The five-year plan to balance the federal budget requires Medicaid savings of approximately $16 billion. The compromise between President Clinton and Congress generated savings from increased state flexibility and limitations on disproportionate share hospital (DSH) payments rather than imposing caps on the increase in average federal Medicaid expenditures per enrollee. This paper analyzes several issues: imposition of limits on the growth in average expenditures; reduction in DSH payments; expansion of state flexibility in managing the Medicaid program; and use of some of the savings to encourage states to expand health insurance coverage for children.