Next steps: Implications of proposed changes in federal Medicaid financing on hospital services for children

As has been widely reported, major cuts to the Medicaid program are on the table in federal budget negotiations.1 While details are still forthcoming, among the proposals most discussed are changes in the structure of federal financing and restrictions on state financing mechanisms often used to pay hospitals. Medicaid is a core source of payment for hospital-based services, particularly for children, and changes in federal and state financing may have significant fallout for hospital services that could ultimately negatively affect children's health. While many people understand that funding cuts are on the table, fewer comprehend the mechanisms and details of how these cuts may be enacted; understanding these details can help connect the dots between federal debate and access to children's health care services. Medicaid provides health insurance for nearly 80 million people, including 38 million children.2 The program finances 19% of all US hospital expenditures3 but plays a larger role in children's hospital care. Medicaid covers over 4 in 10 births (and nearly half of births in rural areas),4 pays for over half of non-infant pediatric hospitalizations in the United States,5 and accounts for more than half (54.3%) of gross revenue to children's hospitals.6 Medicaid also finances ancillary and outpatient services related to hospital care for children (such as laboratory services, rehab services, or care coordination services), preventive and routine pediatric care, and community-based services to support children with special health care needs.7 Medicaid hospital payments are a mix of federal and state dollars. Within federal requirements, state have discretion in setting methods and rates for Medicaid hospital payment, including whether services are provided under fee-for-service or managed care arrangements. The federal government then matches state Medicaid spending on an open-ended basis, with the share paid by the federal government ranging from 50% to 77% (federal shares are higher in lower-income states).8 States can finance their share of Medicaid through general revenues or other sources such as provider taxes, in which states use revenue from fees on health care providers to finance their share of Medicaid costs. In addition to base payments for hospital services paid through claims, states make Medicaid supplemental payments to hospitals. Medicaid supplemental payments are generally lump sum payments not tied to specific encounters, and they take various forms including disproportionate share hospital payments, upper payment limit payments, and uncompensated care pools. State use of supplemental payments is governed by federal regulations that essentially cap expenditures (specific rules vary by type of payment). While base payments are frequently below the cost of care for delivering services to Medicaid patients (leading to the so-called “Medicaid shortfall”), supplemental payments may bring reimbursement close to the cost of care for Medicaid patients. Nationwide, supplemental payments account for a substantial share (53%)9 of fee-for-service Medicaid hospital reimbursement, with wide variation across states. States may also make supplemental payments under managed care by including “state directed payments” (SDPs) in managed care contracts. Use of SDPs has grown in recent years, and in 2022, they accounted for over half of Medicaid supplemental payments to hospitals.10 A strong base of evidence indicates that, despite challenges with the Medicaid shortfall, Medicaid helps support hospitals and facilitates children's access to needed care. Research indicates that Medicaid can help reduce hospital uncompensated care and improve financial outcomes.11, 12 Medicaid's open-ended financing structure allows spending to adjust to emerging needs such as new technologies, innovative treatments, pandemics, or economic downturns. Flexibility in Medicaid hospital payment also facilitates value-based payment to promote population health, in which payments are tied to quality or population health outcomes, and has provided a lever for the federal government and states to direct dollars to providers in line with public health priorities. Importantly, Medicaid has led to long-term improvements in children's health outcomes13 that have been shown to extend into adulthood.14, 15 The most widely discussed proposed Medicaid policy change is the elimination of open-ended federal funding and institution of capped federal funding in the form of a “per capita cap.” Medicaid per capita cap proposals introduced in the past have limited aggregate federal spending to a state to a preset per enrollee cap times the number of enrollees (caps may differ for different enrollment groups). Per enrollee caps are based on past per enrollee spending and increased each year based on predetermined growth rates. Growth rates are typically set below predicted per enrollee spending growth, leading to lower federal expenditures relative to “baseline,” or currently budgeted amounts. In return, the federal government may offer states flexibilities in benefits or eligibility not allowed under current law. Proponents of this approach argue that it allows for state variation and ensures that federal spending grows with enrollment. However, per capita cap proposals are ultimately budget proposals that lead to decreased federal funds available for Medicaid over time. Analysis of the potential impact of Medicaid per capita caps estimates substantial long-term reductions in federal funds (up to 15% over 10 years from this provision alone16). States are unlikely to be able to make up this loss and will most likely need to reduce total Medicaid budgets (including state and federal dollars). The combined loss of federal dollars and commensurate state dollars in Medicaid could lead to reductions in Medicaid spending beyond just the federal cut. Other proposed federal budget actions target supplemental payments and aim to curtail state use of provider taxes. Such limits on state financing options could lead states to reduce their Medicaid spending, which would in turn reduce federal Medicaid spending. There is uncertainty in the potential scale of spending changes from these policies, but reductions could be hundreds of billions over time.17 While it is unclear exactly how states will respond to reductions in federal Medicaid funds, there are multiple potential impacts on pediatric hospital services. Most directly, hospitals face potential loss of payment. Provider rates are a common target for state budget cuts during Medicaid budget shortfalls, as they provide immediate savings and reduce per enrollee spending.18 Combined with potential limits on supplemental payments, rate cuts could exacerbate Medicaid shortfalls. Loss of payment would lead to financial hardship for providers, which in turn could exacerbate the reduction of pediatric hospital services at smaller or rural hospitals.19 Rate cuts could also limit Medicaid participation among community-based providers, putting further strain on hospitals or health systems that remain in the program. Medicaid service limits are also possible as, in the past, states have cut benefits in response to budget pressure.20 States may impose limits on hospital services, increase prior authorization requirements, or drop ancillary services that facilitate appropriate access to hospital care (i.e., prescription drugs or care coordination or home-based services provided through waivers), as they did during the Great Recession21; such changes could increase administrative burden on patients and providers in accessing services. While states generally try to maintain eligibility, states may respond to decreased federal funds for Medicaid by reducing enrollment. Eligibility restrictions will likely lead to loss of insurance coverage and could increase uncompensated care. Lastly, the use of per capita caps in Medicaid could pose a challenge to Medicaid's ability to innovate or adapt to changing technology or emerging threats in pediatric health care. Ultimately, state responses to decreased funds could negatively impact children's access to hospital-based care and health outcomes. While children account for a relatively small share of Medicaid spending, Medicaid is a central support for the system of child health services in the United States. Even with payment challenges, this system has improved children's health outcomes and continues to serve as a driver of advances in child health. Policy changes that limit provider payment (and potentially participation), impose barriers on services, or restrict coverage will reduce access to care for Medicaid enrollees, which has been shown to worsen health outcomes. Budget debate continues, and the question of whether these changes become law remains to be seen. Proposals to cap federal Medicaid spending through per capita caps have been proposed many times in the past, but the implications on state finances and enrollee access to care have led them to fail.22 While some may argue that these changes in program financing will merely make Medicaid more efficient or reduce waste, they will have implications for states' ability to finance children's health care services. Attention to the importance of Medicaid in supporting the system of care for children in the United States and advancing child health outcomes over time may help sway decisions in the current round of debate over federal financing. The author declares no conflicts of interest.