By Alicia Carbaugh(*)
Reprinted with permission from the Kaiser Foundation
From Foresight, No. 45
published 2006
Medicaid is the nation’s major public health program for low-income Americans, financing health and long-term care services for more than 50 million people—a source of health insurance for low-income children and parents and a critical source of acute and long-term care coverage for elderly and disabled individuals, including millions of low-income Medicare beneficiaries. In addition, the program supports tens of thousands of health care providers throughout the country, including hospitals, nursing facilities, group homes and community health centers, as well as managed care plans. The program’s financing structure—the federal matching arrangement—and the magnitude of Medicaid spending enable the program to make significant contributions to state economies in terms of jobs, income and overall economic activity. As state policymakers grapple with closing budget shortfalls, many look to Medicaid for savings, as it is a major component of state budgets. However, it is argued that cutting Medicaid not only adversely affects the beneficiaries and providers, but also may have an impact on the larger state economy.
The Kaiser Commission on Medicaid and the Uninsured has compiled the findings from 17 studies analyzing the role Medicaid plays in state and local economies. These studies estimate the economic stimulus derived from Medicaid spending, and also analyze the adverse effects on the state economy from reducing Medicaid spending. This policy brief provides an overview of Medicaid financing, explains the methods used to assess economic impact and summarizes the main findings from the research.
Authorized by Title XIX of the Social Security Act, Medicaid is a means-tested entitlement program jointly financed by the federal and state governments. According to Congressional Budget Office estimates, the federal government spent $161 billion on Medicaid in fiscal year (FY) 2003.(1) In addition, the states are estimated to have spent $121 billion, bringing total program spending to $282 billion.(2) Medicaid is the second largest line item in state budgets—16 percent of state funds are allocated to Medicaid on average—and is the largest source of federal grant support for the states.(3)
The federal government matches each state’s Medicaid spending at an established rate that varies by state. The rate, the Federal Medical Assistance Percentage (FMAP), is determined by a set formula and tries to account for variation in incomes across the states. All states receive at least a 50 percent match and states with per capita incomes below the national average receive higher matching percentages. On average across all states, the federal government matches 57 percent of what states spend on Medicaid. The economic downturn has precipitated a significant decline in state revenues, leaving states with budget shortfalls in the tens of billions. In legislation enacted in May 2003, Congress temporarily increased the matching rates for FY 2004 by nearly 3 percent as part of a package providing states with fiscal relief. However, the fiscal relief will expire at the end of June 2004 (see Table 1 for FY 2004 and FY 2005 FMAP by state).
To assess economic impact, most studies utilized either the RIMS II (Regional Input-output Modeling System) or IMPLAN (Impact Analysis for Planning) input-output models, which are widely used for assessing economic impact resulting from an event or major capital input such as a military base closing or airport construction. Input-output economic models account for the relationships between industries in an economy and allow for estimating the effects of changes in expenditures on state industries and the economy as a whole. Both models are based on similar theory—a change in input (e.g., a cut or increase in Medicaid expenditures) will produce direct impacts that will then “ripple” through other sectors of the economy producing indirect and induced impacts. This process does not continue endlessly as with each round of spending, a portion of dollars is used for purchases made outside the state, or is taxed or saved.
The RIMS II model was developed by the U.S. Department of Commerce, Bureau of Economic Analysis and the IMPLAN model was originally developed by the U.S. Department of Agriculture Forest Service and then extended by the Minnesota IMPLAN Group, Inc. As discussed above, the models are based on similar economic theory; however, there are inherent differences in the models, primarily related to the types of multipliers each model uses and the approach used to compute multipliers. Both models make several assumptions in order to quantify impact; the assumptions and limitations of input-output economic modeling are included within the studies as appropriate.
Economic impact can be defined as the net change in the economy resulting from an event such as an increase or decrease in government spending. New spending can create a larger impact than the amount of new spending alone through “multiplier effects” because of the successive rounds of spending that occur when money is injected into a state economy. For instance, state businesses and residents spend their earnings on purchases from other businesses or residents in the state, who in turn make other purchases and so on.(4) Conversely, multipliers can work in reverse when spending is reduced. Economic impact is generally quantified in terms of employment, income, state revenue and overall economic output (also referred to as business activity, gross state product or value added).
Both state and federal Medicaid spending have a multiplier effect. State spending alone yields multiplier effects as money is injected into the state’s economy and used to conduct business, make purchases and support salaries. However, because of the matching arrangement, the economic impact of Medicaid spending is intensified by the infusion of new dollars from the federal government that would otherwise not exist in the state—a dollar of state Medicaid spending attracts at least one federal dollar. Thus, the total impact multiplier, relative to the multiplier of the state dollar alone, is considerably larger. Not including the temporary federal fiscal relief, the FMAP ranges from 50 to 77 percent among states—meaning that for every dollar a state spends on Medicaid, the federal government contributes at least one dollar and up to roughly three and one half dollars. The higher the matching rate, the stronger the financial incentive for states. For example, if a state’s matching rate is set at 70 percent, for each $1 the state spends on Medicaid, the federal government contributes $2.33. Conversely, for every $1 that the state cuts in Medicaid spending, it will forgo the $2.33 match from the federal government. Therefore, the state is actually reducing its Medicaid spending by $3.33 to save $1 in state funds.(5)
State-only funded health programs and state spending in other areas may have economic multipliers roughly in the same range as Medicaid; however, these programs may not generate the added impact, as they typically do not attract federal matching funds. It is important to note that there are state programs that receive federal support, though not matching funds, and that there are other state programs, such as highway construction, that do attract federal matching funds.
Figure 1 presents an example of how Medicaid spending flows through an economy and demonstrates how the relationships within an economy can generate impacts greater than the original spending alone. First, while Medicaid payments are made on behalf of enrollees, the direct recipients are providers, including hospitals, private physicians and nursing homes, or managed care organizations. Therefore, Medicaid funding directly impacts health care service providers, supporting the jobs, income, and purchases associated with carrying out health care services.
Figure 1: Flow of Medicaid Dollars Through a State Economy: An Example
Through the multiplier effect, other businesses and industries are indirectly affected due to the direct impact. For example, a medical supply firm may be affected through its business dealings with Medicaid providers—fluctuations in Medicaid funding may affect a Medicaid provider’s supply order which then may affect the medical supplier’s purchases from its vendors, and so on. Lastly, both the direct and indirect effects induce changes in household consumption and tax collection primarily due to household income fluctuations. Employees of Medicaid health care providers that are directly impacted or the employees of businesses that are indirectly impacted may change their spending patterns according to increases or decreases in income—the change in income triggers the household to increase or decrease spending on consumer goods. Due to changes in personal income and, subsequently spending, sources of government revenue—including income and sales taxes—would be affected as well.
Medicaid spending generates economic activity, including jobs, income and state tax revenues, at the state level.
• Medicaid is the second largest line item in state budgets.
• Money injected into a state from outside the state is critical to generating economic activity. Medicaid’s economic impact is
intensified because of the federal match—state spending pulls federal dollars into the economy.
• Medicaid is the largest source of federal funds for states. The amount of federal dollars each state receives depends on the state’s Medicaid spending and their FMAP.
• Federal Medicaid matching dollars support jobs and generate income within the health care sector and throughout other sectors of the economy due to the multiplier effect.
The economic impact of Medicaid spending varies from state to state.
• Regardless of the economic impact model used, all studies have similar findings—Medicaid spending has a positive impact on state economies.
• The magnitude of the impact is dependent on state Medicaid spending, a state’s matching rate from the federal government (FMAP) and the economic multipliers used in the studies, which reflect economic conditions within the state.
• The size of the health sector and the interdependence of industry sectors within a state and its regions can modify the impact.
• States and state regions and/or counties that are more reliant on public services and the health care industry may be disproportionately affected.
Reductions in state and federal Medicaid will lead to declines in economic activity at the state level.
• Reductions in state spending automatically reduce the infusion of federal dollars. States lose at least one dollar in federal funds for every dollar of state Medicaid spending cut.
• Decreases in funding reduce the flow of dollars to hospitals, nursing homes, home health agencies and pharmacies, and reduce the amount of money circulating through the economy, affecting employment, income, state tax revenue and economic output.
All of the studies examined provide evidence that Medicaid spending has a positive impact on state economies. It is clear from the studies conducted thus far that in addition to providing valuable health coverage for low-income people, state Medicaid spending also yields significant economic benefits for states, and that, largely as a result of Medicaid’s unique matching arrangements, these benefits may be larger than state spending alone. As states address their budget shortfalls, spending decisions will hinge on a variety of factors. However, it will be important to consider the role of Medicaid in state economies and its economic impact relative to state spending in other areas.
* This issue brief was prepared by Alicia Carbaugh of the Kaiser Commission on Medicaid and the Uninsured (KCMU) with assistance from Barbara Lyons, Julie Hudman and Victoria Wachino of the Commission staff. KCMU would like to acknowledge the comments provided by Leighton Ku of the Center on Budget and Policy Priorities, Andy Schneider of Medicaid Policy, LLC, and Alan Weil of the Urban Institute.
Editor’s Note: This April 2004 Kaiser Commission on Medicaid and the Uninsured report examines the multiplier effects of state Medicaid spending and federal matching dollars as they apply to a state’s economy. It summarizes 17 similar state-level studies that estimate the quantity of health care jobs, business activity, income, and tax revenue this state and federal spending generates.
In 2001 Kentucky’s Legislative Research Commission (LRC) conducted its own analysis of the $2.2 billion in federal Medicaid matching dollars Kentucky received during Fiscal Year 2000. LRC economists found that these federal dollars resulted in $2.6 billion in output or sales beyond the original federal outlay for all Kentucky firms, employment of 68,000 people or the creation of 90,000 jobs, and about $2 billion in state personal income. In turn, about $50 million in sales and $80 million in personal income taxes were generated. Since 2000, state spending for Medicaid has risen by about half a billion dollars, as health care costs have soared and the number of eligible recipients has risen. In turn, federal Medicaid matching dollars have increased by over $1 billion. The economic consequence of this infusion of federal dollars has likely expanded as well.
Medicaid has a tremendous positive impact in local Kentucky communities, in their ability to sustain rural hospitals and recruit physicians. It is critical to Kentucky’s ability to sustain the current level of health services. As this Kaiser Commission report details, Medicaid spending supports the health care industry where that spending occurs.
This Kaiser report, however, focuses exclusively on the multiplier effects of Medicaid spending. Evaluating the full impact of such spending on Kentucky’s economy would require consideration of opportunity costs such as forgone consumer spending and investment or the economic impact of spending in other sectors. As LRC economists noted in 2001, at some point forgone services and improvements in other sectors, such as education, become more valuable than the economic impact of federal Medicaid matching dollars that require state investment in the program.
The indirect economic activity generated by any state spending may have its greatest impact with Medicaid because Kentucky receives a disproportionate federal match. However, the federal government requires discipline in state Medicaid programs and caps the expansion of state spending for the program. Kentucky’s Medicaid program can expand beyond these limits, but, without the federal match, greater spending would not automatically yield the same results of current spending.
Quantifying the ability of Medicaid spending to multiply in Kentucky’s economy is important, but perhaps the most important effect of Medicaid is that, by helping keep people healthy, it provides opportunity. While the Kaiser report does not investigate it, Medicaid affects a local economy by promoting better health, which in turn can lead to a more productive workforce. Good health, for example, is important to students’ ability to participate in their education and learn. These multiplier effects are long-term, and perhaps the most significant. Return to text.
1 Congressional Budget Office, Fact Sheet for March 2004 Baseline–Medicaid and the State Children’s Health Insurance Program. Return to text.
2 KCMU estimates based on Congressional Budget Office March 2004 Baseline and General Accounting Office report to the Committee on Finance, U.S. Senate, Medicaid: Improved Federal Oversight of State Financing Schemes Is Needed, February 2004. Return to text.
3 V. Wachino, A. Schneider and D. Rousseau, Financing the Medicaid Program: The Many Roles of Federal and State Matching Funds, KCMU policy brief, January 2004, available at http://www.kff.org/medicaid/7000.cfm. Return to text.
4 Within the health care sector, spending is largely internal to the state as health care is a service-based industry in which the product is generally consumed locally. Return to text.
5 V. Wachino et al., January 2004. Return to text.