Medicaid Once More: Can We Please Get Serious?

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Yesterday’s Wall Street featured a scathing editorial on Arizona Governor Janet Brewer’s emphatic call for the state’s participation in Obamacare’s Medicaid expansion. Arizona, you’ll recall, was among the states that litigated against the Medicaid expansion in NFIB v. Sebelius, and it’s supposed to be ground zero for resistance to federal overreach in general (e.g., on immigration).  However, under a “provider tax” scheme cranked up by the health care provider lobby (and practiced by most other states), Arizona has figured out a way to make money on federal Medicaid grants. Too good to pass up. Notes the Journal:

Ten other GOP Governors have rejected Mr. Obama’s Medicaid bribe, with another 20, Democrats and Republicans, undecided. Twenty are expanding, including Republicans Brian Sandoval of Nevada, Susana of New Mexico, Jack Dalrymple of North Dakota and even, on Monday, Ohio’s John Kasich. Thus does modern government create the carrots and sticks of ever-larger government.

Prediction: the undecided and no-thank-you’s can hold out for at most another two or three years. They, too, will succumb to Medicaid’s pernicious incentives.

At the risk of repetition and I-told-you-so: the rush for the federal fleshpot illustrates, yet again, that there is something badly wrong not only with Medicaid but also with the states’ and their cheerleaders’ supposed litigation “victory” in the Obamacare litigation. The states persuaded the justices that the planned Medicaid expansion was unconstitutionally “coercive” because it threatened non-participating states with a withdrawal of all federal Medicaid funding, including funding for existing programs. Given the fantastic sums at stake, argued the states,  no state could afford to say “no.” Seven justices agreed and effectively re-wrote the statute: states must be permitted to keep existing funding regardless of whether or not they agree to expand the program.

That decision marginally improved the states bargaining position vis-à-vis the federal government. The feds are mindful of that: they will let expansion states get away with absolutely any strategic abuse and gold-plating until the last hold-out has cried “uncle.” Then, they will tighten the strings. We could and would have had that result without all the commotion and litigation, quite probably at a cheaper price.

The mistake lies in thinking about the Medicaid problem—and the conditional grants problem in general—as a “coercion” problem. It’s nothing of the kind; it’s an incentive problem. To put the problem in constitutional terms:

Conditional grants programs, the Supreme Court says, are “in the nature of a contract.” They’re permissible on two key conditions: (1) states must have a choice to participate (they can’t be commandeered); and (2) the grant conditions must be cleared stated at the front end. That’s sensible as far as it goes, but it misses two incentive problems. First, all federal grant problems create a fiscal asymmetry: taxpayers in non-participating states will pay “their” share of the program one way or the other. The state as a state can say “no” only to the proceeds, not to its taxpayers’ contributions. Second, funding programs create powerful lock-in effects. Political and fiscal considerations make it well-nigh impossible to exit or even limit the programs. Every unspent or cut state dollar is a federal dollar (or some fraction or multiple thereof) left on the table.

The half-baked NFIB decision did nothing to break these nasty incentives. Neither will block grants. To fix the programs, you have to fix the fiscal asymmetry on the funding side. Here’s how that might be done:

Medicaid is somewhere around eight percent of federal expenditures (growing fast). For taxpayers in non-participating states, let’s rebate those eight percent against their income tax returns. Each state could then freely decide whether it wishes to participate in the federal program or rather exit, let its taxpayers keep the rebate, and run a comparable program—presumably on a smaller scale—on its on nickel.

Would that reform wring all the crazed incentives, cross-subsidies, and fiscal illusions out of Medicaid? No, but it would go a long way. Would all states exit? Probably not. But a few might; and in many more, we’d get a more realistic and informed debate about the program—not some burble about “coercion,” but a debate about the costs and benefits of the transfer state.

Wouldn’t that be nice.