The Affordable Care Act (ACA), particularly the expansion of Medicaid, has created considerable controversy, with 20 states opting not to expand the program, leaving over 3 million Americans uninsured who might otherwise be covered by Medicaid. With the recent election in Kentucky threatening Medicaid expansion there, and ongoing debate about the future of the Medicaid expansion program in other states, the topic is likely to remain high on the policy agenda.
Often the opposition to Medicaid expansion is couched in economic terms, with statements about the inability of states to afford the cost of coverage. Specifically, while the Federal government pays 100 percent of the cost of Medicaid expansion for 2014 through 2016, that share falls to 95 percent in 2017, 94 percent in 2018, 93 percent in 2019, and levels off at 90 percent for 2020 and beyond.
The concern is that the state’s 10 percent share of Medicaid expansion spending could represent a significant expenditure that the state could not afford. If taxes were raised to cover the expense, those taxes would dampen economic activity and, to some extent, harm the very people the ACA is intended to help. While the magnitude of these effects is subject to debate, the notion that states must fund a portion of the costs of Medicaid expansion is correct.
The Multiplier Effect
Yet the analysis presented above is incomplete. Even in steady state beginning in 2020, the states that do opt to expand receive 90 percent of the funding for Medicaid expansion from the Federal government. Those dollars do not sit idle. They largely support provision of care, and the largest share of that expense is labor. The workers in organizations supported by Medicaid spend the funds on everyday expenses. They eat at restaurants, buy groceries, and go to movies. The businesses who supply those services, many of whom will be in-state entrepreneurs, in turn spend the money on wages and supplies, and the cycle continues.
In economics this process is known as the “multiplier effect.” A dollar put into an economy creates more than a dollar of economic activity. The magnitude of that multiplier is again subject to debate, but a reasonable estimate could be between 1.5 and 2.0. Thus after 2020, the 90 cents received from the federal government for each dollar in Medicaid spending translates to between $1.35 and $1.80 in state economic activity (crucially assuming enough slack in the economy to absorb the spending).
The state in turn taxes that extra economic activity. If the aggregate state tax rate (income tax plus sales taxes etc.) is 10 percent, then the extra economic activity generated by Federal government subsidy generates between 13 and 18 cents in tax revenue. The break-even tax rate (where added revenue due to induced economic activity equals the state share of spending) is about 7.5 percent, which is generally below the tax rate in many states.
Additional Economic Factors
There are also a number of broader economic factors to consider. For example, if Medicaid expansion induces previously Medicaid-eligible beneficiaries who were uninsured to enroll at the lower match rate, the state would have to finance that enrollment with less of an economic bounce. This is offset to some extent by federal support for programs otherwise funded by the state. Overall, with reasonable assumptions, a full accounting of the impact of Medicaid expansion on the state budget suggests states may break even, or even come out ahead, particularly if there is a lot of slack in the state economy.
In fact, more detailed analysis of the two states that experienced the biggest reductions in the uninsured rate, Arkansas and Kentucky, predicted that the state-tax revenue associated with expansion would rise $360 and $50 million over five years, respectively. In essence states are exporting care of low-income populations to other states, which benefits the state economy just as if they were exporting a different good or service.
This system may well be criticized because Federal subsidies must come from tax payers. But as long as the ACA stays in place, from the perspective of state taxpayers, those costs are largely fixed. State taxpayers are forced to pay for the care of low-income Americans in other states, so the only question is whether these taxpayers want taxpayers in the other states to also pay for their low-income people in their state. The basic nuance is that the economics of the ACA from a federal perspective is very different than the economics from a state perspective.
The preceding analysis is not intended to advocate for or against Medicaid expansion or the ACA framework. There are a number of broader issues. But on the narrow issue of the economics of Medicaid expansion within the ACA framework, the simple economic analysis gives at best an incomplete, and at worst an incorrect answer, and policymakers pondering these decisions should be aware of the full economic accounting.