July 14, 2012

The New Tug of War Over Medicaid

Tyler Cowen

Holbert L. Harris Chair of Economics at George Mason University

The new law is a carefully calibrated compromise between Medicaid extensions and subsidies for private insurance. Looking ahead, however, the chosen balance will tip one way or the other. Most of the paths forward are likely to prove unworkable, but one tenable option does exist, albeit very different from what was voted into law.

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The new health care law’s individual mandate — the provision pushing people to buy insurance, and upheld last month by the Supreme Court — has garnered huge attention. But about half the planned expansion of insurance coverage under the new law comes from another source entirely: growth of the Medicaid program.

Yet Medicaid has never been especially popular, and when its expanded role becomes more widely understood, it is likely to become less popular still.

Medicaid beneficiaries have limited means, and their low incomes usually translate into below-average political influence. The joint federal-state financing of Medicaid reflects its lack of broad support among the more affluent. Neither the federal government nor the states wish to pick up the entire tab, and many state governments — and not just Republican administrations — would prefer to spend more on education, roads and other programs. Yet the federal subsidy for Medicaid expenditures keeps many states locked in — the Feds usually pick up at least half the cost — at levels they would not have chosen on their own.

Those are signs of a program ripe for cuts, and yet the law is bringing a major Medicaid expansion. Will it stick? The additional federal subsidy is probably high enough to induce most states to expand Medicaid in the short run. (Under the Supreme Court decision, states can back out of the Medicaid expansion and lose only the new federal subsidy rather than all of their Medicaid funds.)

The greater likelihood is that, over time, American voters will rebel against Medicaid and dismantle the subsidies that keep the states locked in, and will prefer instead to spend the money on other programs.

Change might come soon. If Mitt Romney wins the presidential election, and if Republicans control both houses of Congress, they could turn Medicaid into a block grant program, where states can spend the money as they wish.

Even if President Obama is re-elected, some state governments will work hard to reduce the number of people covered by Medicaid. State officials know that limiting Medicaid will place more individuals in the new, subsidized health care exchanges, and that those bills will be paid by the federal government. The basic dynamic is that state and federal governments have opposite incentives as to how many people should be kept in Medicaid.

Of course, we don’t know who will win this tug of war. Along the way, we can expect state governments to threaten and bluff their way toward a smaller Medicaid obligation. The current state-level threats not to accept federal dollars to expand Medicaid are arguably part of that game. In any case, as the Medicaid expansion receives more publicity, voters may realize that they want to spend less money on it.

There are several potential outcomes. Along one possible path, Medicaid survives this added scrutiny and grows anyway, perhaps because the federal government takes over more of its funding or federalizes it altogether.

Unfortunately, Medicaid has some of the worst features of single-payer systems. Typically, a single-payer system will bargain down medical prices, thus adding to affordability, but at the risk of having long lines of patients waiting for care. As it stands now, though, the low reimbursement rates of Medicaid already lead to long lines, or an inability to find a good doctor altogether, while the higher reimbursement rates of Medicare and private insurance keep health care costs high.

Along another possible path, the subsidized private insurance market — a central feature of the new law — will gradually displace Medicaid. And, eventually, another feature of the law will grow more important: the excise tax on employer-supplied health insurance, which will cover increasing numbers of employer-based plans over time. This could be accompanied by a gradual migration out of workplace-based coverage. Over time, the system might evolve toward means-tested private insurance vouchers, with the insurance sold on exchanges rather than tied to employment.

That would have the unfortunate effect of channeling people into what will be the most expensive segment of health care coverage. That’s because the new law offers insurance subsidies to eligible incomes up to 400 percent of the current poverty line, a fiscal burden that would be unsustainable if it replaced Medicaid, which, with all its problems, is now the cheapest way to provide basic insurance coverage.

There is one way this might work: by limiting the subsidies for insurance. Note that the law itself mandates cuts if those subsidies exceed a certain percentage of gross domestic product by 2018. Most likely, the reform could not stop there, because the insurance cost burden for many Americans would feel intolerably high without the subsidies.

The next step, therefore, would lower costs by limiting the mandate to covering catastrophic conditions. Yet a further step would remove the mandate for noncatastrophic coverage, thus giving people more control over how much they want to spend on health care versus other priorities.

We would then have government-subsidized and mandated catastrophic insurance, and a freer market for other health care expenditures. We might even return to a health savings account approach on the noncatastrophic side.

That’s far from a perfect outcome, but it’s probably the most positive path that can be achieved. One problem is that mandates often don’t stay modest. Insurance mandates at the state level, for instance, have grown consistently, as various groups push to have their medical priorities reflected in law. A second problem is that voters may ask Congress to remove the subsidy limits planned for 2018, thus allowing costs to escalate. Still, we can hope for the best.

Over all, the new law is a carefully calibrated compromise between Medicaid extensions and subsidies for private insurance. Looking ahead, however, the chosen balance will tip one way or the other. Most of the paths forward are likely to prove unworkable, but one tenable option does exist, albeit very different from what was voted into law.