Bring Welform Reform lessons to Medicaid

Unfortunately, the body politic’s grasp of Medicaid lags about 20 years behind its understanding of welfare. The Left launches a fusillade at any mention of such heresies as applying the lessons of welfare reform to Medicaid. The New Republic’s Jonathan Cohn calls such an approach “heartless” and says that “rolling back Medicaid means the poor and disabled will have to confront medical bills alone. The bankruptcies will pile up, emergency rooms will get even more crowded, and, yes, some people will die.”

Rip van Welfare One wonders whether Cohn and others slept through the last ten years. During the welfare-reform debate, the Left predicted that scaling back federal cash assistance to the poor would be similarly disastrous. The most hysterical predictions were that one million children would be thrown into poverty and that the poor would be starving in the streets.

Welfare reform produced exactly the opposite of what the Left expected. Caseloads plummeted and poverty decreased — often dramatically — for every racial category and age, including children. Poverty remains lower today than at any point prior to welfare reform, going back to 1979. Many who opposed the 1996 law have since admitted that it accomplished a large measure of good. And evidence stemming from part of that law suggests that with regard to Medicaid, the Left is again misreading the tea leaves.

Though wholesale Medicaid reform was thrown overboard in 1996, the welfare-reform law contained a little-noticed provision that eliminated Medicaid eligibility for non-citizen immigrants. One person who did notice was Harvard economist George Borjas. He discovered that the result of this “draconian” measure was exactly the opposite of what many would predict: coverage among non-citizen immigrants increased.

Borjas explains, “The immigrants most likely to be adversely affected by the new restrictions significantly increased their labor supply, thereby raising their probability of being covered by employer-sponsored insurance. In fact, this increase in the probability of coverage through employer-sponsored insurance was large enough to completely offset the Medicaid cutbacks.”

The robust economy of the late 1990s cannot explain these results, Borjas argues, because states that offered coverage to those cut from the Medicaid rolls saw coverage levels for this group decrease, while states that did not saw coverage levels increase. As author Jason DeParle has written, “When welfare was there for the taking, they got on the bus and took it; when it wasn’t, they made other plans.”

Borjas notes that immigrants responded not just to the Medicaid cuts, but to all the changes in the 1996 law. Nonetheless, a natural experiment has demonstrated that Medicaid cuts produced exactly the opposite of what opponents would predict, and that — by at least one measure — the cuts were more compassionate than the program’s previous (supposed) generosity.

The Status Quo Prevails With these successes pointing the way, one might think Republicans would be eager to mount an all-out assault on Medicaid’s vicious cycle of inflating health-care costs and promoting dependency. Not so.

In its proposed budget for fiscal year 2006, the Bush administration backed away from its earlier reform proposals, which themselves were a watered-down version of what Republicans offered in 1995. Indeed, the budget laments that states have not done enough to expand Medicaid. It proposes additional state flexibility, but mostly in the service of such expansions. The CBO estimates the administration’s proposed reductions in future spending would amount to one half of one percent of Medicaid spending over the next ten years. Projected Medicaid spending fell by as much due to technical adjustments that CBO made in March to its baseline projections. The administration’s budget boasts that Medicaid “will continue to grow at a robust rate.”

The picture is no less bleak at the other end of Pennsylvania Avenue. After a tough negotiating session — with themselves — congressional Republicans have just agreed to a budget that reduces future federal Medicaid spending by less than one percent. Lest anyone think this constitutes a cut, instead of growing 41 percent by 2010, federal Medicaid spending will now grow by 39 percent — again, about the same as the change wrought by the CBO’s technical adjustments.

Some Republican governors, notably Florida’s Jeb Bush and South Carolina’s Mark Sanford, have proposed restructuring Medicaid benefits with health savings accounts (HSAs). Beneficiaries would receive money in an HSA to use toward copayments and deductibles, and could keep what they don’t spend. The idea is to give beneficiaries an incentive to be prudent consumers, and it builds on what seem to be successful “cash and counseling” programs in Florida, Arkansas, and New Jersey.

Yet this approach may trade one set of problems for another. Beneficiaries should be more careful shoppers if they share in the savings. However, the lure of cash benefits may lead to higher enrollment (only about half of Medicaid-eligible individuals are enrolled), longer enrollments (many beneficiaries only use Medicaid for brief periods), greater utilization of all available benefits, and greater dependency.

Real Medicaid Reform States should experiment with HSAs and other approaches, including different rules for different types of beneficiaries. Far more important than restructuring benefits, however, is reducing the reach of Medicaid’s perverse and harmful incentives.

First, Congress should stop encouraging Medicaid expansions by freezing payments to states at the 2005 amount, just as welfare reform froze payments to states at the 1995 amount. According to Congressional Budget Office figures, freezing federal Medicaid spending at 2005 levels would produce $941 billion in savings by 2015, or enough to wipe out 96 percent of the cumulative ten-year federal deficit.

Second, Congress should give states maximum flexibility to use federal funds to meet a few broad goals, as it did with AFDC’s replacement, the Temporary Assistance for Needy Families (TANF) program. Those goals should include:

targeting medical assistance to the truly needy; reducing dependency; reducing crowd-out of private effort, including charitable care; and promoting competitive private markets for medical care and insurance.

A necessary first step toward allowing states to focus resources on the truly needy would be eliminating the federal entitlement to Medicaid benefits, just as Congress eliminated the federal entitlement to cash assistance under TANF.

By themselves, these reforms would not alter a single state’s program. Each state would have the power to keep its program running (and growing) just as it would under current law. However, states likely will experiment with ways of providing efficient care to those who truly need assistance and encouraging private charitable care, without encouraging dependency, increasing health-care costs, or imposing a crushing burden on taxpayers.

To state plainly what it means to focus resources on the truly needy, states should use this new flexibility to remove from the Medicaid rolls all those who could obtain coverage elsewhere. To do otherwise robs taxpayers and diverts assistance away from those who need it more.

Opponents will argue that those who move from Medicaid to private insurance may end up with less coverage. But as important as how much coverage people have is how they obtain it. When people work and become more productive, both they and society benefit. Offering people Medicaid in lieu of (allegedly) inferior private coverage, on the other hand, tells them that the way to get more is by doing less: work less, save less, cultivate less self-reliance. That is a recipe for dependency.

Like welfare, Medicaid must be reformed for the sake of its recipients. The likelihood that anyone will soon offer this type of assistance brings to mind a passage from Charles Murray’s 1984 book Losing Ground, which is credited with sparking the welfare reform movement: “The real contest about the direction of social policy is not between people who want to cut budgets and people who want to help. When reforms finally do occur, they will happen not because stingy people have won, but because generous people have stopped kidding themselves.”

Setting Medicaid reform aside might have made political sense in 1996. It makes zero sense today. The Left may be forgiven for missing or misinterpreting the lessons of welfare reform, or the effects of Medicaid. Republicans, however, have little excuse. Republicans and moderate Democrats need to take stock of this program, take stock of themselves, and finish the job of welfare reform.

— Michael F. Cannon is director of health-policy studies at the Cato Institute. Parts I & II of this article are adapted from his upcoming book, Healthy Competition: What's Holding Back Health Care and How to Free It, co-authored with Michael D. Tanner (Cato Institute, forthcoming).

PART # I May 17, 2005, 8:05 a.m.
Welfare Reform’s Unfinished Business
Medicaid has to be reined in.
By Michael F. Cannon

I n the 40 years since it was created to provide medical care to the needy, Medicaid has metastasized beyond this narrow purpose. According to the National Association of State Budget Officers, in 2004 Medicaid surpassed elementary and secondary education as the largest item in state budgets, consuming an estimated $309 billion of tax revenue.

This would be less of a problem but for the significant portion of its budget that provides coverage to those who could obtain it elsewhere. The problem is not merely (or even principally) fiscal. Like other components of the old welfare system, Medicaid harms many purports to help by lulling them into dependency. And it constantly draws more Americans toward dependency through an ever-increasing tax burden and higher health-care costs.

For the sake of the truly needy and everyone else, Congress and the states should pare this behemoth down to a flexible program focused solely on those who cannot help themselves. The Left's predictable response presents only a minor obstacle to reform. Still intent on expanding the program to cover all Americans and thus deepening the crisis, Medicaid's apologists have nothing to offer but echoes of the dire and famously inaccurate predictions the Left made about welfare reform ten years ago. The real obstacles to reform are Republicans who are willing to accept the status quo.

Medicaid's Perverse Incentives
Medicaid operates much like other components of the old welfare system, notably the now-repealed Aid to Families with Dependent Children (AFDC) cash-assistance program. In each program, Congress created: a legal entitlement to benefits for anyone who meets the eligibility criteria; a scheme where the more money a state spends, the more it receives from Washington; and centralized control over how states run their programs. Each feature creates perverse incentives that increase Medicaid spending, overall health-care costs, and dependency on government.

Medicaid typically offers services to beneficiaries free of charge, which creates the program's first perverse incentive: encouraging beneficiaries to consume medical care without regard to cost. Requiring the truly destitute to contribute to the cost of their care is of course impossible, not to mention undesirable. Yet allowing 50 million Americans to consume care as if it were free brings its own raft of undesirable consequences.

As the RAND Health Insurance experiment demonstrated, removing price-sensitivity induces patients to consume more medical care — 43-percent more under the conditions tested — but fails to produce measurable health gains. Though few data exist for Medicaid, leading researchers at Dartmouth College estimate that 20 percent of Medicare expenditures purchase care that provides no clinical value.

Medicaid's second perverse incentive is that it discourages private efforts that provide for those who are eligible. Anyone who meets federal eligibility criteria (regarding age, income, assets, etc.), or a particular state's broadened criteria, is entitled to benefits, which encourages many to enroll even when they could obtain care and coverage elsewhere.

Researchers at the Robert Wood Johnson Foundation surveyed 22 leading studies on whether "free" government coverage crowds out private coverage and concluded that crowd-out "seems inevitable." While the scale is uncertain, over half of these studies found that expansions of public coverage were accompanied by reductions in private coverage. Some even found that enrollment growth in public programs was completely offset by reductions in private coverage. The lure of "free" medical care is a powerful draw, and an entitlement makes it impossible for states to focus resources on the truly needy.

The states' open-ended entitlement to more federal funding creates Medicaid's third perverse incentive. States receive an average of $1.30 from Washington for every dollar they spend. This encourages states to broaden their programs beyond what is necessary to assist the truly needy. According to the Urban Institute, close to one-fifth of Medicaid-eligible adults and children have private coverage, which strongly suggests that states have expanded Medicaid well beyond its original purpose.

Inflating Health-Care Costs
Medicaid undermines private health insurance in more ways than just giving some people a "free" alternative. It also makes private health insurance more expensive by shifting part of its costs onto private parties.

Price controls enable Medicaid to pay below-market rates, and providers make up the difference by charging private payers more. Mark Duggan of the University of Maryland and Fiona Scott Morton of Yale University estimate that Medicaid increases the price of non-Medicaid prescriptions by 13.3 percent. So if Grandma's medications cost her $1,000 per year, upwards of $110 of that is her contribution to Medicaid. When unleashed market-wide, this mix of inflated demand and cost-shifting makes private health coverage less affordable, particularly for low-income Americans who are already Medicaid-eligible or on the cusp of eligibility.

A convention among health policy writers is to hail Medicaid as the white knight that rescues the uninsured when employers find they can no longer afford private coverage. As Jonathan Cohn wrote in The New Republic this February, "If Medicaid hadn't grown to fill the yawning gaps in private coverage over the last decade, today we would probably have 50 million uninsured Americans instead of 45 million." It's a convention that turns reality on its head. Medicaid is a prime culprit behind rising health-insurance premiums.

Promoting Dependency
Because Medicaid is a means-tested program, many beneficiaries become or remain eligible by avoiding constructive behaviors — such as earning, saving, and purchasing private insurance — that would make them ineligible.

Jonathan Gruber of MIT and Aaron Yelowitz of the University of Kentucky found that Medicaid beneficiaries save less and consume more in order to remain eligible. They estimate that in 1993, Medicaid reduced asset holdings among those eligible by the equivalent of $1,600 to $2,000 in today's dollars. Those disincentives are even greater today, thanks to subsequent expansions of eligibility and benefits.

The program also discourages private insurance for nursing home and other long-term care expenses. Jeffrey Brown of the University of Illinois at Urbana-Champaign and Amy Finkelstein of the National Bureau of Economic Research found that 60 percent to 75 percent of the benefits from private long-term care insurance "are redundant of benefits that Medicaid would otherwise have paid." They estimate that Medicaid by itself discourages 66 percent to 90 percent of seniors from purchasing such insurance. Even seniors with considerable means are able to avoid tapping those resources; gaping loopholes in asset tests make them eligible for Medicaid as well.

A Familiar Ring
The congruity with to the old welfare system could not be more striking. Medicaid encourages the poor — and the not-so-poor — to become dependent on government. It encourages people to behave in ways that increase the cost of government and of health care, which makes self-reliance more difficult for their neighbors. And it encourages states to get more people to behave that way.

With so many similarities, many have proposed reforming Medicaid along the same lines as welfare: end the entitlement to benefits; eliminate open-ended entitlement to matching federal funds by capping federal payments to the states; and give states greater flexibility to pursue a few broad goals. This was the Republican plan in 1996 before President Clinton threatened to veto welfare reform if it included Medicaid reform. Perhaps wisely, Republicans sacrificed Medicaid reform and reformed welfare.

Yet if Republicans were intent on enacting meaningful Medicaid reforms ten years ago, and welfare reform was an enormous success, why are we no closer to Medicaid reform today?

[EDITOR'S NOTE: Read part II of this article tomorrow...]

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