America spends around $500 billion annually on Medicaid, the government health insurance program for the poor and disabled.  Despite this expenditure, Medicaid delivers poor coverage and medical outcomes for low income Americans, as I discussed last time.  Fortunately, reform offers the potential to curb spending and improve the quality of care.

Medicaid is a joint state and Federal program, with states operating programs under Federal rules.  Washington provides around 60% of the funding through matching grants, under which every dollar a state spends is matched by Washington.  States have different matching rates based on state income.  The highest income states get a $1 for $1 match, while Mississippi gets about $3 for each dollar spent.

Matching grants encourage extra spending.  The reason is simple: states only pay half (or less) of every extra dollar spent.  Half or more of savings from cutting waste also returns to Washington.  By distorting decisions about spending or cutting waste over time, matching grants lead to excessive spending.

The important question, though, is what portion of today’s Medicaid spending is attributable to matching grants.  Economists have authored numerous studies exploring the causes of the growth of Medicaid.  In a study just published by the Mercatus Center, I reviewed these studies for evidence of an impact of the matching grant structure on spending.

Differences in spending across states provide the best documentation of the role of matching rates, party politics, and interest group lobbying.  But a complication arises.  The Federal government mandates coverage certain for groups (for example, low income children and pregnant women) and treatments (like hospitalization), while other groups and treatments are optional.  State factors will likely affect only optional spending.  Research studies focusing on optional spending do reveal significant effects of party control of state government, the matching rate, and interest groups on differences in spending.

The interest group effects provide insight into an otherwise surprising aspect of Medicaid.  Although Medicaid is frequently described as for low income Americans, almost two thirds of spending is on the disabled and elderly.  Many political observers concur that the poor are a weak interest group, and they appear to lose out in the competition for Medicaid dollars.

States with the best matching grant rate spend more than high income states, but since all states get at least a dollar for dollar match, even high income states spend more than they might otherwise.  This helps illustrate why Medicaid has failed to equalize spending between high and low income states, which was the rationale for low income states’ more favorable match.  High income states secure a large share of Federal dollars for themselves by covering optional groups and optional procedures.  The Affordable Care Act sought to make adults in all states who earn up to 138% of the poverty level eligible for Medicaid, but several high income states already covered adults beyond this level.

Block grants, which fix the level of Federal aid to a state for several years at a time, provide an alternative way to distribute money.  Importantly, the Federal grant does not increase if a state spends more.  Block grants encourage responsible spending by having states pay the full cost of optional spending and keep the savings from cutting waste.

The idea of replacing matching grants with block grants is not new.  Welfare reform under President Bill Clinton involved this change, which has helped check spending growth.  Rhode Island has experimented with block grants for Medicaid.

Block grants could help direct more Federal dollars to low income states, enabling higher reimbursement rates to doctors and hospitals for Medicaid patients and improve health care outcomes.  Adjustment of the block grant amount for changes in the poverty rate or health care inflation can ensure that states have extra dollars when a weak economy increases eligibility for Medicaid.

Reform is sometimes a code word for cutting government services.  But ending the Medicaid match game could help deliver better care for low income Americans and curb spending growth.

Daniel Sutter is the Charles G. Koch Professor of Economics at Troy University and host of Econversations on TrojanVision.  His study “The Political Economy of Medicaid Expansion: Federalism, Interest Groups, and the ACA” is available at http://mercatus.org/