The remaining 60 percent of the nonfederal share can come from “other state funds” including funding transferred from local governments or revenue collected from provider taxes and fees.

According to the National Association of State Budget Officers, in fiscal year 2020 (which for most states is July 1–June 30) the program cost a total of $647 billion, about $241 billion of which was the nonfederal share.

A majority of Medicaid funding comes from the federal government

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How Does Medicaid Affect State Budgets?

Medicaid’s role in state budgets is unique, since the program acts as both an expenditure and the largest source of federal support in state budgets. In 2020, total Medicaid expenditures (including federal matching funds) made up 28.6 percent of state budgets, on average, making it the largest category of spending. When considering only nonfederal funds, it comprised 19.6 percent of general fund expenditures, making it the second largest category of state spending after primary and secondary education.

Medicaid is typically the largest expenditure in state budgets

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Medicaid expenditures rose steadily from 2008 to 2018 as a percentage of total state spending, growing from 20.5 percent of state budgets to 29.3 percent. That growth reflects broader health spending trends and includes the effect of the ACA expansion in 2014. Nevertheless, Medicaid expenditures grew more slowly than other elements of state budgets — including education — and have declined slightly in the last two years.

Medicaid expenditures have increased as a percentage of state budgets

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States finance the nonfederal share of their Medicaid expenditures in large part through general revenues, which consist of revenue from sources including personal and corporate income taxes and sales taxes. States can also use funds raised from local governments and through taxes on healthcare providers to finance the nonfederal share of their Medicaid payments.

Those sources of Medicaid funding have received increased attention because states have used them to create complex financing mechanisms designed to maximize the amount of federal Medicaid funds coming to the states, thereby drawing down federal Medicaid funds without expending much, if any, state general funds.

What Impact Did the ACA Expansion Have on State Finances?

Prior to enactment of the ACA, few states covered non-disabled, non-pregnant adults without dependent children under Medicaid and the income limits for parents were significantly lower. States are allowed to forego the Medicaid expansion — as of early 2021, 12 states had chosen not to adopt it. In those states, the median income eligibility for parents is 40 percent of the poverty level (rather than 138 percent); the only state that extends Medicaid to adults without children is Wisconsin.

Under the ACA expansion of Medicaid, the federal government paid 100 percent of the cost of Medicaid expansion coverage from 2014 to 2016. The federal share dropped in subsequent years before settling at 90 percent in 2020 and each year thereafter. By comparison, the federal government pays between 50 and 78 percent of the cost of other Medicaid enrollees, depending on the state.

Research indicates that states that expanded their Medicaid coverage saw no significant increases in spending on Medicaid from state funds, and no significant reduction in state spending on education or other state programs as a result of the expansion. This is because the increased spending on the expansion population is completely or largely offset by savings in other areas, as states spend less on programs for behavioral health, corrections, public health, and uncompensated care. For example, a state might spend less on corrections as federal Medicaid dollars pay for a greater share of the inpatient hospital costs of inmates enrolled in Medicaid, or it might spend less on people with behavioral health needs as those costs would be covered under Medicaid and therefore subject to federal cost-sharing. In addition, the 38 states that have adopted expanded Medicaid through the ACA have seen markedly lower rates of uninsured people.

Federal funds make up an increasing share of Medicaid spending

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Furthermore, some evidence points towards the positive economic impact of Medicaid expansion as a result of the influx of federal funding, citing increased economic activity and redirected personal spending.

How Has COVID-19 Impacted State Medicaid Spending?

Medicaid enrollment rates have increased during the pandemic and related recession, increasing overall program spending at the same time that state tax revenues are falling. To help support Medicaid and provide fiscal relief, the Families First Coronavirus Response Act enacted a 6.2 percentage point increase in the FMAP if states meet certain requirements like ensuring continuous coverage for those enrolled as of March 18, 2020. That FMAP increase will remain in effect until March 31, 2021, though the Administration has indicated that it is likely to extend the deadline. As a result, much of the increased Medicaid spending resulting from the pandemic will fall to the federal government. Nevertheless, states are concerned about a period of time that comes after the cessation of the additional federal funding and before states are able to complete the eligibility verification that allows them to ensure that those who receive benefits are in fact eligible for the program (and thereby contain costs). States are anticipating future budget shortfalls, and many have announced or are considering policy changes that include hiring freezes, reduced healthcare provider reimbursement rates, and paused Medicaid coverage expansions.

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