New Ways to Reduce Medicaid Spending While Protecting the Vulnerable

Republicans are using the reconciliation process—which allows them to pass bills with 50 votes in the Senate instead of 60—to renew a set of 2017 tax cuts. As part of the effort to reduce the deficit impact of that tax cut renewal, the House has instructed its Energy & Commerce Committee to come up with $880 billion of savings from 2025 to 2034. Because the Energy & Commerce Committee has jurisdiction over Medicare and Medicaid, much of the focus of their deliberations has been on trying to find savings in Medicaid, the health insurance program for those at or below the Federal Poverty Level.

The Medicaid debate of 2025 has been framed as a choice between balancing the budget and providing health care for the vulnerable. This framing is wrong. There are ways for Congress to provide better health coverage for the poor at a lower price. But to do that, you have to understand where the opportunities are for improvement. In this blog post, I’m going to introduce a few of these opportunities. (There are many more I’ll save for future posts.)

Medicaid spending is increasing at a extremely rapid pace

The first thing to know is that Medicaid spending is increasing at an incredibly fast pace. In 2020, the last year of the first Trump administration, state and federal governments combined spent $672 billion on Medicaid. In 2025, the first year of the second Trump administration, we are projected to spend $903 billion on Medicaid: an increase of $231 billion per year. 2025 will likely be the first year that we spend more on Medicaid than we spend on national defense. Put another way, if Congress somehow managed to freeze federal spending on Medicaid at 2024 levels for the next ten years, the savings would amount to $2.1 trillion.

The federal government’s Medicaid formula is biased in favor of wealthy states

As I noted above, the federal government and the states share Medicaid’s costs. But the formula that Washington uses to parcel out its share of Medicaid funds is biased towards wealthy states. In theory, Medicaid’s Federal Medical Assistance Percentage, or FMAP, for pre-Obamacare Medicaid enrollees is set up so that the feds supply a greater share of Medicaid’s costs in poor states, and a lower share in wealthy states. But as my Forbes colleague Chris Conover detailed in 2017, the formula is heavily biased in favor of wealthy states like D.C., Massachusetts, and Connecticut. This is because Congress established a floor of 50% for the federal government’s share of the costs. In theory, poor states like West Virginia should have an FMAP percentage of 74%, while wealthy states have an FMAP of 25%. But because the FMAP floor is 50%, wealthy states get a massive subsidy. Conover calculated that in 2017, New York received $1.35 in federal Medicaid spending for every $1.00 in federal Medicaid taxes its residents paid. Put another way, taxpayers in the other 49 states were paying to subsidize New York’s Medicaid program.

Republicans could fix this by reducing the FMAP floor to 40%, especially for states with large populations with equally large revenue bases such as California. (Currently, wealthy states hitting the FMAP floor of 50% are California, Colorado, Connecticut, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Washington, and Wyoming.)

On top of that, states have gotten very good at introducing accounting gimmicks to increase federal spending on their states’ Medicaid programs. Joseph Walker of the Wall Street Journal recently detailed how these money-laundering maneuvers work, usually through “taxes” on hospitals that are recycled back to the states through a quirk in the Medicaid program, enabling hospitals to enrich their coffers while suppling the same amount of care to patients. The Congressional Budget Office has estimated that phasing out these accounting gimmicks could reduce the deficit by as much as $668 billion from 2025–2034. (The reform, CBO estimates, would reduce Medicaid spending by $880 billion, but this reduction would be offset by $212 billion in increased subsidies for exchange- or employer-sponsored insurance.)

Another accounting gimmick states have used with great success is to…exaggerate a state resident’s income in order to enroll that individual on Obamacare’s Medicaid expansion, which has a 90% federal match in every state, or on the Affordable Care Act’s private insurance exchanges, where feds pick up 100% of the tab. States combine these tricks by paying for their 10% share of the ACA Medicaid expansion by using the provider taxes I described above.

A simple idea: Replacing Obamacare’s Medicaid expansion with exchange-based coverage

When you combine the states’ incentives for accounting gimmicks and FMAP arbitrage together, you get an incredible result. It now costs the federal government more to subsidize someone under Obamacare’s Medicaid expansion—despite the supposed 10% state match—than it does for the government to pay for coverage through the exchanges. In 2025, according to the Congressional Budget Office, it costs the feds $8,527 per enrollee per year to cover an able-bodied non-elderly adult in Medicaid, but only $6,714 to do so under the ACA exchanges.

What makes this a remarkable outcome is that when the CBO first estimated the cost of Obamacare, they made the exact opposite projection: that it would cost Obamacare $6,000 per year to cover people through Medicaid, and $9,000 per year to cover people through the exchanges. It was that lower estimated cost for Medicaid that led President Obama to propose using Medicaid expansion in the first place.

In other words, it’s possible to kill multiple birds with one relatively simple reform: replacing Obamacare’s Medicaid expansion with exchange-based coverage. If we swapped everyone in the Medicaid expansion into the exchanges, and factor in the fact that some ACA enrollees get a partial subsidy whereas Medicaid enrollees get a full ride, I estimate the federal government could save approximately $159 billion from 2025–34. The Fair Care Act, a bill based on a broader set of FREOPP reforms sponsored by Bruce Westerman, Jim Banks, and others, contains legislative language that could be adapted for this purpose.

Along with saving money, this reform would actually improve coverage and care for low-earners. Today, if someone’s income goes above 150% of the Federal Poverty Level in September, and below 100% of the FPL in October, she has to switch from exchange-based coverage to Medicaid-based coverage, with a whole new insurance plan and provider network, possibly forcing her to switch primary care doctors and other providers. This churn creates disruptions in care for people who are already struggling to get through life. Enabling low-earners to keep their plans, if they like them—what a concept!—would reduce that coverage disruption.

How to get to $880 billion in savings

Congress could pair this fix with another reform, placing responsibility for Medicaid eligibility determination with the federal Centers for Medicare and Medicaid Services (CMS). In this way, the feds could ensure that only those enrollees who are eligible for the higher federal match actually receive it.

Now, $159 billion in savings over 10 years isn’t enough to get you all the way to $880 billion. Phasing out the provider taxes is another essential step. And there are other options for health care savings that we will discuss in a future blog post. But I’ll leave it here for now.