Medicaid Is Broken Because It Pays States to Break It
States exploiting the Medicaid funding mechanism undermines federalism.
Author’s Note: Hey everyone, first post here in a little while. I write when I can but otherwise need to make ends meet. Speaking of which, and in light of the flooding disaster in Central Texas, I ask you to consider making a donation to help my neighbors in the surrounding counties. TEXSAR is an Austin-based nonprofit specializing in emergency response that have deployed swiftwater rescue teams in the recovery effort. You can donate here.
This newsletter advocates for greater defederalization of policymaking as well as the denationalization of the political culture — but that recognizes the useful role the federal government has in redistributing resources from richer states to poorer states of the country. To create a sustainable system of federalism and distributed risk, the federal government cannot limitlessly bear the burden of protecting the vulnerable. And that’s where the so-called “big, beautiful bill” comes in.
Or should I say law, since the president signed it on Friday. The law didn’t expand a program or create a new one. It tightened the screws on one that had quietly spiraled out of control. Democrats denounced it as a cruel ripping away of care from the vulnerable. House Minority Hakeem Jeffries took a stand with a record-breaking floor speech in opposition to majority’s advancement of disruptive policies. But Republicans framed it as a return to sanity. The bill reins in pandemic-era Medicaid policies and forces states to take more responsibility for the benefits they offer. For years, Medicaid had drifted far from its intended purpose. This bill is the first serious effort to steer it back.
Medicaid was designed as a safety-net program: a shared federal-state effort to provide health coverage to low-income children, pregnant women, seniors, and people with disabilities. But after Obamacare expanded eligibility in 2014 to include able-bodied, working-age adults, that balance began to shift—especially financially. Historically, Washington covered about 60% of Medicaid costs, with states picking up the rest. But for the expansion population, the federal share jumped to 90%. That opened a new incentive: the more a state enrolled, the more federal money it could draw. States made money simply by signing people up.
The COVID public health emergency supercharged this. Congress offered states a 6.2 percentage point bonus in federal Medicaid funding—on the condition they keep recipients enrolled continuously, even if they no longer qualified. That emergency rule remained in place for over three years. Medicaid enrollment surged from 71 million in early 2020 to more than 94 million by early 2023. Much of that growth was legitimate. But a lot of it wasn’t. States had no incentive to verify eligibility, and federal rules barred them from doing anything about it. As long as someone was in the system, the state got paid.
Even before COVID, states had found another way to inflate Medicaid revenue: provider taxes. A state imposes a tax on hospitals or nursing homes, then uses that revenue to make inflated Medicaid payments right back to those same providers. Those higher payments trigger a flood of federal matching funds. Everyone wins—except the federal taxpayer. The providers break even (or profit), the states get a bigger match, and the illusion of fiscal effort is preserved. There’s no actual investment, no tradeoff made. It's a closed circuit of rent-seeking. And because this setup is so lucrative, both providers and states lobby to keep it going. Presidents Bush, Obama, and Trump all proposed limiting it. The liberal Washington Post’s Editorial Board even endorsed such a reform in 2012. Yet they remain central to Medicaid financing in nearly every state.
The new bill makes a small but serious move to curb this: it lowers the ceiling on provider taxes from 6% to 3.5% of a provider’s revenue by 2031. That might not sound dramatic, but it could reduce combined state and federal Medicaid funding by as much as $1.3 trillion over the next several years.
If Congress had left the system untouched, the consequences would’ve compounded. The Congressional Budget Office projects that federal Medicaid spending will be $1.2 trillion higher over the next decade than it was when President Biden took office. Most of that is driven by the expansion population and the open-ended incentives tied to their enrollment. And this surge isn’t helping those who need the program most. Research shows Medicaid expansion diverted resources away from the vulnerable. After expansion, Medicaid enrollees became markedly less likely to secure a doctor’s appointment, as able-bodied adults crowded out traditional recipients. Seniors and children increasingly wound up in ERs for routine care. Medicaid, in effect, became too generous where it shouldn’t be and too stretched where it mattered most.
The new law doesn’t fix all of this—but it changes the direction. It ends continuous coverage. It restores eligibility checks. But importantly it signals that if states want to expand their programs, they need to find the money to do it. There is nothing stopping states from tweaking revenue sources to create supplemental coverage outside the requirements of Medicaid. There’s nothing stopping states from organizing other means to fill gaps. What is fair is to say we can’t have states just riding federal funds with zero friction and zero downside or tradeoff.
Longer term, Medicaid needs a structural fix. Block grants or inflation-adjusted per-capita caps could align incentives better than the current match-rate model. At minimum, the federal match rate for expansion enrollees—now 30 points higher than for children or the disabled—needs to be brought in line with the rest of the program. Even President Obama floated that idea in 2012.
Federalism means giving states the freedom to shape programs. But it also means they should bear the cost of their decisions. If California wants to extend Medicaid to undocumented immigrants or offer long-term care to high-income residents, fine. But the rest of the country shouldn’t be footing the bill. That’s not sovereignty—that’s subsidy.
Too many governors and legislators have treated Medicaid as a tool for moral posturing, touting their compassion while offloading the cost to Washington. Provider taxes and inflated match rates let them expand benefits without raising taxes, cutting spending, or even telling voters what it costs. It’s not leadership—it’s arbitrage. The pandemic merely widened the gap between what states could promise and what they were actually willing to pay for.
If states want their sovereignty respected, they have to earn it. That means making hard budgeting decisions, accepting tradeoffs, and putting real political capital behind their social priorities. Federalism can’t just be a shield against federal overreach—it must also be a framework for responsibility. Because if state lawmakers are allowed to game the system while claiming virtue, then federal taxpayers will keep footing the bill for policies they never voted on. And eventually, that kind of “sovereignty” invites the very federal intervention they claim to oppose.
This new bill doesn’t end the games. But it finally puts a little skin back in. And that’s a start.
