In 1993, Medicaid, the government’s health financing program for certain low-income populations, cost the federal and state governments $131 billion—almost $100 billion more than just a decade ago. During that same period, the number of Medicaid beneficiaries increased from 22 million to 33 million. Although about three-quarters of the beneficiaries are poor children and their parents, two-thirds of the expenditures are for poor elderly, blind, and disabled individuals. Funding is a shared responsibility between the federal and state governments, with respective federal and state shares determined through a statutory matching formula. Federal law mandates coverage of certain medical services and population groups. It also includes coverage options, allowing states to choose whether to cover additional services or low-income population groups. Dramatic differences in Medicaid programs across states reflect spending priorities of the states, their ability to pay, and incentives inherent in the federal matching formula. States partly determine the extent of their Medicaid program when they set eligibility requirements for receiving cash assistance (primarily Aid to Families with Dependent Children—AFDC).Under federal law, AFDC recipients are automatically eligible for Medicaid. States also determine program scope by selecting which optional services or groups to include in their programs. With some discretion to modify eligibility and benefit provisions, the proportion of the poor (as defined by the federal poverty level) and near-poor served by Medicaid varies greatly by state. For example, for every 1,000 people with incomes under 150 percent of the federal poverty level, Rhode Island serves 913 beneficiaries, whereas Nevada serves 284. Nationally, in 1994 Medicaid covered medical services for 58 percent of people under age 65 living in poverty. State Medicaid programs also vary in the levels of benefits provided. For example, some states limit their Medicaid coverage of inpatient days (a required service) to a certain number per person. States also have the discretion to drop their coverage of optional services, such as dental or optical care. The average Medicaid benefit (that is, total medical spending divided by total beneficiaries) ranges from $2,372 in Mississippi to $7,286 in New York. (See fig. 1.1 for grouping of states by their average benefit level and table 1.1 for state-by-state data.) States with higher Medicaid benefits tend to cover a greater proportion of poor people, relative to states with lower benefits. Thus, the differences among states in spending per poor person are even greater than the differences among states in spending per beneficiary. By far, the majority of Medicaid funds are paid on behalf of poor elderly, blind, and disabled individuals. Representing only slightly more than a fourth of all Medicaid beneficiaries, these groups incurred about 66 percent ($82.2 billion) of Medicaid’s 1993 expenditures, as shown in figure 1.2. The average per person spending for these beneficiaries exceeded $9,200—four times more than was spent on other adults ($2,292) and seven times more than was spent on other children ($1,360). The per person spending for all Medicaid beneficiaries averaged nearly $3,900; in contrast, health spending per person for the U.S. population averaged about $3,300. In 1993, about 35 percent of Medicaid spending was for long-term care, including nursing home care payments. Medicaid pays about 52 cents of every nursing home care dollar. About 46 percent of all Medicaid spending was for acute care. (See fig. 1.3 for a breakdown of Medicaid spending.) The financing of Medicaid is shared by the federal government and the states. The federal share paid to a state is based on the federal medical assistance percentage (FMAP). Determined separately for each state, the FMAP ranges from a minimum of 50 percent to a maximum of 83 percent of total Medicaid costs. The formula for determining the FMAP is based on a state’s per capita income. It is designed to provide a higher federal match to states with low per capita incomes. In fiscal year 1993, Mississippi, West Virginia, and Utah had the highest federal match percentages; each received more than 75 percent of its Medicaid program funding from the federal government. Alternatively for that year, the federal government paid 50 percent of Medicaid costs, the minimum match, in 12 states and the District of Columbia. In spite of the formula’s sliding match rate, federal spending per Medicaid beneficiary tends to be highest in states with high per capita incomes. Because high-income states tend to offer relatively generous benefits, the absolute amount of federal spending per beneficiary is high, even though the match rate is only 50 percent. For example, New York—a high-income state with a 50-percent match—receives $3,600 per beneficiary in federal aid, while Mississippi—a low-income state with approximately an 80-percent match—receives $1,900 per beneficiary in federal aid. Reporting on this subject in 1983, 1990, and 1993, we noted that the FMAP formula could be improved to meet federal goals. The federal assistance formula is designed to reduce differences among the states in medical care coverage of the poor and distribute fairly among the states the burden of financing program benefits. However, the formula’s reliance on a state’s per capita income does not adequately address these equity goals. In fiscal year 1991, for example, the District of Columbia and Nevada received the same FMAP, despite the District’s greater proportion of people eligible for Medicaid. Our prior work in this area concluded that the formula could better adjust for states’ different needs and varying abilities to fund benefits by considering a state’s number of persons in poverty and more comprehensive measures of taxing capacity. In recent years, many states have been experimenting with health financing reforms. Under Medicaid law, states proposing to implement payment and service delivery innovations outside the range allowed by federal rules must seek approval to waive certain federal requirements. Until recently, though, Medicaid experiments have been relatively limited. However, states have been seeking approval for broader changes under section 1115 waivers, so called because of the statutory provision authorizing them, which offer more open-ended opportunities to make major changes in Medicaid than program waivers. Changes proposed in section 1115 waiver applications are considered demonstration projects. Unlike the routine approvals for program waivers, approvals for demonstration waivers are subject to much greater discretion by the Secretary of the Department of Health and Human Services (HHS). (The Health Care Financing Administration (HCFA) and the Office of Management and Budget (OMB) have also been key players in the waiver approval process.) Section 1115 waivers can exempt states from compliance with normal Medicaid requirements and allow them to receive federal funding for expenditures normally not eligible for such assistance. HHS requires that waiver applications include a formal research or experimental methodology, and historically waivers have not been considered automatically renewable. Section 1115 waivers typically involve limited research projects, but since 1993 several statewide demonstration projects have been approved. Among other things, recent section 1115 waivers have allowed states to mandate enrollment of all their beneficiaries in Medicaid-participating managed care plans and to prevent disenrollment for specific periods of time, usually 6 to 12 months. States with recently approved waivers have proposed expanding coverage of their indigent citizens by recycling savings anticipated in changing from a fee-for-service to a managed care system and redirecting other Medicaid and state funds. If these states’ demonstrations are implemented as planned, the states would be covering some low-income individuals that would not otherwise qualify for Medicaid. We discuss the significance of these waivers to the restructuring of the Medicaid program in chapter 3 and their potential impact on the federal budget in chapter 4. The House Budget Committee asked us to examine (1) the nature of federal and state Medicaid spending in recent years, (2) some states’ efforts to contain Medicaid costs and expand coverage through waivers of certain federal requirements, and (3) the potential impact of the waivers on federal spending and on Medicaid’s program structure overall. To address the issue of federal and state Medicaid spending, we analyzed data contained in HCFA statistical reports and also reviewed and synthesized information from research articles and major studies that focused on Medicaid costs. To obtain information on states’ efforts to contain Medicaid costs and expand coverage through waivers, we interviewed Medicaid program and other state agency officials, providers, advocacy groups, and state legislators in five of the eight states with approved waivers. We also interviewed HCFA officials responsible for examining waiver proposals and reviewed documentation for the approved and pending projects as well as statistical and other reports on the Medicaid program. We determined the potential impact of waivers on federal spending by developing and applying a consistent framework that compares spending limits approved in each waiver with a benchmark incorporating current services budgeting concepts. To eliminate the effect of accelerated program growth from past years—acceleration due in part to high medical inflation, large increases in state disproportionate share hospital (DSH) payments, and mandated expansions in program eligibility—we compared the waiver spending limits with a projection of spending for each state’s current Medicaid program over the life of the waiver. To make these projections we used the administration’s estimated rate of growth of Medicaid current services outlays for the nation as a whole. These estimated growth rates are based only on expected increases to medical inflation and program population growth—without any change in eligibility requirements. To make the current services projection for each state’s Medicaid program (what we call our budget-neutrality benchmark) we multiplied each state’s base-year estimates of Medicaid funding (for the segment of the population to be covered by their waiver) by the administration’s estimates of national program growth made when HCFA approved the waiver. We adjusted our baseline, when necessary, to reflect constraints on the growth of DSH payments in each state’s Medicaid program. The actual process varied slightly, depending on whether the state’s waiver was subject to an aggregate or per capita funding limit. Once we had determined our administration-based estimate of current services outlays, we compared it with the estimated program funding from the waiver agreements.