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Federalism and Health Policy
An Overview

John Holahan
Alan Weil
Joshua M. Wiener

The financing of health and long-term care for the low-income population in the United States is a joint federal and state responsibility. The states have major financial and administrative responsibilities, with the federal government providing substantial funding and oversight. The appropriate balance of these responsibilities has been a matter of considerable debate over the past 40 years. Some argue for a greater federal role, others for more devolution of responsibility to the states. In recent years, waivers have given states the flexibility to change many features of their Medicaid programs; moreover, the states have considerable flexibility in establishing State Children's Health Insurance Programs (SCHIP). More radical forms of devolution, such as block grants, have been proposed but not enacted.

This book examines the record. How well have states done in providing acute and long-term care services to low-income populations? How have they responded to financial incentives and various federal regulatory requirements? Have they used the flexibility available to them? How innovative have they been? Once some states developed new programs and methods of providing services, did others implement those changes?

The book begins by considering the theoretical arguments for federal or state primacy in financing and program design—for example, in determining eligibility, reimbursement rates, and quality standards. Studies show that some states have demonstrated a great willingness to support their low-income populations, whereas others have not. The result is considerable inequity across states: Coverage and spending are low in some states and high in others. The record also shows that several states have been innovative in expanding coverage, implementing Medicaid managed care, and designing long-term care systems. But the system supporting health care for low-income people is under considerable budget pressure, and questionable financial arrangements have affected the fiscal integrity of the Medicaid program. Finally, the book explores alternative models of federalism, meaning different allocations of responsibility between the states and the federal government, including SCHIP, Medicare, and health insurance regulation and patient protection laws.

This book has been produced as part of the Assessing the New Federalism (ANF) project at the Urban Institute. The project was designed to assess the devolution of health and income support programs to the states. Over the past seven years, Urban Institute staff have conducted two rounds of case studies to examine how states responded to new opportunities to expand coverage in the midst of a rapidly growing economy and, more recently, how they are responding to the budget pressures that have developed as the economy slowed. The ANF project is also conducting a quantitative evaluation of SCHIP and various state coverage expansions aimed at low-income adults.

This introductory chapter describes the current health care system for low-income Americans and all that it has achieved. It then summarizes the primary issues raised and conclusions reached in each of the other chapters. Throughout the book, unless otherwise noted, programmatic data refer to federal fiscal years, while survey and other data refer to calendar years.

The Health Care System for Low-Income Americans

Medicaid is the backbone of the financing system that provides health and long-term care to low-income Americans. It extends insurance coverage to more than 35 million people.1 In recent years, SCHIP has expanded coverage to near-poor children and to some parents. The private insurance market also provides coverage to many low-income people; state governments affect private coverage through regulation of insurance markets, and the federal government exerts control through the Health Insurance Portability and Accountability Act (HIPAA). The operation of managed care plans is influenced by state patients' rights legislation, and Congress is currently debating a federal extension of patient protections.

Medicaid is an open-ended funding program in which the federal government matches state spending on health insurance. Matching rates range from 50 percent to 77 percent, depending on a state's per capita income, with poorer states receiving higher rates. The average federal match is 57 percent. Combined federal and state Medicaid expenditures in fiscal year (FY) 2002 were more than $256 billion, about equal to Medicare's $257 billion. Medicaid expenditures are expected to exceed Medicare's in FY 2003.2

Medicaid has improved access to health services for large numbers of low-income Americans. It covers low-income pregnant women, parents and children (and in some states, adults without children), elderly persons, and persons with disabilities. States must provide a wide range of acute care services, including hospital inpatient and outpatient care, physician services, and laboratory and X-ray services, and they have the option of covering prescription drugs, dental services, physical therapy, prosthetic devices, and other medical care services. The program also covers institutional and community-based long-term care, supports state systems for people with mental illness and developmental disabilities, and provides financial support for state and local public health systems. Studies have shown that people with Medicaid coverage have better access to care and use more services than people without insurance coverage, after controlling for differences in population characteristics (Dubay and Kenney 2001; Newacheck et al. 1998; Rosenbach 1989). The program has also reduced out-of-pocket spending on health care, relative to a comparable uninsured population (Davidoff et al. 2000).

By serving a large share of the neediest, most vulnerable populations, Medicaid plays a critical role in the American health care system. While coverage varies extensively by state, Medicaid, along with smaller, state-funded programs, covers about 35 percent of Americans with incomes below the federal poverty level (FPL, which is $18,400 for a family of four in 2003) and 25 percent of those with incomes of less than twice the FPL. About 51 percent of children and 24 percent of adults with incomes below the poverty level are covered.3 Medicaid pays for more than one-third of all births in the United States and provides prenatal care for low-income pregnant women as well as preventive services for children.4

The Medicaid population is considerably less healthy than average—beneficiaries are far more likely than either the privately insured or the uninsured to report being in fair or poor health and to report having activity limitations and chronic conditions. This is particularly true of disabled beneficiaries, who also receive Supplemental Security Income, but it applies to nondisabled beneficiaries as well (Holahan 2001). These groups would have great difficulty obtaining conventional health insurance, and even if they could, premiums would be extremely high.

Medicaid covers people with a wide range of disabilities, including mental illness, developmental disabilities, physical disabilities, and HIV/AIDS. Increasingly, Medicaid is paying for long-term care in the community. It provides major support for institutional care of low-income elderly persons and disabled persons, paying for about one-half of all nursing home expenditures and contributing to the cost of care for two-thirds of all nursing home residents. It also pays Medicare premiums, deductibles, and coinsurance for 5.2 million elderly or disabled persons, as well as for a number of acute care services not covered by Medicare. In particular, Medicaid finances the purchase of prescription drugs for many of the nation's sickest individuals, spending about $16 billion in 2001 on prescription drugs for older people and persons with disabilities.5

Finally, Medicaid provides considerable financial support for safety net hospitals in urban and rural areas. These hospitals not only provide care to Medicaid populations but also serve large numbers of uninsured Americans. Medicaid supports these hospitals both through direct payments for services and through disproportionate share hospital (DSH) payments, which help them defray the costs of caring for the uninsured.

While Medicaid provides extraordinary benefits to the U.S. population, it is plagued by an array of problems that have made it difficult to use as a mechanism for expanding coverage and services. One such problem is the stigma attached to Medicaid in many states because of its link to welfare. Medicaid's negative image is also attributable to the program's cumbersome enrollment processes, low provider payment rates, variable quality of care in nursing homes and other settings, and its reputation as a budget buster. There are also such extensive variations in coverage and spending across states that some of Medicaid's positive and negative features are not found in all states.

Another problem with Medicaid has been some states' use of dubious financing arrangements, including DSH payments and, more recently, upper payment limits (UPLs), to bring in large amounts of federal dollars with little or no state contribution (Coughlin, Ku, and Kim 2000). These arrangements have undermined the core financing structure of the program and have created considerable tension between the federal government and the states. Finally, while the program brings in federal revenues to support many state functions, it is also a constant source of pressure on state budgets because of state matching requirements.

In 1996, Congress established SCHIP to extend health insurance coverage to near-poor children—those living in families with incomes too high to be eligible for Medicaid. States were allowed to expand eligibility to twice the FPL and, through the use of liberal definitions of income, to people with considerably higher incomes. States were granted substantial flexibility in program design, including the ability to establish enrollment caps, to offer more limited benefit packages than Medicaid, and to impose significantly higher premiums and cost-sharing arrangements than allowed under Medicaid. The federal government established budget allocations for states, and it matches state expenditures at a considerably higher rate than it does for Medicaid, up to the limit established by the allocation.

In its short life, SCHIP has been more popular than Medicaid. States have embraced it enthusiastically, but it is impossible to tell whether this is because the program focuses on children, has higher federal matching rates, features greater flexibility in design, or includes no entitlement to benefits. How the program will do over a longer period, as it grows to account for a more significant share of state spending, is hard to predict, especially if state fiscal conditions do not radically improve.

State and Federal Roles in Health Care: Rationales for Allocating Responsibilities

The federalism debate in the United States centers on how strong the central government should be, what functions logically belong at the national level, when state autonomy should reign, and what state responsibilities should be. In Chapter 2, Randall Bovbjerg, Joshua Wiener, and Michael Housman examine this debate, with a particular focus on health care financing.

The case for federal or state preeminence can be argued on the basis of political philosophy, political and economic competition, or pragmatism. The political argument for state dominance is that state government is closer to the people and therefore better able to determine what works than the federal government. Moreover, local autonomy is essential in a country as diverse as the United States. This is especially true in health care, where health care institutions, medical practice patterns, referral networks, and provider markets are local. Those who argue for a stronger federal role believe it is the responsibility of the national government to "promote the general welfare." As Americans, citizens in one state are concerned about the well-being of citizens in other states. National citizenship implies some level of cross-state consistency.

A second set of arguments is rooted in economic theories of competition. Those who favor a strong state role contend that interstate political competition will make states perform better: If individuals and businesses dislike one state's policies, they can move to another state. The threat of exit means that state policy will need to reflect the will of individuals and businesses. The alternative argument is that interstate competition will undercut programs that attempt to redistribute income. States with generous benefits will experience an influx of low-income users and the subsequent exodus of taxpayers unwilling to pay the higher taxes required to sustain benefits. As a result, benefits and taxes will spiral downward to less generous programs than the states would have offered otherwise.

Finally, the pragmatic approach considers whether states or the federal government would do a better job of administering programs. This perspective views states as laboratories of democracy. Policymakers in the various states design new approaches to meet their state's responsibilities. Innovations that are successful will be replicated in other states; those that are not will disappear. The pragmatic argument for a greater federal role is, first, that some benefits, such as healthy citizens, are national in scope. The nation as a whole is hurt to the extent that individual states under-invest in the health of their citizens. Second, solving some problems, particularly those involving redistribution of resources, requires the fiscal capacity of the federal government. The federal government can more efficiently tax because populations and businesses cannot easily cross national borders to escape tax burdens. Third, in times of recession or economic slowdown, the federal government can adopt countercyclical spending; states are limited in their fiscal responses because almost all of them must have balanced budgets.

U.S. health policy reflects a shared approach to federalism, particularly in regard to low-income populations. There is little agreement that either level of government would necessarily do better than the current arrangement. While many people believe that a smaller government is better, that competition can improve government performance, and that redistribution can lead to economic inefficiencies, they also recognize that federal action is needed to improve the welfare of the citizens most in need. Some degree of redistribution is necessary if a basic level of care is to be provided, if poor health is to be avoided, and if long-term gains in productivity are to be reached. Moreover, while it is generally agreed that truly local problems are best dealt with on the state or local level, it is also understood that a federal solution is probably needed for problems that affect other states, that prompt substantial concerns about the welfare of residents of other states, and that are very costly or require redistribution.

Most Americans are in the middle of the ideological spectrum, Bovbjerg, Wiener, and Housman argue, and most Americans are pragmatic—they want to do what works best. Therefore, it is important to understand how well current health care arrangements work. Is there a reasonable minimum standard of care? Has the system produced innovation? Do the states learn from one another? Are state revenues sufficient in good times and bad? Does interstate competition thwart redistribution efforts? With these issues in mind, the remaining chapters seek to provide evidence of how well the federal-state sharing of financial and administrative responsibilities has worked in providing care for low-income populations.

Federalism and the Financing of Health Care

After laying the groundwork with an exploration of federalism, the book moves to fiscal issues. Chapter 3 examines the reasons for the growth in Medicaid spending and assesses the pressure Medicaid places on state budgets. Chapter 4 provides data on variations in coverage and spending, resulting in part from the health care system's federal-state structure. Chapter 5 looks at how states have used provisions of Medicaid law to maximize federal funding.

Health Care within the Larger State Budget

Medicaid has been growing as a share of state spending for many years and is now one of the largest components of state budgets. Donald Boyd shows that, between 1990 and 2000, Medicaid spending per capita increased by 88 percent, adjusted for inflation, whereas total state spending net of inflation increased by 32 percent. By 2002, Medicaid spending accounted for 12 percent of state and local general fund expenditures—21 percent when federal funds are included.

There are many reasons why Medicaid spending has grown, including increased enrollment—particularly a gradual shift toward relatively larger numbers of aged and disabled people (whose care is more expensive), inflation in health care costs, growth in DSH payments to hospitals, and greater use of health services. Expenditures have also grown as a result of various state attempts to maximize federal Medicaid revenues, a practice discussed in depth in Chapter 5.

Between 1990 and 1995, Medicaid grew substantially faster than any other part of the state budget. Spending on elementary and secondary education, higher education, and corrections also grew, but less rapidly than state spending, on average. It is difficult to tell whether spending in these other areas would have grown more if the rate of Medicaid spending had grown more slowly.

Between 1995 and 2000, Medicaid spending slowed because of declining enrollment, the expansion of Medicaid managed care, federal controls on the use of DSH programs, and reduced inflation in medical care costs. During this period, states greatly increased the resources devoted to elementary and secondary schools, which were experiencing higher enrollment. In addition, many states were shifting spending on elementary and secondary education from localities to the state. Welfare rolls dropped, providing states with a fiscal windfall, because federal funding for welfare was no longer linked to enrollment. At the same time, sales and income tax revenues rose because of extraordinary growth in incomes, especially the capital gains related to new stock market wealth. Thus, states could expand spending on education and other areas, reduce taxes, and increase reserves or rainy day funds—all at the same time.

After 2000, the picture began to change dramatically. The economy slowed, and state revenue growth leveled off, then fell—precipitously in some cases. The terrorist attacks of September 11, 2001, the sharp decline in the stock market, and state tax cuts enacted in the late 1990s accentuated the revenue shortfalls. Elementary and secondary education enrollment slowed, but states were under increased pressure to improve education standards, reduce class sizes, and raise teacher salaries. While growth in K-12 enrollment slowed, enrollment in higher education increased, forcing state decisionmakers to consider increased revenues to support higher education.

Meanwhile, Medicaid spending began to accelerate again. It is expected to grow at a rate of approximately 8.5 percent per year over the next decade because of a combination of factors.6 First, between rising health care costs and slower economic growth, employer coverage may decline and the number of uninsured increase. States will see increased Medicaid and SCHIP enrollment, even with no expansion of eligibility standards. Second, hospital costs and prescription drug expenditures are likely to continue increasing at fairly rapid rates. Third, Medicaid managed care is no longer providing the same savings as it did in the 1990s and will not provide states with the tools they need to constrain spending on acute care. Fourth, long-term care costs are also likely to rise because of the aging of the population, labor force shortages, and efforts to improve nursing home quality. Recent court decisions have required states to expand coverage of services in the community for disabled persons. And finally, the federal government is determined to curtail use of DSH and UPL programs, which have been an attractive source of revenue for states.

The bottom line is that states will face extraordinary budgetary pressures in the coming years. Increased spending on health care can only be accommodated if spending on services such as education is curtailed or if taxes are increased. States face difficult trade-offs, and the likelihood of significant retrenchment is real; furthermore, the prospects for expanding health care programs to serve the uninsured seem bleak.

Variations in Health Insurance Coverage and Medical Expenditures: How Much Is Too Much?

With states having considerable administrative and financial flexibility in their Medicaid programs, substantial variation in coverage should be expected, although observers can disagree about how much is acceptable. John Holahan examines these variations in Chapter 3, presenting data on health insurance coverage and expenditures across states. Average uninsurance rates of children from 1997 to 1999 ranged from 8 percent in Minnesota to 25 percent in Texas; for adults under age 65, the rates ranged from 11 percent in Minnesota to 27 percent in Texas. Uninsurance rates tend to mirror variations in employer-sponsored insurance; that is, states with high rates of employer-sponsored insurance have low uninsurance rates and vice versa. Accordingly, employer-sponsored insurance covers 76 percent of persons under age 65 in Wisconsin and 58 percent in California. Public coverage affects uninsurance rates as well, particularly for low-income people. Again, coverage varies substantially among states: Massachusetts covered 35 percent of its low-income population between 1997 and 1999, while Colorado covered only 15 percent.

Spending per low-income person varies similarly. Medicaid spending on acute care services for the population under age 65 varies among states by roughly a factor of three—even more if only state spending is considered. State wealth is a major determinant of spending per low-income person. As state income rises, so does spending of state revenues on Medicaid and SCHIP. Although federal matching funds vary inversely with state income, they are not sufficient to reduce spending differentials greatly. Moreover, states that spend less on Medicaid and SCHIP do not increase other health spending to compensate. Finally, the chapter shows that low-income people in states with high uninsurance rates are less likely to have access to health care and more likely to be in fair or poor health.

Some states have very large gaps in employer-sponsored insurance coverage, while others have much smaller ones. The result is considerable differences in uninsurance rates, an outcome that is not wholly the fault of states. States with low rates of employer coverage have a very difficult time overcoming the fiscal problems they face because of their employment base. Nonetheless, some states make a greater effort than others to cover their low-income population. The chapter concludes that while some of the wide variations in Medicaid coverage are due to differences in ability to pay, much also depends on state willingness to expend resources on health care for their low-income populations.

State Strategies for Tapping Federal Revenues: Implications and Consequences of Medicaid Maximization

While growth in Medicaid spending has placed pressures on state budgets, the program's growth should not be surprising—nor has it always been unwelcome. Medicaid has responded to the desire to expand coverage of children and to the needs of a growing aged and disabled population. When the economy declines, more people will be eligible for coverage, even with no change in eligibility criteria. The program is also vulnerable to spending pressures facing the entire health system. Finally, Medicaid expansions are affected by federal incentives that encourage states to spend more by sharing the cost. States must spend their own money on the program, but more state spending brings in more federal dollars.

Thus, some of the growth in Medicaid spending is attributable to state efforts to maximize federal funding. As Teresa Coughlin and Stephen Zuckerman (Chapter 5) show, states have financial incentives to expand Medicaid eligibility and services to obtain additional federal matching funds. This has led to the shifting of state-funded programs and services (such as maternal and child health programs, mental health services, home care, and school-based services) into the Medicaid program. With Medicaid financing, these services are often improved and expanded, and the states realize some savings. Similarly, states have shifted populations previously covered through state-funded programs into the Medicaid program. Such Medicaid maximization strategies have been encouraged by federal policy.

DSH payments and UPL programs raise different issues. Under these arrangements, a state obtains money from providers, through donations or taxes, or from government agencies, through intergovernmental transfers. The state then uses these funds to make DSH or UPL payments to providers under Medicaid, thereby obtaining federal matching funds. State or locally generated funds are returned to the state or locality, along with some or all of the federal payments. Providers benefit to the extent that they retain some of the federal funds. These programs have generated a considerable amount of money for states and their providers. Between 1990 and 1992, DSH spending increased from $1.4 billion to $17.5 billion, but it fell to $14.4 billion in 2000. UPL programs, which began in the mid-1990s, increased from $313 million in 1995 to $1.4 billion in 1998 and $10 billion in 2000.

The programs pose several problems. First, while some of the payments are used as intended, to meet the needs of providers that serve substantial numbers of Medicaid and uninsured patients, some are primarily strategies for obtaining more federal funds for state government with no additional state spending. This causes Medicaid expenditures to be overstated. Second, when federal dollars are actually retained by providers, state and local subsidies are often lower. In this case, as in the previous one, there is little increase in health spending relative to the amount of the increase in Medicaid expenditures. Third, DSH and UPL payments are not distributed equitably. The amount of money coming into states through this mechanism depends on state creativity and the willingness to exploit these mechanisms. For example, DSH spending in 1998 varied from 23 percent of Medicaid spending in Louisiana, 20 percent in Missouri, and 19 percent in South Carolina to less than 1 percent in Arkansas, Nebraska, and Wisconsin.

In addition to the inequities and the overstatement of Medicaid expenditures, these mechanisms have led to considerable tension between the federal government and the states. The federal government has undertaken a series of legislative and regulatory efforts to curtail DSH and UPL spending, but these efforts have never attempted to redistribute DSH dollars in a more equitable way, such as equalizing expenditures per uninsured person or per low-income person. Rather, expenditures have been frozen or special deals have been worked out to leave many of the existing inequitable arrangements in place. DSH and UPL spending has also been highly politicized. Members of Congress have wanted to close the loopholes but at the same time have wanted to protect their home states.

States as the Laboratories of Democracy

In their capacity as laboratories of democracy, states have brought about change in many areas of the Medicaid program. Innovations have been made in data systems, reimbursement methodologies, development of preferred drug programs, and extension of drug coverage to older people. The majority of state initiatives have centered on three areas: expanded coverage, managed care, and design of long-term care systems. Chapters 6, 7, and 8 focus on innovation in those areas of Medicaid.

Leaders and Laggards in State Coverage Expansions

The states have several federal mechanisms at their disposal to extend insurance coverage of low-income populations. These include traditional Medicaid, Section 1115 research and demonstration programs, SCHIP, Section 1931 provisions in the 1996 welfare reform legislation,7 and, more recently, Health Insurance Flexibility and Accountability (HIFA) waivers. John Holahan and Mary Beth Pohl (Chapter 6) analyze the states' use of these mechanisms to expand coverage. They divide states into four groups on the basis of whether they cover any adults without children and how extensively they cover parents and children. The first group includes all states that cover all nondisabled adults without children, at least up to the federal poverty level (these adults may have incomes that exceed the federal poverty level). The second group covers parents whose incomes may exceed the federal poverty level; some of these states have also extended coverage to adults without children, but with fairly restrictive caps on enrollment and services. The remaining two groups have not extended coverage of children and parents much beyond minimum standards. Eleven states met the criteria for the first group, 10 for the second.

States in the first group have generally been extremely creative in using different funding streams, both federal and state, to develop their programs. They have used combinations of Medicaid, SCHIP, and state funds; and they have used authorities permitted under Section 1931 and Section 1115 waivers of the Social Security Act. Some of the most generous programs—for example, those in Massachusetts, New Jersey, and Tennessee—have been scaled back in the 2002-03 budget squeeze. Thus, the data presented in Chapter 6 may represent a high water mark of coverage, innovation, and political will, all of which could decline over the next several years.

States in the first group are considered leaders. This means that only about one-quarter of the states have taken advantage of existing federal law or established their own programs to extend coverage in significant ways. Another 10 states have taken important steps to expand coverage. As of 2001, the states in the first group covered 30 percent of their low-income population in public programs; states in the other groups covered 23 percent. Uninsurance rates for the first group were also lower, at 25 percent versus 30 percent. The leading states are much more likely to be politically liberal, to have higher incomes and education levels, and to have larger urban populations.

In sum, the amount of success in extending coverage is fairly limited. Holahan and Pohl suggest that this is due to limits on state resources; different budget priorities (e.g., for education, transportation, or tax relief); ideological aversion to public program expansions; and the structure of federal programs, particularly Medicaid, which makes it hard to cover adults without children. Fundamentally, however, coverage expansion requires some amount of income redistribution, and there are clearly limits on states' willingness to do this.

Medicaid Managed Care: State Flexibility in Action

Robert Hurley and Stephen Zuckerman (Chapter 7) paint a more optimistic picture of the creative capacity of states when it came to implementing Medicaid managed care, perhaps because the issues involved were largely administrative, not matters of financing or income redistribution. Medicaid managed care has been widely implemented over the past 10 years, substantially changing how the program operates. It has endured and changed many times in response to state needs. It has faced a range of problems, including enrollment abuses, inadequate access to care, low payment rates, conflicting evidence of its effects on utilization and cost savings, and difficulty keeping commercial managed care plans in the program. Some of these problems have been overcome, at least in some states, while others persist.

Hurley and Zuckerman point to a number of important innovations states have made in managed care. California's two-plan model provides a way to contract with mainstream plans while protecting safety net providers. Florida maintained access to a wide range of providers and preserved beneficiaries' choice of providers by establishing a system of competing health maintenance organizations (HMOs) and primary care case managers. Texas, Virginia, and New York also have multiple models, often differing in rural and urban areas, demonstrating the ability of states to refine strategies and adapt them to local conditions.

Many states were faced with a major challenge in the late 1990s because of the exit of commercial plans, mostly due to low payment rates. New York responded by increasing payment rates and expanding its reliance on health plans sponsored by safety net providers. New Jersey, Maryland, and Washington contracted with fewer plans, primarily those that serve only the Medicaid population. Other states, such as Georgia and Vermont, went back to relying on primary care case management. State flexibility allowed this variety of responses.

States also gained administrative expertise. They learned from Tennessee's experience that rapid implementation of Medicaid managed care could result in contentious relationships between the state and providers, which could endure for many years, and in slow implementation. Florida's experience with health plan marketing abuses led states to enrollment brokers to help beneficiaries choose plans, one of Medicaid managed care's most important innovations. Colorado, Washington, and Maryland have been in the forefront of developing payment methodologies that protect plans from the financial risk of enrolling a large number of sick and disabled beneficiaries, and thereby encourage more appropriate care for these vulnerable populations. Massachusetts has added to its primary care case management program many of the desirable and effective features of more comprehensive delivery systems.

Not all states have been innovative. Many pay low rates, and relatively few have sophisticated risk-adjustment payment systems. Most have concentrated on populations that are relatively easy to serve and have avoided the elderly, disabled, and other populations with special needs. Hurley and Zuckerman cite Tennessee as an example of how overly ambitious enrollment goals, coupled with low payment rates and inadequate risk adjustment, can seriously undermine a Medicaid managed care program. However, they conclude that, as innovators, states compare quite favorably with private purchasers and Medicare when it comes to managed care.

Long-Term Care: Can the States Be the Engine of Reform?

Long-term care is a key area of state health policy and spending because people requiring such care rely heavily on publicly funded programs. Long-term care accounted for 27 percent of state and local spending for personal health services in 2000. As with acute care, spending on Medicaid long-term care ranged widely, from $709 per capita in New York to $147 per capita in California. Joshua Wiener and Jane Tilly (Chapter 8) analyze federal-state relations in long-term care, focusing on older people and adults with physical disabilities.

The primary argument for greater state responsibility for long-term care is the ability of states to tailor programs to local conditions and preferences, something that is critical to long-term care because the service is so personal. The main argument for a strong federal role is that the federal government already has primary responsibility for the older population's health care (through Medicare) and income support (through Social Security and Supplemental Security Income). Adding long-term care could result in better coordination across these programs.

Financing of long-term care is complex and fragmented. Although Medicaid funding dominates, financing from Medicare and programs funded by the Older Americans Act, the Federal Rehabilitation Act, and the states themselves all play a role. While the states have been demanding additional programmatic flexibility, federal funding of long-term care through Medicare and Medicaid has become increasingly dominant. This has been caused, in part, by states shifting costs to Medicare and by Medicaid's increasingly important role in funding home and community services.

For years, adults with disabilities have been given long-term care primarily in institutions, despite their strong preference for living in the community. For a variety of reasons, states have been increasing funding for home and community-based services, mostly through the use of the Medicaid home and community-based services waivers. Funding for these waivers and noninstitutional services varies across the states, resulting in very great disparities in access to care.

The states' claim to being long-term care innovators is strongest in the context of Medicaid waivers. The waivers allow states enormous flexibility in service design while providing them with a great deal of fiscal control. All states have at least one waiver for older people and adults with disabilities, although many of them are small. Some states have used waivers to enable individual beneficiaries to select and manage their caregivers and to provide care in nonmedical residential facilities, such as assisted living. A minority of states rely heavily on such innovative services.

Quality of care has been a perennial problem, particularly in nursing homes. The federal government has played the dominant role in ensuring quality, establishing standards, and determining the enforcement process, while states largely implement the federal rules. Despite the large federal role, nursing home quality has remained problematic. Although states have responsibility for ensuring the quality of home and community services, they have done relatively little, concentrating their energies on expanding services instead.

Wiener and Tilly conclude that all states have learned enough from each other to move toward a more balanced system of long-term care delivery, but some have made more progress than others. Most states offer a fairly modest set of home and community services, but there is tremendous variation across states, raising questions of equity. Neither federal dominance of nursing home quality assurance nor state dominance of noninstitutional quality assurance has guaranteed a high level of service.

New Models of Federalism

This section examines three models of health care in the United States. The most recent is SCHIP, an effort to combine increased federal financing with more state flexibility, described in Chapter 9. Medicare is included because, while it provides a national base of financing, it ultimately relies on states to fill in the cracks (Chapter 10). Finally, Chapter 11 examines federal and state roles in insurance regulation and patient protection.

The State Children's Health Insurance Program: A New Approach to Federalism

SCHIP, enacted as part of the Balanced Budget Act of 1997, enabled states to expand coverage for children. Alan Weil and Ian Hill examine the program and ask whether the model has promise for further expansions of health insurance coverage. States responded to the new opportunity enthusiastically, and most of them implemented the program rapidly. Enrollment grew slowly at first but reached 3.6 million by June 2002. States made major efforts to improve outreach and simplify enrollment procedures, and more than a dozen states have extended coverage to children with family incomes of more than twice the federal poverty level. Other states have extended coverage to parents of SCHIP enrollees, arguing that it will lead to greater participation among children.

States could impose premiums and cost sharing in amounts up to 5 percent of family income, but few did so. Analysis of benefit packages finds that non-Medicaid-based SCHIP programs have extended very broad benefits to children. In addition, a positive relationship has developed between states and the federal government, unlike the often contentious and adversarial relationship surrounding the Medicaid program.

The program does face challenges. The first is the formula for allocating federal funds to the states. The original intent was to base allocations on the number of low-income uninsured children in a state, as well as the number of all low-income children in the state, with a gradual shift toward the latter. States that had already expanded Medicaid coverage had fewer low-income uninsured children and were thus penalized for their earlier generosity.

Another potential limitation is that SCHIP is not an entitlement program, so states can cap enrollment. With the weakening economy, some states are planning to freeze enrollment and to lower eligibility limits and benefits. The inability of eligible families to enforce a right to services has not been a problem so far, but it could emerge.

There are several reasons for the apparent success of SCHIP. States are attracted to the program because of its high matching rates and the increased flexibility it gives them. The design allows governors and key legislators to do something for children, a politically popular group. The capped appropriation limits the exposure of the federal government, making Congress feel that the program is more controllable than an entitlement program would be. The capped federal appropriation also limits state incentives for manipulating the financing system, as has occurred with Medicaid DSH and UPL payments. States find the funding limits acceptable because they can cap enrollment or adjust benefits. However, once the population becomes used to the extended coverage, capping enrollment and reducing benefits may be more politically problematic, despite the authority states have to use such mechanisms.

It may be difficult to extend the SCHIP model to other populations, the authors contend. While federal matching rates are high, a state contribution is still required—and for a broad expansion beyond low-cost children, those expenditures could be quite high. Caps on federal spending translate into financial and political risks for states. In addition, groups such as low-income adults without children are not as popular politically as children and their parents. Economic conditions are not as positive as they were when SCHIP was launched, and they may not be for some time. Nonetheless, it is plausible that the higher federal matching payments and greater flexibility in program design, coupled with the pressures that the large low-income uninsured population places on health care institutions within the state, would make SCHIP an attractive model for coverage expansions.

Making Medicaid a National Program: Medicare as a Model

Extending federal funding to much of the Medicaid program through a Medicare-like administrative structure might be a way of improving on current arrangements while giving the states fiscal relief. Marilyn Moon examines the many ways in which this could be done. The federal government could provide an acute care benefit much like Medicare's, perhaps with prescription drugs and some preventive services, and with uniform eligibility criteria across the country. For example, coverage might be extended to all children and pregnant women with incomes as high as twice the poverty level and to all adults with incomes up to the poverty level. Medicaid benefits not included in the new federal program could continue to be provided by states with federal matching payments. Provider payment rates would be based on methods used by the Medicare program.

A federal structure would have the advantage of providing uniformity of core coverage and benefits. Unlike the considerable variation that exists in the current Medicaid and SCHIP arrangements, a federal program would treat all Americans the same no matter where they lived. The financing of the program would be more equitable because it would rely on more progressive federal personal and corporate income taxes, both of which have broad revenue bases. The federal government also has the advantage of being able to incur budget deficits, allowing the system to more easily maintain coverage and benefits during economic downturns.

The program would also benefit from having consistent rules and regulations across states; rules covering payment systems are an example. A federal program could improve coordination of services provided to elderly and disabled persons who are currently eligible for both Medicare and Medicaid. Finally, a central program would benefit from economies of scale in program evaluation, systems development, and refinement of administrative and payment structures.

The disadvantages of a federal model center on the fact that health care is delivered locally. The states differ in their reliance on hospital inpatient care, the importance of specialists as opposed to primary care physicians, and the extent to which managed care has penetrated the health care market. Medicaid allows states to adapt more readily to local conditions and permits more program innovation than a federal model would. Change is arguably harder in a federal program because national politics are more polarized and the implications of any significant change are so far-reaching. Medicare still lacks a drug benefit and protection against catastrophic illness, despite years of debate.

A final concern is that national minimum standards of coverage would probably be set below the level of the most generous states. In fact, states that have greatly expanded their coverage could maintain current standards only by using their own funds, and they might well choose to cut back. This could be avoided if the national program were structured in a way that created few losers among the states. But a policy that creates only winners will be very costly for the federal government, particularly if eligibility is expanded significantly in the new acute care program.

Alternative Models of Federalism: Health Insurance Regulation and Patient Protection Laws

Even as Medicaid policy has shifted toward more state control, regulation of health insurance has moved toward a stronger federal role. Randall Bovbjerg (Chapter 11) traces federal and state actions over time and shows that federal insurance regulations have increasingly preempted state roles, thereby increasing standardization of regulatory policy. In general, federal regulations have moved toward enforcing desired policy results on a national basis, typically through setting minimum national standards.

Prior to the 1970s, the federal government completely deferred to state authority to regulate health insurance. Then, a series of acts changed the federal-state balance. In 1973, the federal Health Maintenance Organization Act forced states to allow new forms of insurance and service delivery previously barred in some states. In 1974, the Employee Retirement Income Security Act (ERISA) wholly preempted state regulation of employee health benefit plans in favor of federal oversight. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) created a new set of federal obligations, both for states and for private providers of insurance coverage, primarily designed to cover enrollees who left their jobs. More recently, proposed patient protection legislation has built upon the HIPAA model.

The HIPAA model changed federal-state relationships in two primary ways. First, it set national minimum standards for all health coverage affecting the general population, including HMOs and conventional insurance. Second, the new federal rules were designed to be implemented by the states, although they could choose not to do so. States that did not choose to implement HIPAA would get federal implementation instead, so the standards are effectively national. States could impose more stringent requirements and could choose among a variety of ways of ensuring insurance availability for individuals.

The evidence shows that state innovation often spread, consistent with the idea of states as laboratories of democracy. The federal government often followed the lead of pioneering states. For example, HIPAA adapted some state individual and small group insurance market reforms and applied them nationally.

The primary lesson Bovbjerg draws from health insurance regulation and patient protection laws is that, while federal policymakers have often adapted state methods for federal use, they have also overridden the states when they perceive a national interest. HIPAA and the patient protection bills are models of minimum standard setting by the federal government and of implementation by the states. Because the standards are minimums, states can go beyond them. Variation in regulations across states is reduced but not eliminated.

The Future of Federalism in Health Care

The final chapter reviews state performance under Medicaid and SCHIP and discusses where federalism in health care should go from here. Alan Weil, John Holahan, and Joshua Wiener conclude that the current federal-state partnership in health care has a decidedly mixed record. The current system has many strengths—it covers 35 million low-income Americans, supports the nation's long-term care system, provides an extensive range of acute and long-term care services to low-income disabled persons, and underpins, directly and indirectly, safety net hospitals in urban and rural areas. But the system also has numerous problems: the poor public image in many states, the substantial pressure on state budgets, the great differences in health coverage and benefits among states, the limited amount of state innovation, and the DSH and UPL arrangements that have allowed states to garner large amounts of federal dollars with little or no contributions of their own.

The current system provides a base, but it has proven a difficult base to build upon. Both the federal and state governments are reluctant to extend Medicaid to other uninsured populations and to aggressively change the balance of services in long-term care. Because of the large fiscal shortfalls they will face for the foreseeable future, states may not even be able to maintain their current levels of coverage and benefits. The innovations and the will to expand coverage that are analyzed in this book are probably as good as it gets, which leaves huge chunks of the population uninsured and without adequate services.

For these reasons, the present system of care for low-income people needs a stronger federal role—both in setting higher minimum standards for coverage and benefits and in providing financing. Two proposals along these lines are put forth.

The first proposal would redefine the base of Medicaid and SCHIP coverage while giving the states incentives to extend coverage further. For example, minimum eligibility standards would be set at twice the FPL for children and at the FPL for all adults, and the federal government would define a set of benefits for people who meet the standards. The current federal entitlement to coverage would remain in place. States could extend coverage beyond the federal base of eligibility as high up the income scale as they wish. They could impose copayments, premiums, limits on benefits, and enrollment caps on groups with higher incomes. Federal matching payments would be 15 percent higher than they are under Medicaid. The federal government would also take over all financial responsibility for Medicare-covered acute care services and prescription drugs for persons who are eligible for both Medicaid and Medicare (dual eligibles). A new and expanded Medicaid home and community-based services program would be adopted, with the 15 percent higher federal matching rate. There would be minimum standards for payments to providers, but the current DSH program would be eliminated and perhaps replaced with a program that would provide grants directly to designated providers.

The second proposal would be to shift responsibility for a substantial portion of the health care safety net to the federal government. For example, the federal government could assume full responsibility for covering the acute care costs of the same groups described above: children with family incomes up to twice the FPL and adults up to the FPL. The federal government would finance and operate this program uniformly across states, alongside the current Medicare program. There would be a federally defined, comprehensive package of benefits and a uniform national system of provider reimbursement. As above, the federal government would take over full responsibility for dual eligibles. States could continue to cover populations and provide benefits beyond the federally defined minimum, using the savings from the new federal program. Existing shared responsibility for long-term care would remain in place, but the new program for home and community-based services described above could be included as an option. The DSH program would be eliminated, as described above.

These basic goals could undoubtedly be achieved in other ways, but either of these approaches would provide fiscal relief to states, ensure a higher base of coverage, limit the extensive disparities that exist today, and eliminate at least some of the financial machinations that plague the current system. If the federal government wanted to expand coverage further, it could do so by increasing minimum coverage levels, through tax credits to individuals or through block grants or matching grants to states. Either option would be a major departure from the current system, and the cost to the federal government would be substantial. But if the current problems in financing health care for low-income people are to be successfully addressed, a greater fiscal and programmatic role by the federal government is essential.


1. Authors' estimates of full-year equivalents based on the enrollment projections in the Congressional Budget Office (CBO) March 2002 baseline.

2. Authors' estimates of total Medicaid expenditures in 2002 based on the CBO March 2002 baseline estimate of federal expenditures.

3. Calculations from the 2002 Current Population Survey.

4. Urban Institute tabulations of the 1996 National Hospital Discharge Survey.

5. Authors' calculations from Centers for Medicare and Medicaid Services data.

6. CBO March 2003 baseline.

7. Section 1931 of the Social Security Act requires states to provide coverage to families that have income and resources that would have qualified them for Aid to Families with Dependent Children under the state's welfare plan, effective as of July 16, 1996, but also allowed them to use "less restrictive methodologies" for counting income and resources in determining eligibility.


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Davidoff, Amy, A._Bowen Garrett, Diane Makuc, and Matthew Schirner. 2000. "Children Eligible for Medicaid but Not Enrolled: Health Status, Access to Care and Implications for Medicaid Enrollment." Inquiry 37(2): 203-18.

Dubay, Lisa, and Genevieve M. Kenney. 2001. "Health Care Access and Use Among Low-Income Children: Who Fares Best?" Health Affairs 20(1): 112-21.

Holahan, John. 2001. "Health Status and the Cost of Expanding Health Insurance." Health Affairs 20(6): 279-86.

Newacheck, Paul W., Jeffrey J. Stoddard, Dana C. Hughes, and Michelle Pearl. 1998. "Health Insurance and Access to Primary Care for Children." New England Journal of Medicine 338(8): 513-19.

Rosenbach, Margo_L. 1989. "The Impact of Medicaid on Physician Use by Low-Income Children." American Journal of Public Health 79(9): 1220-26.

Federalism and Health Policy, edited by John Holahan, Alan Weil, and Joshua M. Wiener, is available in paperback from the Urban Institute Press (6" x 9", 446 pages, ISBN 0-87766-716-0, $34.50). Order online or call (202) 261-5687; toll-free 800.537.5487.

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