(Archived document, may contain errors)

Special Report to the House Subcommittee on Human Resources and Intergovernmental Relations

No. 22 2/8/96

THE COSTS TO THE STATES OF NOT FUNDAMENTALLY REFORMING MEDICAID.

William W. Beach Visiting Fellow in Tax Analysis

"We must, however, continue to express our concerns about mandated Medicaid expansions. States do not have the luxury of operating a budget deficit. Every mandated dollar that we spend is a real dollar that has to be taken from another program." -Govemor Bill Clinton of Arkansas, June 7, 1990 Much of the debate between Congress and the President on reforming Medicaid, the health care pro- gram serving the nation's poor, has transpired without adequate attention paid to the effect of the pro- gram on state finances. If -significant reforms in Medicaid are not enacted, states will face a heavy in- crease in spending and a rise in the proportion of their projected revenues that must be dedicated to the program. And because the rate of growth in state Medicaid spending will exceed the rate for total state spending, the states will be forced either to increase taxes or to divert money from other programs, such as education and crime control.

Medicaid is a state-administered program that operates under federal guidelines. Federal and state governments jointly fund the program. Federal reimbursement to the states is based on a statutory for- mula designed to give a higher matching rate to states with lower per capita incomes. Matching 'rates for these services range from 50 percent to 83 percent and are adjusted annually. The cost of Medicaid to the federal government has been growing at double-digit rates in recent years. The Congressional Budget Office (CBO) projects that annual federal Medicaid costs will almost double by 2002.

Annual Federal Medicaid Costs (Millions of Dollars)

Fiscal Year Annual Federal Medicaid Costs 1995 $89,216 1996 97,292 1997 107,021 1998 118,060 1999 129,631 2000 140,116 2001 156,600 2002 172,800 7-Year Total 1,010,736 Source: Congressional Budget Office (December 1995)

Although the financial impact on the federal government of generally unrestrained Medicaid growth is alarming enough, the future impact on states could be even more severe: a remorseless growth in the share of their own projected revenues going to Medicaid that forces them either to raise taxes in order to maintain spending for other programs or to reduce state expenditures for non-Medicaid programs. States can make some cost-saving reforms in the program, but only subject to federal rules requiring that certain levels of coverage (entitlements) be provided to certain populations. To examine the probable future budget impact on states, The Heritage Foundation analyzed the likely trend of total Medicaid spending using certain assumptions to forecast the state share of Medicaid pay- ments for the period 1995 through 2002.2 This analysis resulted in two sets of findings: first, the addi- tional costs to- the states if no changes are made in the Medicaid program and, second, the additional costs stemming from President Clinton's proposed "per capita cap" reforms in Medicaid. Hence, the fol- lowing charts and tables project the future state-level Medicaid burden if Congress either does nothing or adopts the President's proposal. These projections of state spending incorporate expected changes in state economic activity, in the size of the eligible population, and in the trend of federal Medicaid trans- fers to the states. These forecasts of future state Medicaid spending were prepared jointly by Heritage and Wharton Econometric Forecasting Associates (WEFA), a nationally recognized economic consulting firm that maintains detailed models for each state. For 47 states, WEFA found a significant relationship between changes in historical Medicaid spending and fluctuations in the states' economic activity and Medicaid- eligible populations. In four cases, however, the relationship was sufficiently weak that WEFA -simply projected the historical trend in spending; these states are North Dakota, South Carolina, Utah, and Wyoming. Table I shows the additional state revenues or program cuts needed if the states are to meet their projected Medicaid expenditures.

Estimated Additional Costs Without Reform

Between 1995 and 2002, if no reforms are enacted that address the costs of entitlements and the com- position of covered groups, states will have to spend $688 billion of their own money on Medicaid. To- tal state spending over this period is projected to be $1,700 billion, of which $ 1,011 billion will be sup- plied by the federal government (if CBO's forecasts of federal spending Medicaid Expenses Paid With State Revenues,, 1990-2002 prove correct). The Billions of Dollars difference between $120 federal and state spending on Medi- $100 caid means that states will have to N $80 devote an average of 8 percent of their 1 $60 non-federal reve- nues to the program. $40 Among the hardest hit states, Pennsylva-:T $20 - nia will have to de- vote 17 percent of its revenues to the 1990 1991 1992 1993 1994 1995 1996 1 "7 1998 1999 2000 2001 2002 health cam program. Source: 1990-1994 data from WEFA fbrecasts fbr 1995-2002 from WEFA and Heritage calculations. As Chart I shows, the amount of state Medicaid payments alone steadily increases between 1995 and 2002. In 1990, the states spent just $32 billion of their non-federal funds on Medicaid. These unfunded payments are pro- jected by our analysis to grow to $69 billion by 1995 and $104 billion by 2002. In other words, the Medicaid amount : @ " Chart paid by the states will have increased Relationship Between Total Expenditures and by 225 percent over Medicaid Spending the 12-year period between 1990 and 35% Percentage Change 2002. 30 State Medicaid Spending Some individual states will be particu- 25 larly hard hit. For ex- 20 ample, California will need to raise 15 $18 billion in new revenues or in 10 41- budget cuts to pay 5 Total State Spending 0 its part of Medicaid growth between 1996 and 2002. 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Similarly, New York Source: WEFA Trend Forecast. July 1995 will need to raise $17.3 billion; Florida, $12.9 billion; Pennsylvania, $11.6 billion; and Texas, $7.2 billion. If these states choose to raise taxes to meet their Medicaid obligations, then California will have to increase the average taxpayer's bill by $246 per year; New York, by $370; Florida, by $374; Pennsylvania, by $362; and Texas, by $177. This rapid growth in the states' Medicaid share is reflected in the annual percentage change in state- level Medicaid spending as compared with total state spending, which includes support of such things as education, crime control, and transportation infrastructure (see Chart 2). The Heritage analysis antici- pates 1995 state Medicaid spending to grow at a rate of 7.5 percent, while total state spending should grow at a 6.4 percent rate. This higher rate of change for Medicaid means that states either must raise taxes or must take funds away from other state programs. The forecast suggests that state spending on Medicaid will continue to keep pace with total spending. Over the forecast period (1995-2002), Medi- caid spending is projected to grow at an 8.4 percent rate, while total state expenditures are expected to grow by an average of 5.8 percent.

Fiscal Effects of the "Blue Dog" Democrat Plan The Democratic "Blue Dog" plan to reform the federal Medicaid program, the principal elements of which have been advanced by the Clinton Administration in its seven-year budget proposal, would in- crease the federal fiscal burden on the states by an estimated $47.4 billion over the next seven years. This new fiscal burden has been described as "one of the biggest and most expensive unfunded [fed- eral] mandates evee'3 and, over the seven-year period 1996-2002, would amount to $4.4 billion in Cali- fornia, $3.7 billion in Florida, $3.4 billion in New York, $3.2 billion in Pennsylvania, and over $2.9 bil- lion in Texas. Overall, this unfunded federal mandate would exceed $1 billion in 16 states. First proposed by a group of Democratic House members earlier this year,4 this plan would further challenge the fiscal resources of the states by maintaining all the existing program mandates which the federal government imposes on the states5 while simultaneously reducing the federal government's con- tribution through the mechanism of a "per capita cap" on the federal share of the program. Under the "Blue Dog" plan, the per capita cap limits the amount of federal medical assistance that states would re- ceive for each 'Medicaid recipient. Any expenses that exceed this limit would be the sole responsibility of state and local taxpayers. Because the full array of federal Medicaid mandates would remain in ef- fect, states would not be able to offer innovative, and less expensive, health care options to Medicaid re- cipients. Overall, the per capita cap would shift an estimated $47.4 billion of mandated Medicaid spend- ing from the federal to state governments over the next seven years. States would probably respond to this shift in one of three ways: 1) enact dramatic tax increases; 2) reduce state spending on education, infrastructure, law enforcement, and other important state func- tions; or 3) some combination of the above. Indeed, the proliferation of Medicaid mandates during the late 1980s and early 1990s has already forced the states to reallocate their resources to Medicaid. Ac- cording to the National Association of State Budget Officers, Medicaid spending has doubled from ap- proximately 10 percent to 20 percent as a share of overall state spending since 1987.6

Technical Assumptions The Heritage Foundation and Wharton Econometric Forecasting Associates used state models of eco- nomic activity to develop state-by-state estimates of Medicaid spending and the additional funds states would need to meet their future Medicaid obligations. Our baseline estimates assume no change in current Medicaid eligibility rules and allowed federal Medicaid transfers to the states to grow at the rates implied by the history of this program. Total Medi- caid program spending in each state is a function of the state's historical Medicaid expenditures and ex- pected demographic and economic change. We used this as the basic structure for future Medicaid spending. These baseline forecasts of state Medicaid spending were adjusted upwards by Heritage to reflect the higher federal expenditures on Medicaid projected by the Congressional Budget Office. The difference between our initial baseline for total (federal and state) spending and the CBO adjusted estimates is $58 billion over the period 1996 to 2002. We distributed the state portion of this additional amount by each state's annual percentage of total national Medicaid spending for each of the seven forecast years fol- lowing 1995. Estimates of additional taxes that would be raised to meet each state's additional funding requirement were calculated by dividing the additional funding requirement by the estimated number of taxable individual federal income tax returns in 1995.

Note: Estimates include new CBO economic assumptions from December 12, 1995.