United States: Breaking Down Medicaid Financing

Last Updated: March 28 2018
Article by Thomas Barker

In the past several months, we have highlighted some fascinating Medicaid litigation against CMS in several US District Courts across the country. This litigation deals with the Medicaid disproportionate share hospital (DSH) requirements of section 1923 of the Social Security Act. But what we haven't focused on – until now – is how the DSH program fits into the overall Medicaid financing system. It's a topic of enormous complexity with a rich 35-or more year history. We try to break it down here.

To begin with: Medicaid is a jointly-financed program, with the costs split between the states and the federal government. States must come up with their share of program costs (in this post, we'll call it the "non-federal share"), and the federal government matches those costs by a percentage known as the federal medical assistance percentage, or FMAP. A state's FMAP bears an inverse relationship to its per capita income; the lower a state's per-capita income, the higher its FMAP, and the higher a state's per capita income, the lower its FMAP. Each state is guaranteed an FMAP of 50%, and it can go as high as 83%.

To make the math easy, let's say that the hypothetical state of New Columbia incurs $10 billion in expenditures for medical assistance and that its FMAP is 60%. The state is responsible for a non-federal share of $4 billion, and the federal government kicks in $6 billion.

Simple, right?

But this is Medicaid ... where nothing is simple.

Base Payments

For one thing, in New Columbia, what exactly constitutes that $10 billion? Well, a large portion of it is likely payments to providers – hospitals, nursing homes, pharmacies, physicians, and the like. Each state Medicaid plan sets a base payment for each provider. For example, a state may choose to pay hospitals based on their patients' diagnoses. Each hospital gets a fixed amount per discharge, based on each patient's diagnosis.

One thing about Medicaid, though: it is a notoriously bad payer. In many cases, hospitals can't recover their costs when they treat Medicaid patients. And this is an important public policy problem; low payments can result in poor access and subtle discrimination if hospitals discourage admissions of Medicaid patients. That's one reason that the Medicaid program authorizes some forms of "supplemental" payments that can enhance a hospital's base rate.

The Disproportionate Share (DSH) Program

In 1981, Congress focused on the problem of poor payments to hospitals. The timing was interesting: it was the beginning of the Reagan Administration, when Congress and the new Administration were trying to cut spending on social welfare programs. But in section 2173 of the 1981 Omnibus Budget Reconciliation Act, Congress directed state Medicaid plans to "take into account the situation of hospitals which serve a disproportionate share of low income patients." Social Security Act § 1902(a)(13)(E). Over the next decade, Congress gradually enhanced directives to states so that now, the requirements for DSH hospitals are precisely spelled out in section 1923 of the Act.

In a future post, we'll dig further into the mechanics of the DSH program. For right now, it's worth noting two features of DSH. First, it's the only reimbursement mechanism in the Medicaid program that expressly allows reimbursement for uncompensated care. As part of the Affordable Care Act, Congress changed the Medicare disproportionate share formula to account for uncompensated care, but Medicaid got there first. Second, the combination of Medicaid base payments plus DSH payments cannot exceed a hospital's costs – on a hospital-specific basis – in treating Medicaid and uninsured patients.

Other Supplemental Payments

CMS has also authorized other supplemental payments to providers. For example, some states make supplemental payments to teaching hospitals, pediatric hospitals, rural hospitals, and trauma centers. During the Obama Administration, CMS allowed states to make supplemental payments via the § 1115 waiver process to hospitals and other providers. These payments – which were called delivery system incentive reform payments, or DSRIP – are being phased out. Finally, the Medicaid managed care regulation that CMS issued in May of 2016 also authorizes some supplemental payments via Medicaid MCOs.

Where Does the Money Come From?

One might be forgiven for asking: where do states come up with their share of these federal matching payments? The answer is: a variety of sources. States can use their own revenues, of course – derived from income and sales taxes, property taxes, excise taxes and fees, etc. But states also rely on provider taxes, donations, certified expenditures and intergovernmental transfers as well to derive the state share of Medicaid expenditures. All have been a source of controversy over the years and Congress dramatically clamped down on the use of provider taxes in the early 1990s to prevent blatant gaming of the program. Like DSH, these financing mechanisms are worthy of their own blog post.

States are facing enormous financing challenges, and these increase in times of economic uncertainty and downturns. Ironically, it is in times of economic downturns that Medicaid is most important as more low income workers lose their jobs and with those jobs, their health care security. As a result, it's important for states to have flexibility in designing their Medicaid programs.

To view Foley Hoag's Medicaid and the Law blog please click here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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