Hundreds of Billions in Medicaid Savings from Financing Schemes

The budget resolution approved by the House Budget Committee last week includes reconciliation instructions for the Energy and Commerce Committee to reduce deficits by at least $880 billion. While the committee has jurisdiction over many different areas – including several parts of federal energy and environmental policy and the sale of electromagnetic spectrum – much of the conversation around savings has been focused on Medicaid, the joint federal-state health insurance program that covers individuals with low-incomes and disabilities. 

The federal portion of Medicaid is projected to total $8.2 trillion from Fiscal Year (FY) 2025 through 2034. While the entire $880 billion of savings need not come from Medicaid, a substantial portion could form the basis of the committee’s deficit reduction – in fact, it would likely be nearly impossible to meet the target without including some Medicaid reductions. Although fundamental changes to the way Medicaid is funded – such as block grants, per-capita caps, or changes to the Federal Medical Assistance Percentage (FMAP) formula – would generate more than enough savings to meet the target on their own, policymakers need not adopt those changes in order to generate significant savings. As we have discussed before, several incremental policy changes could improve the integrity of the Medicaid program and prevent states from unfairly gaming Medicaid’s financing laws while also leading to savings.

Options to Reduce Medicaid Spending to Target State Financing Gimmicks

*Due to interactions among the policies, the savings amounts cannot be added together.

The Medicaid program is jointly financed by both the federal government and state governments and covers individuals with low incomes and/or disabilities. Due to the size and complexity of the program, states have found ways to exploit financing loopholes and shift the burden of funding the program from the states to the federal government. Many of these loopholes do nothing to improve quality, expand coverage, or increase benefits, and substantial savings could be accrued from limiting the use of these loopholes.

As we have discussed, states often tax providers up to 6 percent of providers' revenue and then use those funds to remit payments back to providers, reporting the payments to the federal government in the process to collect matching funds. In this scenario, neither providers nor states have actually expended new money on Medicaid but are still allowed to receive the matching funds, essentially inflating a state's Medicaid match. Currently, states are permitted to implement this cycle of taxing and paying up to a limit of 6 percent of providers’ revenue; entirely banning the use of this gimmick could save up to $610 billion through 2034, while reducing the limit to 2.5 percent could save $240 billion.

A similar financing scheme involves transferring funds from local governments to the state, a practice called intergovernmental transfers (IGT). Local governments, like counties, often operate hospitals or other medical providers and send IGTs to states to help fund the state’s share of Medicaid expenses. Later the state returns the funds to the county-run hospital, along with inflated federal matching funds that exceed what the hospital actually provided in Medicaid services to beneficiaries. We estimate that restricting IGTs could save $45 billion through 2034.

We have discussed how reforming one form of supplemental payment – state directed payments (SDPs) – could improve the integrity of the Medicaid program as well as reduce costs. States pay lump sum SDPs to groups of providers – such as hospitals, nursing facilities, or physicians – to help ensure they are fully compensated for serving patients with Medicaid in their communities. But over time, states have started using SDPs to increase the amount of money paid to providers beyond what it costs to serve Medicaid beneficiaries and often without strings attached, like quality or program integrity requirements. Payments for SDPs have ballooned from an estimated $26 billion a year as of December 2020 to approximately $110.2 billion in 2024. Without further action, the increases to SDPs are set to continue. Last year, the Biden Administration increased the upper limit on SDPs up to the amount that commercial insurance plans pay providers. Repealing the regulation would decrease the maximum amounts and save $135 billion through 2034.

Lawmakers could also address Disproportionate Share Hospital (DSH) payments. Cuts to DSH payments were scheduled by the 2010 Affordable Care Act (ACA), reflecting the fact that coverage increases in both Medicaid and the exchanges decreased uncompensated care, meaning the need for DSH payments declined. However, Congress has repeatedly delayed these cuts, and as a result the cost of offsetting these delays rises annually. Congress could instead let these cuts take effect, saving $55 billion through 2034.

Outside of these financing gimmicks, Congress should consider alternative savings in Medicaid that could save billions. For example, reducing FMAP for all administrative costs to 50 percent could save up to $80 billion and reducing FMAP for case management costs to 50 percent could save up to $5 billion over a decade. Restricting funding for services that do not provide medical care (such as those that provide for social determinants of health) could also save significant funds. 

In addition to Medicaid, Congress should consider common-sense savings to the Medicare program that would result in lower spending without cuts to beneficiaries. For example, instituting site-neutral payments could save $160 billion through 2034.

It is challenging to cut Medicaid spending, especially if trying to preserve the number of beneficiaries covered, access to medical care, and other policy priorities. But the changes described here, other offsets, and/or reductions in the size of the tax cuts they are helping to offset – could go a long way in crafting a fiscally responsible reconciliation package.