Daniel Sutter: Just what the doctor ordered

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The U.S. House of Representatives recently passed the American Health Care Act (AHCA), an expansive bill which Republicans claim delivers on their promise to repeal and replace the Affordable Care Act. The AHCA proposes changes to Medicaid that should control costs, and could even improve the quality of care for low income Americans.

Medicaid is the joint state and Federal program providing health insurance for the poor and disabled. States operate the programs, with rules and over half of the funding provided by Washington. Since Medicaid’s founding in 1965, matching grants have doled out Federal dollars, with states receiving from $1 to $3 for each dollar spent (low income states get a better match).

Beginning in 2020 under the AHCA, states would receive a fixed dollar amount per beneficiary, for each of five beneficiary categories. Alternatively, states could elect to receive a block grant, meaning a fixed dollar amount not dependent on the number of enrollees.

Medicaid’s match has been open-ended, so that spending more on approved coverage brings in more Federal dollars. High income states have obtained more Federal dollars through generous optional coverage. But this means that for any total of Federal spending, fewer dollars are available to help poor states, compromising the quality of care. Matching grants have also produced billions of dollars of spending on services that Americans do not think are worthwhile.

This last point requires some explanation. People obviously do not agree on how much we should spend on Medicaid (or any program). Labeling spending “wasteful” often simply disguises personal opinion. I think that some Medicaid spending can be more validly called wasteful.

Suppose that a state considers spending $100 million on Medicaid. Given Alabama’s matching rate, our state legislators would need to appropriate about $35 million to cover $100 million of services.

Is this spending worthwhile? Most Alabamians are not on Medicaid, so if we think solely in terms of personal benefit, most of us would say no. But Americans give almost $400 billion annually to charity, and so clearly consider the well-being of others. We would need to think about how much we value providing medical care for those who can’t afford it. The thinking resembles deliberating about individually donating $100 to a charity; if we give the money, we effectively say that helping others is worth at least $100.

For the Medicaid example, Alabamians should consider exactly what procedures and persons will be covered, and whether we can afford the taxes. Let’s say we do this and come up with a value. If the value is at least $100 million, the spending is worthwhile.

Unfortunately, Medicaid’s matching grants encourage Alabamians to only worry if the services are worth the $35 million we must spend. Yes, we pay a share of Federal taxes, but separately from decisions about Medicaid. So we might approve spending which we believe yields only $50 million in value. Spending $100 million to produce $50 million in value, I think, counts as waste.

Block grants make states pay the full cost of extra spending. Consequently, Alabama and other states should only spend $100 million on Medicaid when the perceived value is at least $100 million.

The Congressional Budget Office estimates that the ACHA will reduce Medicaid spending by $880 billion over a decade. Would this eviscerate Medicaid? Spending today exceeds $500 billion annually, and is projected to rise, so we will still be spending roughly half a trillion dollars a year. More importantly, the cuts should target coverage that Americans judge to not be worth the cost. No state would be compelled to cut coverage for any person currently on Medicaid.

The first lesson of economics is that incentives matter. Medicaid’s open-ended matching grants create bad incentives under which states waste our tax dollars. The AHCA is a broad bill, and some elements may do more harm than good. But ending Medicaid matching grants would be a prescription for improvement.

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Daniel Sutter

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.

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