Medicaid’s Funding Formula Rewards Overspending and Fuels Fraud

Congress Must Fix the FMAP to Stop States from Gaming the System

Photo by Getty Images

As House Republicans take steps to advance their tax reform package this week, fiscal hawks have been raising the alarm about Medicaid’s broken financing formula. They’re right to do so. Medicaid’s joint state-federal funding scheme actively rewards overspending, resulting in programmatic bloat, wasted taxpayer dollars, and fraud. If politicians want to actually cut waste in Medicaid, they need to overhaul the program’s funding structure.

Over the last decade, Medicaid spending growth has outpaced every other major federal program, including the largest old-age entitlements: Social Security and Medicare. This growth stems, in large part, from Medicaid’s matching grant system. For every $1 a state government spends, the federal government matches $1 to $9 in additional funding.

This matching system encourages federal overspending, spawning an unholy alliance between state politicians and providers. State bureaucrats want to administer a huge government program while only financing a fraction of its costs, reaping the political rewards of delivering a government benefit without major tax expansions. Meanwhile, hospitals and insurance providers are incentivized to lobby for program expansions, higher reimbursement rates, and relaxed eligibility rules in pursuit of higher revenue. Both win if the federal government spends more money, with federal taxpayers caught holding the bag.

Thanks to repeated Medicaid expansions, states' abuse of financing gimmicks, and uncapped federal spending, annual Medicaid spending will exceed national defense this year ($873 billion) and is slated to grow significantly over the coming decade. With hundreds of billions in tax dollars flowing through this system, there is no shortage of examples of wasteful or fraudulent spending. Here are a few of the lowlights:

• In Arizona, two individuals were charged with submitting $57 million in fraudulent claims for nonexistent or medically unnecessary treatment services.

• In California, the state improperly claimed $52.7 million in federal Medicaid on behalf of noncitizens with unsatisfactory immigration statuses.

• In Delaware, a provider paid $42.5 million to settle kickback allegations related to self-referrals that triggered fraudulent Medicaid billing.

• In Kansas, managed care organizations received more than $18.2 million in Medicaid reimbursements for deceased beneficiaries.

• In Massachusetts, the owner of a home health agency was sentenced to 12 years in prison for stealing at least $100 million from Medicaid

• In Minnesota, three individuals were charged with defrauding the state’s Medicaid program out of nearly $11 million through bogus home care billing schemes.

• In Utah, a woman was charged with defrauding Medicaid of nearly $13 million while also fraudulently collecting public assistance benefits despite exceeding income limits.

• In Virginia, state officials improperly paid $22 million to managed care organizations on behalf of enrollees who were already deceased.

• In Wisconsin, a Milwaukee woman was indicted for stealing $3.7 million in a Medicaid fraud and kickback scheme involving prenatal and childcare services that were never delivered.

These examples represent just a tiny fraction of total Medicaid misspending. In the only two years where full audits of the program were conducted (2019 and 2020), one in four Medicaid dollars were improper payments—payments that should not have been made or that were made in the incorrect amount. Applied over the last decade, that translates to $1.1 trillion in improper payments. That’s a shocking failure on the part of Washington to safeguard federal taxpayer dollars.

So long as Medicaid’s matching system remains in place, states will be incentivized to maximize enrollment over program integrity to capture as many federal dollars as possible. Implementing work requirements will not resolve this underlying incentive structure. Only by overhauling Medicaid’s financing scheme can Congress truly tackle waste, fraud, and abuse in the program.

Eliminate excessive federal matching for able-bodied adults.

Ideally, Congress should convert Medicaid into a capped block-grant program, eliminating the matching grant system entirely (and the perverse incentives that come with it). Congress can work towards this goal by beginning to reduce the federal matching rate, starting with able-bodied, childless adults. Currently, Medicaid provides $9 for every $1 states spend on working-age adults without disabilities. The federal matching rate for low-income children, disabled Americans, and pregnant women is just $1.33 by comparison. Federal tax dollars should not privilege a 30-year-old man capable of holding down a job over needier Americans.

Crack down on provider taxes and other financing gimmicks.

Additionally, Congress should rein in state financing gimmicks designed to abuse the matching grant system and shift costs to the federal government. One prominent example is provider taxes, an unassuming name for what is otherwise a blatant effort to defraud federal taxpayers. The game here is simple. States tax providers, use that revenue to spend more, and capture more federal dollars, with states shuffling that additional money back to providers. The result is legalized budget laundering, where states and providers collude to game the formula and drain federal coffers at the direct expense of federal taxpayers who have no say in the scheme.

Some of the Republican proposals under consideration make a very modest start at reining in this and other financing schemes by, for example, placing a moratorium on new provider taxes and removing the “good faith” waiver for erroneous excess payments. Republicans should go further. Reining in existing provider taxes and cracking down on other financing gimmicks would save hundreds of billions, reduce excessive overspending, and result in a more equitable financing distribution between states and the federal government.

Until Congress reforms Medicaid’s financing structure, waste will remain a feature, not a bug, of the program. Likewise, failing to fix Medicaid’s structural flaws pushes the country closer to a fiscal crisis—one that will ultimately result in more severe, disruptive cuts to the very people many legislators are claiming to protect by resisting spending reform. If the small tweaks Republicans are considering to the program look draconian now, wait until a fiscal crisis forces legislators’ hands.