Medicaid, Incentives and the Future of Federalism

States are unhappy with Medicaid costs, but they’re not willing to surrender federal incentives to cut them.
February 2011
By Donald F. Kettl  |  Columnist
The Sid Richardson Professor at the LBJ School of Public Affairs at the University of Texas at Austin

What do Texas Gov. Rick Perry, the produce aisle at the grocery store and federal district court judge Henry E. Hudson have in common? Together, they’re a trio framing a hot and inescapable battle not only over health reform, but also over the future of federalism.

In a move that reverberated in state capitols across the country, Perry stunned political watchers when he threatened to pull his state out of the Medicaid program. Perry told Fox News Sunday that the feds ought to turn the biggest federal health-care program for the poor into a block grant. End the federal program and give the states the money, he urged, because, "We think we can save substantial dollars for the federal government and for the states if they’ll allow us to implement that program." How much? A December 2009 Heritage Foundation report suggested states would save $1 trillion over the next decade, with Texas reducing its Medicaid budget by about $60 billion to $64 billion between 2013 and 2019.

Until the passage of President Obama’s health-care reform, the federal government’s health-care programs were largely voluntary. Companies aren’t required to offer health insurance. However, they’re encouraged to do so through tax deductions -- and many employees would flee if their company dropped coverage. No hospital has to accept Medicare patients, though few could stay in business if they didn’t. And no state has to provide Medicaid coverage for their poorer citizens. In fact, Medicaid is not one program. It’s 51 programs, with varying options in each state, layered atop the core federal program. As health-care costs have spiraled upward, and as the program has funded more seniors in nursing home beds, Medicaid has become a budgetary Death Star, gobbling up ever more scarce dollars.

That gets us to the produce aisle: Federal health-care programs have been carrots, with inducements to encourage everyone to play. Obama’s health-care reform was built on the premise that this vegetarian federalism wasn’t working well enough -- too many Americans were left without health insurance -- so the program requires individuals to buy insurance. It was never a government takeover of health care. Rather, the federal government merely created the mandate, set the basic rules and put the states in the tough position of having to build and manage the exchanges where uninsured individuals would buy their coverage. The states, in subtle but critical ways, moved out of the produce aisle of carrots to the hardware aisle of sticks.

That takes us to Hudson, the federal district court judge in Virginia who ruled against one of the reform’s core elements. The mandate, he said, would “invite unbridled exercise of the federal police powers,” and thus was unconstitutional. If the U.S. Supreme Court strikes down this keystone of the program, and if the states keep their promise to withdraw from Medicaid, it’s no exaggeration to say that the nation’s health-care system would collapse.

If the carrots aren’t working and the sticks might be unconstitutional, where does that leave us? This is a much bigger issue than the mega-issue of health care. A huge swath of federal programs -- from enforcement of environmental regulations to highway speed limits -- build on vegetarian federalism, and carrots draw the states into conformance with policies shaped in Washington, D.C.

Not long after Perry made national headlines with his threat to opt out of Medicaid, a report by the Texas Department of Insurance and the state’s Health and Human Services Commission caused him to backpedal. The report found that bailing out of the program would leave 2.6 million Texans without health insurance and dump billions of dollars of care for indigent citizens onto fiscally strapped state and county budgets. Medicaid, the report revealed, pays for two-thirds of those in Texas nursing homes and half of all births in the state.

The carrots have drawn states in so deep that there’s no getting out -- but they’re chafing under their share of these programs’ costs. Minnesota Gov. Tim Pawlenty and New Jersey Gov. Chris Christie have joined the rebellion calling for a re-evaluation of the states’ role in health reform. The program is not only putting the states in a central role with the exchanges, but it’s also bringing many more individuals into Medicaid -- almost 16 million by 2019, according to the Henry J. Kaiser Family Foundation -- which will cost states $21 billion. They don’t have to opt in, they can’t afford to opt out, and they don’t think they can afford the program either way. That poses huge risks for the fate of health reform -- and federalism.

For nearly a century, we’ve built a remarkable array of federal-state-local programs premised on vegetarian federalism: If the feds supply carrots, state and local governments will eagerly devour them. Like many of us, they have often complained about eating their veggies, but they’ve found them irresistible nonetheless. With state financial crises dragging on long past the first stages of economic recovery, and with the crises sure to be stoked by unsupportable pension costs, this vast legacy of vegetarian federalism could be in very deep trouble.