The Economics Of Medicaid Expansion

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…

Read full story at Health Affairs (blog)

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