Although every economic downturn reflects varied economic circumstances at the national level and among states, evaluations of prior federal fiscal assistance strategies have identified considerations to guide policymakers as they consider the design of future legislative responses to national economic downturns. These include timing assistance so that aid begins to flow as the economy is contracting and targeting assistance based on the magnitude of the economic downturn’s effects on individual states. To be effective at stabilizing state funding of Medicaid programs, assistance should be provided, or at least authorized, close to the beginning of a downturn. Additionally, to be efficient, funds should be targeted to states commensurate with their level of need due to the downturn. States that experience greater stress in their Medicaid programs—due to increased enrollment or decreased revenues—should receive a larger share of aid than states less severely affected. In addition, economists at the Federal Reserve Bank of Chicago have described the ideal countercyclical assistance program as one having an automatically activated, prearranged triggering mechanism that could remove some of the political considerations from the program’s design and eliminate delays inherent in the legislative process. Past economic downturns hampered states’ ability to fund their Medicaid programs, as Medicaid enrollment increased and tax revenues declined. Medicaid enrollment increases during and after national economic downturns, when the number of people with incomes low enough to qualify for coverage rises as state economies weaken. States also experience declines in tax revenues as a result of declines in wages, salaries, and consumer spending. Most, if not all states are affected by national recessions, although the timing and duration of state economic downturns can vary. States have different industry mixes and resources, which can affect when they enter an economic downturn and when they recover. Therefore, some states may enter an economic downturn in the early stages of a national recession, while other states enter long after the recession has set in. The timing and depth of state economic downturns affects their ability to maintain their Medicaid programs. Under the regular FMAP, the federal government pays a larger portion of Medicaid expenditures in states with low per capita income (PCI) relative to the national average, and a smaller portion for states with higher PCIs. To provide states with fiscal relief and to help states meet additional Medicaid needs during the 2001 and 2007 economic downturns, Congress passed legislation temporarily increasing the FMAP for states. The FMAP is a readily available mechanism for providing temporary assistance to states because assistance can be distributed quickly, with states obtaining funds through Medicaid’s existing payment system. The Recovery Act was the second time Congress temporarily increased the FMAP to provide fiscal relief to states during a national economic downturn. Following the 2001 recession, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (Reconciliation Act) provided states $10 billion in assistance through an increased FMAP from April 2003 through June 2004. In August 2010, Congress extended the increased FMAP provided by the Recovery Act by providing states with an additional $16.1 billion in assistance from January through June 2011. In March 2011, we reported that overall the Recovery Act funds were better timed for state Medicaid funding needs than were funds provided following the 2001 recession; assistance began during the recession while nearly all states were experiencing Medicaid enrollment increases and revenue decreases. Nonetheless, 19 states implemented or proposed eligibility restrictions in response to the economic downturn prior to the passage of the Recovery Act some 15 months after the beginning of the national recession as identified by NBER. In order to be eligible for Recovery Act funds, these states had to reverse the restrictions on eligibility to come into compliance with the Recovery Act’s maintenance of eligibility requirements. The Recovery Act formula incorporated three components for calculating the increased FMAP: a hold-harmless provision that maintained each state’s regular FMAP to at least its highest rate since fiscal year 2008; an across-the-board increase of 6.2 percentage points; and an additional increase in each state’s FMAP based on a qualifying increase in the state’s rate of unemployment. In our March 2011 report we also reported that the unemployment-based component of the Recovery Act formula targeted assistance to states with greater Medicaid enrollment growth as indicated by increases in their unemployment rate. However, the across-the-board increase and the hold-harmless components did not distinguish among states that experienced varying degrees of increased unemployment. (See app. III for more information about the Recovery Act’s across-the-board and hold-harmless provisions.) Furthermore, none of the Recovery Act provisions distinguished among states with varying degrees of reduced revenue in the allocation of assistance. The prototype formula we outlined in our March 2011 report provides a more targeted approach than the increased FMAP formula used in the Recovery Act. It also improves the responsiveness of assistance provided, in part by having an automatic trigger to begin and end assistance. In particular, we discussed mechanisms that (1) improve the timing for starting assistance, (2) better target for state needs, and (3) taper off the end of assistance. More responsive federal assistance can aid states in addressing increased Medicaid enrollment resulting from a national economic downturn, as well as addressing reductions in states’ revenues. Improving targeting is essential to meet the goals of providing assistance to states in an efficient and effective manner. In response to the mandate, our prototype formula offers an automatic, timely, and targeted option for providing states temporary assistance during national economic downturns. Once a threshold number of states show a sustained decrease in their employment-to-population (EPOP) ratio, temporary increases to states’ FMAPs would be triggered automatically and targeted to each state’s Medicaid program. Our prototype formula uses two targeting components: (1) unemployment, and (2) wages and salaries. The amount of Medicaid assistance states receive would be commensurate with their increases in unemployment and decreases in wages and salaries. The prototype formula would end the temporary assistance once fewer than the threshold number of states shows a decline in their EPOP ratio over 2 consecutive months. Our prototype formula uses the monthly EPOP ratio and a threshold number of states to identify the start of a national economic downturn, and to automatically trigger the start of the increased FMAP assistance. (See fig. 1.) The automatic trigger would use readily available economic data to begin assistance rather than rely on legislative action at the time of a future national economic downturn. Once the increased FMAP is triggered, targeted state assistance would be calculated based on (1) increases in state unemployment, as a proxy for increased Medicaid enrollment; and (2) reductions in total wages and salaries, as a proxy for decreased revenues for maintaining state Medicaid programs. The increased FMAP would end when the EPOP ratio indicated that less than the threshold number of states was in an economic downturn. Under our prototype formula, states would have received increased Medicaid funding in response to each of the past three national recessions. For example, in response to the most recent national recession, states would have received up to 15 quarters of assistance that would have begun in January 2008 and extended through September 2011. The total federal cost of this assistance for state Medicaid needs would have been approximately $36 billion. Table 1 provides information on when states would have received assistance in response to the past three national recessions under our prototype formula and the total cost of this assistance for state Medicaid needs. Based on our simulations, the EPOP ratio is a reliable, timely indicator of the start of national economic downturns. At the start of each of the last five national recessions, as defined by NBER, we found a sharp increase in the number of states with declining EPOP ratios. A timely automatic trigger for temporary FMAP assistance would be based on a threshold number of states that show a decrease in their monthly EPOP ratio. We found the beginning of each of these recessions approximately coincided with 26 states having declining EPOP ratios. (See fig. 2.) Therefore, our prototype formula identifies the start of a national economic downturn when 26 states show a decrease in their 3-month average EPOP ratio, compared to the same 3-month period in the previous year, over 2 consecutive months. For the most recent national recession, our prototype would have identified the beginning of the downturn in October 2007 (i.e., the fourth quarter of 2007) and triggered temporary assistance to states beginning in January 2008 (the first quarter of 2008). (See fig. 3.) The increased FMAP payments to states would begin in the first calendar quarter following the quarter in which the EPOP measure indicated the start of an economic downturn. The period of temporary assistance would end after the 26-state threshold is no longer met. In the case of our prototype, the end would have been triggered in April 2011 and would make the third quarter of 2011 the last quarter of the assistance period. The last quarter of payment would be the first calendar quarter following the quarter in which the EPOP threshold was no longer met for 2 consecutive months. The threshold trigger may need to be adjusted periodically, however, because the EPOP ratio is projected to slowly drift downward over the next 30 years due to the aging of the population. If our EPOP measure had been used to determine the beginning and end of assistance during the most recent national recession, temporary increased FMAP assistance would have been provided for a total of 15 quarters, from the first quarter of 2008 (January-March) through the third quarter of 2011 (July-September). This compares to an 11-quarter assistance period under the Recovery Act (9 quarters) and extension (2 quarters), from the fourth quarter of 2008 (October-December) through the second quarter of 2011 (April-June). Because our prototype formula relies on readily available labor market data to automatically trigger the beginning and end of the increased FMAP, assistance would have begun earlier and extended longer than that provided by the Recovery Act during the most recent national recession. As with the Recovery Act, relying on NBER to obtain sufficient data to identify the beginning of a national recession and then providing fiscal assistance through the legislative process results in a time lag before aid is available; the Recovery Act was passed in February 2009, nearly 5 quarters after the national recession began in December 2007. States’ efforts to fund Medicaid during an economic downturn face two main challenges: financing increased enrollment and replacing lost revenue. To assist states in addressing both challenges, our prototype formula includes two components for targeting funding: one for a state’s increase in unemployment as a proxy for increased Medicaid enrollment, and a second for a state’s decrease in total wages and salaries as a proxy for the loss of revenue. The total assistance for a state would be the sum of the employment- and wage-based components. Our prototype formula provides states with a reduction in their financial contribution for Medicaid proportional to their increase in unemployment during the national economic downturn. This component is based on data showing a 1 percentage point increase in a state’s unemployment rate produces approximately a 1 percent increase in state Medicaid spending due to increased enrollment. The unemployment rate change used to calculate assistance for a given quarter is the unemployment rate for that quarter compared to the lowest unemployment rate in the prior 8 calendar quarters. As shown in the formula below, the unemployment-based FMAP increase (FMAP increaseU) for a given quarter is the product of the state share of Medicaid (100-FMAP) and the change in the unemployment rate (UR). FMAP increaseU = (100-FMAP) * ΔUR For example, under our prototype formula, a 10 percentage point increase in the unemployment rate would result in a 10 percent decrease in the state share of Medicaid. If a state had a 60 percent FMAP, and a 40 percent state share, the state share would fall by 4 percentage points (40 percent multiplied by 10 percent) to 36 percent, and commensurately its FMAP would rise to 64 percent. Figure 4 illustrates the targeting of FMAP increases the formula would have provided to states based on their increases in unemployment during the fourth quarter of 2009 (October-December). It indicates a strong proportional relationship between the FMAP increases and increases in unemployment. During the fourth quarter of 2009, FMAP increases due to changes in unemployment ranged from a low of 0.52 percentage points in North Dakota, which had a 1.4 point increase in the unemployment rate, to a high of 5.03 percentage points in Nevada, which experienced a 10.1 percentage point rise in unemployment. (See table 5 in app. IV for the state-by-state data on which this simulation is based, and the state- by-state results of the simulation.) Our prototype formula provides states with a separate reduction in their financial contribution for Medicaid that is proportional to their decrease in wages and salaries during the economic downturn. This component is based on data showing that a 1 percent decrease in total state wages and salaries corresponds to approximately a 1 percent decrease in state tax revenues. The total state wage and salary level used to calculate assistance for a given quarter is the total wage and salary level for that quarter compared to the highest wage and salary level in the prior eight quarters, expressed as a percent change. As shown in the formula below, the wage-based FMAP increase (FMAP increaseW) for a given quarter is the product of the state share of Medicaid (100-FMAP) and the percent change in total state wages and salaries (%∆W). FMAP increaseW = (100-FMAP) * %ΔW For example, under our prototype formula, a 20 percent decline in state wages and salaries would result in a 20 percent decrease in the state share of Medicaid. If a state had a 60 percent FMAP, and therefore a 40 percent state share, the state share would fall by 8 percentage points (40 percent multiplied by 20 percent) to 32 percent, and its FMAP would rise to 68 percent. Figure 5 illustrates the FMAP increases our prototype formula would have provided to states based on their decreases in wages and salaries during the fourth quarter of 2009 (October-December). It indicates a strong proportional relationship between the FMAP increases and decreases in wages and salaries, as the formula was designed to do. During the fourth quarter of 2009, FMAP increases due to declines in state wages and salaries would have ranged from a high of 8.64 percentage points in Nevada, which experienced a 17.3 percent decline in wages and salaries, to a low of 0.0 in three states—Alaska, the District of Columbia, and North Dakota— which experienced no decline in wages and salaries during the period. (See table 5 in app. IV for the state-by-state data on which this simulation is based, and the state-by-state results of the simulation.) The total FMAP increase a state would receive for a given quarter would be the sum of the FMAP increases for the unemployment-based and wage-based components. FMAP increaseTotal = FMAP increaseU + FMAP increaseW For example, during the fourth quarter of 2009, Nevada would have received the largest total FMAP increase of 13.68 percentage points, combining its 5.03 percentage point unemployment increase and 8.64 percentage point wage-based increase; its FMAP would have increased from 50.16 to 63.84. North Dakota would have received the smallest total increase of 0.52 percentage points, combining its 0.52 percentage point increase for unemployment and 0.00 percentage point increase for wage declines; its FMAP would have increased from 63.01 to 63.53. As shown in figure 6, the national average increased FMAP for both the unemployment-based and wage-based components combined is less than 1 percentage point during the first quarter of the assistance period. It rises to 5.6 percentage points in the third quarter of 2009 (July- September) and begins to fall beginning in the fourth quarter of 2009 (October-December). State Medicaid needs resulting from declining revenues exceed state Medicaid needs due to increased Medicaid enrollment through most quarters of the economic downturn. Consequently, the wage-based FMAP increase exceeds the unemployment-based increase through most quarters of the assistance period. Tables 6 and 7 in appendix IV present the results of a simulation of the total temporary increased FMAP provided by our prototype formula by quarter, by state, in response to the most recent national economic downturn. For a given quarter, a state could receive an unemployment-based increase, a wage-based increase, both, or neither, depending on its need. Therefore, not every state would receive an unemployment-based or a wage-based increase in every quarter. As shown in figure 7, for the first quarter of 2008, 40 states would have received assistance based on an increase in unemployment, and 14 states would have received assistance based on a decline in wages. However, the majority of states would have received increases for both components during most quarters of the assistance period. Under our prototype formula, temporary FMAP assistance to states would be triggered off when fewer than 26 states show a decline in their monthly EPOP ratio over 2 consecutive months. Once the program is triggered off, there are a number of ways in which the decrease in FMAP could be introduced to ease states’ transition back to the regular FMAP. Under our prototype formula, states would have a more gradual transition back to their regular FMAP once temporary assistance ended than under the Recovery Act or the Reconciliation Act. First, our prototype formula does not include an across-the-board or hold-harmless provision, as provided by the Recovery Act and the Reconciliation Act. Therefore, states would not be faced with an abrupt loss of a large amount of assistance under our prototype formula. Second, because of the way that our formula generates the unemployment-based and wage-based increases, the increased FMAP generally declines toward the end of the assistance period. As a result, for most states, the drop in FMAP once temporary assistance ended would be modest compared to the Recovery Act. For example, under our prototype, if the first quarter of 2011 would have been the last quarter of assistance during the most recent economic downturn, the average drop in FMAP would have been 0.54 percentage points, ranging from 0.00 in seven states to 4.16 in Nevada. Only seven states would have faced a drop in FMAP of greater than 1 percentage point. In contrast, under the Recovery Act and extension, the average drop in FMAP after the end of assistance in the second quarter of 2011 was 6.2 percentage points, ranging from 10.8 in Hawaii to 4.4 in Kentucky; thus, all states experienced a drop in FMAP of over 4 percentage points. Since its inception, efforts to finance the Medicaid program have been at odds with the cyclical nature of its design and operation, particularly during economic downturns. At such times, states typically experience increased Medicaid enrollment while at the same time their own revenues are declining. During the two most recent recessions, Congress acted to provide states with a temporary increase in federal funds through an increased FMAP. However, these efforts to provide states with increased FMAP assistance during national recessions were not as responsive to state Medicaid needs as they could have been. Legislative action at the time of a recession has not been as timely as an automatic response to changing economic conditions. Such a mechanism would reduce the time between the start of the economic downturn and the beginning of assistance by, in part, eliminating the lag between recognition of the economic downturn and congressional action to authorize assistance. By providing this predictability to states, an automatic trigger would facilitate budget planning and provide states with greater fiscal stability. Similarly, targeting assistance based on each state’s level of need ensures that federal assistance is aligned with the magnitude of the economic downturn’s effects on individual states. The prototype formula we present offers an option for providing automatic, timely, and targeted assistance to states during a national economic downturn. As called for in the mandate, our prototype formula improves the starting and ending of assistance, accounts for variations in state economic conditions, and responds to state Medicaid needs by providing a baseline for full funding of state Medicaid needs during a downturn. However, the level of funding and other design elements— such as the choice of thresholds for starting, ending, and targeting assistance—are variables that policymakers could adjust depending on circumstances such as competing budget demands, macroeconomic conditions, and other state fiscal needs beyond Medicaid. To ensure that federal funding efficiently and effectively responds to the countercyclical nature of the Medicaid program, Congress could consider enacting an FMAP formula that is targeted for variable state Medicaid needs and provides automatic, timely, and temporary increased FMAP assistance in response to national economic downturns. We provided a draft of this report for review to the Department of Health and Human Services (HHS). HHS on behalf of the Centers for Medicare & Medicaid Services (CMS) and the Office of the Assistant Secretary for Planning and Evaluation (ASPE) provided written comments on the draft, which are reprinted in appendix V. CMS officials stated that they agreed with the analysis and goals of the report, and they emphasized the importance of aligning changes to the FMAP formula as closely as possible to individual state circumstances in order to avoid unintended consequences for beneficiaries and to provide budget planning stability for states. However, they stated that the complexity of the prototype formula we present may be difficult for states and the federal government to implement, and the quarter-to-quarter variability of the increased FMAP could present challenges for state and federal budget planning. We note that the level of complexity and variability in our prototype is comparable to the increased FMAP provided under the Recovery Act. While there are inherent trade-offs between precision and complexity in any model, a certain level of complexity is necessary to achieve the goal of better targeting assistance in order to align the level of funding with individual state circumstances. CMS officials also stated that they do not recommend using the formula to provide general fund relief to states through the Medicaid program. Our prototype formula is designed for state Medicaid needs only. However, since Congress has used the increased FMAP for general fund relief in the past, most recently under the Recovery Act, we present several modifications that would permit increased funding to states for general fund relief. In their comments, ASPE officials noted that the prototype formula is designed for a national recession that impacts many states, but it does not deal with more regional economic declines or slower recoveries that are geographically concentrated. We agree that our prototype formula was not designed for economic downturns limited to an individual state or group of states, and we note this limitation in the report. As the mandate specifically called for recommendations to address the needs of states during periods of national economic downturn, such an analysis is beyond the scope of this report. ASPE officials also commented that having an automatic trigger for the temporary increased FMAP was a good idea. Further, ASPE agreed that our use of the employment-to-population ratio (EPOP) is a better measure for beginning assistance than the unemployment rate because the EPOP ratio reflects both unemployed and discouraged workers. ASPE officials also suggested that the EPOP ratio may be a better measure than unemployment for assessing state need and targeting assistance. We relied in part on unemployment for targeting, however, because there is an established relationship between changes in the unemployment rate and Medicaid enrollment. ASPE officials also noted that the relationship between unemployment and Medicaid enrollment may change in the future following full implementation of the Patient Protection and Affordable Care Act of 2010 (PPACA). We agree that the implementation of this act will have implications for the relationship between unemployment and Medicaid enrollment, particularly since an estimated 18 million additional individuals could qualify for Medicaid under PPACA. Such an analysis, however, was beyond the scope of our report, but formula elements could be adjusted to take these changes and effects into account. In their comments, ASPE officials also offered several considerations to guide policy choices regarding appropriate thresholds for timing and targeting of funds. We would note that in the development of our prototype formula and our illustrative simulations, we made a number of choices about specific elements of the formula design, including thresholds for timing and targeting. Alternatives to those design choices— such as those we present in appendix II of our report––involve balancing the advantages of one choice against another. We are sending copies of this report to the Secretary of HHS, the Administrator of the Centers for Medicare & Medicaid Services, and other interested parties. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staffs have questions about this report, please contact Carolyn L. Yocom at (202) 512-7114 or yocomc@gao.gov or Thomas J. McCool at (202) 512-2642 or mccoolt@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Major contributors to this report are listed in appendix VI. To evaluate the performance of the prototype formula, we examined the timing and targeting of the formula, and we simulated its application over the period of the most recent national economic downturn. We also considered the effects of using alternative design choices, and these are discussed in appendix II. Our prototype formula relies on changes in the employment-to-population (EPOP) ratio to identify the start of a national economic downturn, and to provide a trigger for a targeted temporary increase in states’ Federal Medical Assistance Percentage (FMAP). We define the EPOP ratio as the ratio of the number of jobs to the working-age population aged 16 and older. Employment data are represented by the number of jobs by state, and come from the Bureau of Labor Statistics’ Current Employment Statistics. To simulate the use of the EPOP ratio to identify the start of a national economic downturn and trigger temporary FMAP assistance, we calculated a 3-month moving average of the EPOP ratio starting in March 1977 through May 2011 for each state and the District of Columbia. This time period covered the last five national recessions as defined by the National Bureau of Economic Research (NBER). To calculate the decline in EPOP, we subtracted the EPOP 3-month moving average for a given month from the average for the same month in the preceding year. For example, for each state, the EPOP ratio’s 3-month moving average for May 2011 was subtracted from the average for May 2010. We identified a threshold number of states with declining EPOP ratios that was consistent with the start of each of the last five NBER recessions. Our prototype formula is designed to provide assistance during periods of national economic downturn; it is not designed for economic downturns limited to an individual state or region. To simulate the targeting of temporary increased FMAP assistance to states, we calculated increased FMAPs under our prototype formula during the most recent national economic downturn. (The period of targeted increases in FMAPs is defined by the EPOP “trigger.”) As outlined in our March 2011 report, we used increases in states’ unemployment rates and declines in states’ wages and salaries as indicators of states’ increased funding needs for Medicaid. The increased needs result from (1) increased Medicaid enrollments as people are affected by the economic downturn and become eligible for Medicaid; and (2) states’ revenue losses, which affect their ability to fund their share of Medicaid. To avoid taking into account states’ choices regarding Medicaid policies and procedures, we used increases in state unemployment rates as a proxy to indicate Medicaid enrollment growth attributable to the economic downturn—our unemployment component. Similarly, to avoid taking into account state policy choices (e.g., statutory tax rates), we used decreases in wages and salaries as a proxy to indicate revenue losses attributable to effects of the economic downturn—our wage and salary component. Our calculation of targeted assistance to every state is done on a quarterly basis, and the total increase in FMAP is the sum of amounts calculated separately under the unemployment component, and the wage and salary component. The overall method involves first selecting for each state a “base quarter” from which increases in unemployment and decreases in wages and salaries are calculated. While individual states may experience many factors or trends that contribute to increases or decreases in their unemployment rate or wages and salaries, such as changes over time in the mix of industries in a state, we determined that accounting for such factors for each state would make the prototype formula too complex. Thus, the formula is based on the assumption that all increases in unemployment or decreases in wages during the period of assistance are attributed to the effects of the economic downturn. For the unemployment component, when the program is triggered on, a base quarter is identified for each state by looking back over 8 quarters from the current quarter and selecting the quarter with the lowest unemployment rate. For the first 8 quarters of the program, the amount of assistance for each quarter is calculated based on the difference between the unemployment rate in this low base quarter and the rate in the current quarter. After the first 8 quarters of assistance, the state’s increase in unemployment is calculated using the unemployment rate in the current quarter minus the lowest unemployment rate in the previous 8 quarters. As shown in figure 8, the start of the look-back period remains fixed for the first 8 quarters of assistance; thereafter, the look-back period is limited to the prior 8 quarters. For example, in the fourth quarter of 2009, the look-back period extends for 15 quarters; however, beginning in the first quarter of 2010, the look-back period is limited to the prior 8 quarters. Under the unemployment component of the prototype, the increase in unemployment provides states with a reduction in their financial contribution for Medicaid that is proportional to their increase in unemployment over the base quarter. A 1.0 percentage point increase in a state’s unemployment rate corresponds to an increase in Medicaid enrollment, which produces a 1 percent increase in state Medicaid spending. As shown in the formula below, the unemployment-based FMAP increase (FMAP increaseU) for a given quarter is the product of the state share of Medicaid (100-FMAP) and the change in the unemployment rate (UR). FMAP increaseU = (100-FMAP) * ΔUR For example, under our prototype formula, a 10 percentage point increase in the unemployment rate would result in a 10 percent decrease in the state share of Medicaid. If a state had a 60 percent FMAP, and a 40 percent state share, the state share would fall by 4 percentage points (40 percent multiplied by 10 percent) to 36 percent, and commensurately its FMAP would rise to 64 percent. For the prototype formula’s wages and salaries component, the base quarter is again found for each state by looking back over eight quarters when the temporary assistance begins. The base quarter selected is the quarter with the peak value in wages and salaries. For the first eight quarters of the program, the amount of assistance for each quarter is calculated based on the difference between the total state wages and salaries in the peak quarter and the total state wages and salaries in the current quarter. After the first eight quarters of assistance, the state’s decrease in wages and salaries is calculated using the peak total wages and salaries in the previous eight quarters minus the wages and salaries in the current quarter. As with the unemployment component, the start of the look-back period remains fixed for the first eight quarters of assistance; thereafter, the look-back period is limited to the prior eight quarters. Our prototype formula provides states with a separate reduction in their financial contribution for Medicaid that is proportional to their decrease in wages and salaries during the economic downturn. This component is based on evidence showing a 1 percent decrease in total state wages and salaries corresponds to a 1 percent decrease in state tax revenues. For the purposes of our formula we assume a reduction in state tax revenues corresponds to an equal percent reduction in the funds available for funding the state share of Medicaid. The total state wage and salary amount used to calculate assistance for a given quarter is the total wage and salary amount for that quarter compared to the highest wage and salary level in the prior eight quarters, expressed as a percent change. As shown in the formula below, the wage-based FMAP increase (FMAP increaseW) for a given quarter is the product of the state share of Medicaid (100-FMAP) and the percent change in total state wages and salaries (%ΔW). FMAP increaseW = (100-FMAP) * %ΔW For example, under our formula, a 20 percent decline in state wages and salaries would result in a 20 percent decrease in the state share of Medicaid. If a state had a 60 percent FMAP, and therefore a 40 percent state share, the state share would fall by 8 percentage points (40 percent multiplied by 20 percent) to 32 percent, and its FMAP would rise to 68 percent. To simulate the use of the prototype formula to end temporary FMAP assistance, we examined the EPOP ratio to determine when program assistance would stop. If the number of states having declining ratios falls below a threshold level (26) for 2 consecutive months, the FMAP assistance would end in the following quarter. While the EPOP test employed to initiate temporary FMAP assistance is also used to end it, the ending of assistance is not comparable to the NBER dates of the end of a recession. In the five past national recessions we examined, the EPOP test would end assistance after the NBER-designated economic recovery began. This is appropriate because, as indicated in our March 2011 report, state Medicaid needs persist into the early stages of recovery. In the case of the automatic trigger to start and stop the temporary assistance to states, increased FMAP payments to states would begin in the first calendar quarter following the quarter in which the EPOP measure indicated the start of a economic downturn, and the last quarter of payment would be the first calendar quarter following the quarter in which the EPOP threshold was no longer met. In the case of the targeted assistance to states, for the purposes of our simulation we did not build in any delay between the availability of data and the calculation of increased FMAPs. For example, although unemployment and wage and salary data both become available with a delay of up to several months, we used state unemployment and wage data for the first quarter of 2008 to calculate the increased FMAP for the same quarter in our simulation. Given the lag time associated with the availability of unemployment and wage data, it may be advisable to calculate preliminary FMAPs based on the most recent quarterly data available, and then to calculate final FMAPs for that quarter when final data for the quarter are published. In the development of our prototype formula for increased Federal Medical Assistance Percentages (FMAP) during national economic downturns, we made a number of choices about specific elements of the formula design. Alternatives to those design choices involve balancing the advantages of one choice against those of another. For example, a design alternative that would lessen the quarter-to-quarter variation in FMAPs would also lessen the formula’s responsiveness to quarterly changes in economic conditions. Thus, there is a trade-off between establishing an increased FMAP that has relatively greater stability and predictability and FMAPs that are reflective of states’ current economic conditions. Table 2 presents a selection of formula design features contained in our prototype formula and presents some alternatives. With each alternative, there is a discussion of key considerations involved in making that choice. Table 3 describes two additional adjustments that were not included in our prototype formula, but could be applied. The across-the-board and hold-harmless provisions of the American Recovery and Reinvestment Act of 2009 (Recovery Act) did not provide a needs-based method for targeting Medicaid assistance to states during an economic downturn. Because these provisions did not distinguish among states that experienced varying degrees of increased unemployment or decreased wages and salaries during an economic downturn, they are not included in our prototype formula. The largest share of total assistance to states under the Recovery Act was the 6.2 percentage point across-the-board FMAP increase that each state received. However, because states are not equally affected by national economic downturns an equal FMAP increase does not address variable state Medicaid funding needs. Furthermore, as we discussed in our March report, equal percentage point changes in FMAPs do not result in equal percent reductions in state contributions for Medicaid. States with higher regular FMAPs received a disproportionately large reduction in their state contribution for Medicaid under the across-the-board provision. For example, during the fourth quarter of assistance under the Recovery Act, Nevada—a low FMAP state—had a 7.1 percentage point increase in unemployment and a 27.9 percent decline in the state share of Medicaid, while Arkansas—a high FMAP state—experienced a 2.1 percentage point increase in unemployment, but a similar 28.1 percent decline in state share. Under the hold-harmless provision of the Recovery Act, each state’s regular FMAP rate was held to the state’s highest rate since fiscal year 2008, regardless of changes in the state’s per capita income (PCI). As a result, the largest FMAP increases due to the hold-harmless provision went to the states with the greatest improvements in their underlying economic condition, as measured by PCI, relative to the national average. Furthermore, states with both higher unemployment and rising unemployment tended to receive the least benefit from the hold-harmless provision. As shown in table 4, many states that benefited from the Recovery Act hold-harmless provision often had relative increases in their PCI compared to the national average, while some states that had little or no increase in PCI received little, if any, benefit from the hold-harmless provision. Percentage change in 3-year average per capita income (PCI) from 2003-05 to 2006-08, relative to U.S. average -0.9% (3-month average ending Sept. 2010) 11.7 3-month average since Jan. 2006) During the first quarter of 2011, 9 of the 10 states that received the largest FMAP increases due to the hold-harmless provision had rising PCIs relative to the national average. For example, Hawaii, which had a 4.0 percent increase in its PCI, received a FMAP increase of 4.71 percentage points. Conversely, 11 of the 12 states that received no benefit from the hold-harmless provision in the first quarter of 2011 had declining per capita incomes relative to the national average. In addition, states with the greatest recession-related needs, such as high and rising unemployment rates tended to receive the least benefit from the hold- harmless provision. For example, Michigan received no benefit from the hold-harmless provision despite a much worse economic condition relative to other states: a 13.1 percent unemployment rate and a 6.4 percent increase in its unemployment. Appendix IV: Temporary Increased FMAP Data by State, GAO Prototype Formula (2009, Qtr 4) (2009, Qtr 4) In addition to the contacts named above, major contributors included Robert Copeland, Assistant Director; Eric R. Anderson; Robert Dinkelmeyer; Greg Dybalski; Drew Long; and Max Sawicky.

Summary: In response to the recession of 2007, Congress passed the American Recovery and Reinvestment Act of 2009 (Recovery Act). Recovery Act funds provided states with fiscal relief and helped to maintain state Medicaid programs through a temporary increase to the federal share of Medicaid funding-the Federal Medical Assistance Percentage (FMAP)-from October 2008 through December 2010. In March 2011, GAO reported that states' ability to fund Medicaid was hampered due to increased Medicaid enrollment and declines in states' revenues that typically occur during a national downturn. The Recovery Act mandated that GAO provide recommendations for modifying the increased FMAP formula to make it more responsive to state Medicaid program needs during future economic downturns. In this report, GAO presents a prototype formula for a temporary increased FMAP and evaluates its effects on the allocation of assistance to states. To evaluate the three components of the prototype formula--starting assistance, targeting assistance, and ending assistance-- GAO uses the 2007 recession. GAO's prototype formula offers a timely and targeted option for providing states temporary Medicaid assistance during a national economic downturn. Once a threshold number of states--26 in GAO's prototype formula--show a sustained decrease in their employment-to-population (EPOP) ratio, temporary increases to states' FMAPs would be triggered automatically. The EPOP ratio compares the number of employed persons in a state to the working age population aged 16 and older. This assistance would end when fewer than the threshold number of states shows a decline in their EPOP ratio. Because the prototype formula relies on labor market data as an automatic trigger rather than legislative action, assistance would have begun earlier and extended longer than the assistance provided by the Recovery Act. The prototype formula would have triggered assistance to begin in January 2008 and end in September 2011, compared with the Recovery Act which provided an increased FMAP from October 2008 through June 2011. Once the increased FMAP is triggered, targeted state assistance would be calculated based on two components: (1) increases in unemployment, as a proxy for changes in Medicaid enrollment; and (2) reductions in total wages and salaries, as a proxy for changes in states' revenues. GAO's prototype formula provides a baseline of funding for state Medicaid needs during an economic downturn by offering automatic, timely, and targeted assistance to states. Such assistance would facilitate state budget planning, provide states with greater fiscal stability, and better align federal assistance with the magnitude of the economic downturn's effects on individual states. In commenting on a draft of this report, the Department of Health and Human Services (HHS) agreed with the analysis and goals of the report and emphasized the importance of aligning changes to the FMAP formula with individual state circumstances. HHS noted the complexity of the prototype formula and offered several considerations to guide policy choices regarding appropriate thresholds for timing and targeting of increased FMAP funds. To ensure that federal funding efficiently and effectively responds to the countercyclical nature of the Medicaid program, Congress could consider enacting an increased FMAP formula that targets variable state Medicaid needs and provides automatic, timely, and temporary assistance in response to national economic downturns.