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Why States Have a Huge Fiscal Incentive to Opt Out of Obamacare's Medicaid Expansion

July 13, 2012

By Avik Roy

Eight state governors have stated that they will take advantage of the recent Supreme Court ruling, allowing them to opt out of Obamacare’s dramatic expansion of Medicaid. Their actions have been dismissed by liberal columnists as mere partisan posturing. After all, argue the liberals, the federal government is picking up most of the tab, so what’s the problem? Don’t governors have every incentive to fleece the taxpayers of other states? It turns out, however, that this logic is flawed, and that the Medicaid expansion will cause state budgets to explode. Here’s why.

Prior to Obamcare, the Medicaid program was somewhat limited. All states who have signed up for the program (which, today, is all of them) are required to cover pregnant women and children younger than 6 with family income under 133 percent of the federal poverty level, and children aged 6-18 with family income under 100 percent of FPL. There are other eligible populations, such as people with disabilities, certain low-income parents, and low-income Medicare beneficiaries.

How federal and state governments share Medicaid’s costs

The federal government provides matching funds to states, to help them fund their Medicaid programs, using a formula called the Federal Medical Assistance Percentage, or FMAP. On average, Washington will spend $57 for every $43 that states spend on Medicaid. Over time, this has led many states—like New York—to substantially expand their Medicaid programs, because for every dollar they spend expanding Medicaid for their residents, taxpayers in other states are on the hook for an extra $1.33.

Obamacare takes these incentives to their logical conclusion. Under Obamacare, starting in 2014, everyone with income below 133 percent of FPL will be eligible for Medicaid. For the first three years of the expansion, federal taxpayers will pick up the full cost of the expansion. This 100 percent funding rate will phase down to 95 percent in 2017, 94 percent in 2018, 93 percent in 2019, and 90 percent in 2020.

Many states are rightly worried that, given federal budget pressures, Washington won’t continue to cover 90 percent of the costs after 2020. But because the new Medicaid enrollees will now be dependent on the government, states won’t be politically or legally able to roll back their programs, leaving state taxpayers with the bill. The Wall Street Journal aptly compares this to "a subprime loan with a teaser rate and balloon payment."

"Folks don’t really understand the struggle states are in," notes Dennis Smith, secretary of the Wisconsin Department of Health Services, who ran the federal Medicaid program under George W. Bush, in an interview with Julie Rovner. "States just don’t have the dollars, even with those enhanced federal match rates."

Medicaid "woodwork" is a hidden time bomb

But an even bigger problem for states is what’s being called the "woodwork effect." Harvard’s Ben Sommers and Arnold Epstein, in a 2010 article for the New England Journal of Medicine, estimated that only 62 percent of people who are eligible for Medicaid today have actually signed up for the program. As the below chart shows, participation rates are below 50 percent in large southern states like Florida (44 percent) and Texas (48 percent).

Here’s the kicker: this "woodwork" population, that was already eligible for Medicaid but not enrolled, won’t get the Obamacare 90-100 percent funding rate. Their expenses will be covered under the traditional FMAP percentage, meaning that states will be on the hook for 43 percent of the costs.

Nationally, Sommers and Epstein estimate that more than 9 million uninsured Americans were already eligible for Medicaid, pre-Obamacare, while failing to enroll. "Although only a portion of these people are likely to enroll in Medicaid" now that the program has been expanded, "adding them to the program’s rolls would nonetheless cost states billions of dollars in increased spending. Most affected would be states that currently have generous eligibility criteria for Medicaid, lower participation rates, a higher prevalence of low-income uninsured residents, or some combination of these factors."

It’s not just red states like Texas that face this woodwork problem. New York’s generous eligibility criteria, combined with a substantial woodwork population, means that the Empire State faces substantial additional costs if these unenrolled individuals sign up for benefits. And New York is one of the states that has been most supportive of Obamacare’s coverage expansion.

These woodworkers will find it much easier to sign up for Medicaid under the program’s new rules. "It won’t be an in-person visit, it won’t be a ’bring six forms of ID,’" University of Virginia’s Jeff Goldsmith told Rovner. "There will be an expedited—lubricated, if you will—process to get people onto the rolls, and I think that’s the part that’s giving state budget officers serious indigestion at this point."

Look before your governor leaps

The bottom line is that states—and taxpayers in those states—need to keep a close eye on this woodwork problem, and understand how much it would cost them if these unenrolled Medicaid-eligible patients sign up. As P.J. O’Rourke memorably put it, "If you think health care is expensive now, wait until you see what it costs when it’s free."

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