Lesson 2: How is Medicaid financed?

You must first complete Lesson 1: What are the major regulations for Medicaid? before viewing this Lesson

Lesson Goal


For you to understand the way Medicaid is paid for, including differences in state’s use of federal funds.

Lesson Summary


Medicaid is paid for through a complicated system of financing mechanisms, calculations and processes. The federal share of Medicaid is provided using a calculation called the Federal Assistance Matching Percentage. The state share of Medicaid costs is managed using various mechanism including taxes on providers, contributions from local governments and transfers across state agencies. State budget processes for Medicaid funding vary from state to state, but usually involve an ongoing effort to estimate how much the program will cost, with multiple stakeholder groups participating.

The Big Topics in This Lesson


1- The Federal Matching Assistance Percentage

The information under this topic explains how this calculation is used to determine the amount of Medicaid costs the federal government will pay.

2- State Budget Processes

The information under this topic introduces key concepts about how states budget for their share of Medicaid costs.

3- Other Financing Mechanisms- DSH, Provider Taxes, and IGTs

The information under this topic introduces some of the more complex financing mechanisms used to pay for Medicaid.

Lesson Video


Lesson Q & A


Click on each question to learn more

Q1: What is the Federal Matching Assistance Percentage (FMAP)?


FMAP is the percentage of Medicaid costs that the Federal government pays. FMAP is different for each state and is based on a calculation that accounts for the poverty level in each state. The lowest FMAP possible is 50%, and the highest possible (for non-enhanced FMAP programs, such as technology projects or Medicaid expansion) is 83%. Most states have FMAP of 60% or higher. In effect, the FMAP is used to “leverage” state funding. For example, in states like Alabama, where the FMAP is 70%, for every $1 that AL pays in Medicaid costs, the federal government will pay $2.30.

Q2: How is FMAP calculated for each state?


The FMAP formula divides the per capita income of a state to the per capita income of the U.S.. States with lower than average per capita income will receive more assistance from the federal government and states with higher average per capita income will receive less assistance. The formula also includes other factors to help smooth out results nationwide as well as favor poorer states.

Q3: What is “enhanced” FMAP? What types of things can a state get enhanced FMAP for?


CMS uses enhanced (higher) FMAP to encourage adoption of its (White House) policy priorities. States can receive much higher amounts of federal assistance for things like Medicaid expansion (100% FMAP for first few years, then 90%), CHIP services (avg FMAP of 88%) and implementing new technology systems (90% FMAP).

Q4: How do states budget for their share of Medicaid costs?


Most states have an annual process lead by the Medicaid agency and the Governor’s budget office. These stakeholders work together throughout the year to develop the Governor’s budget package, and this budget is then presented to the legislature. Depending on the state, the state Senate and House will also provide budget proposals and the annual legislative session is focused on arriving at an approved budget using the different proposed budget amounts. There are budget deficits in most states, and in many cases the deficit is driven by Medicaid spending. In these cases, the state must use monies for other items (such as education or roads), obtain additional federal funding (often from one time monies) or cut Medicaid spending. Very rarely do states cut Medicaid spending, although there may be attempts to reduce the rate of growth.

Q5: What are the recent trends in state Medicaid budgets?


Medicaid spending has consistently increased in size as a percentage of state budgets for most of the past 30 years. When looking at state general funds only, Medicaid grew from 5.7% of state budgets in 1987 to 15.1% in 2013. When looking at the full picture of state spending (including federal funds), Medicaid spending as a % of state spending grew from 10.2% in 1987 to 24.5% in 2013.

Q6: What are the steps in a state budget process related to Medicaid?


While each state is different, there are some general patterns. Usually there is a Governor’s Office of Planning and Budget (or similarly named group) that works with key contacts in the Medicaid agency each year to understand costs of the program including projected and recent costs. The Governor is then able to put together a proposed budget for Medicaid and present it to the state legislature during the legislation session. The state senate and house then usually review and revise the Medicaid budget based on the Governor’s proposal as part of the overall budget process for the state. Committees are usually convened to discuss details of program changes and requests for additional funding. Once a budget is passed and signed by the Governor it becomes law. The Medicaid agency will then be given detailed budget instructions based on the language in the approved law.

Some states pass two years of budgets at a time (bi-ennial) and some states pass only one at a time. For those that pass 2, they submit an amended budget the next year for the 1st year of the 2 year budget passed to reflect actual costs and updated efforts.

Q7: What are Medicaid Disproportionate Share Payments (DSH)?


Medicaid Disproportionate Share Payments (DSH) are additional payments made to hospitals that serve a higher percentage of Medicaid members than other facilities. DSH payments get federal matching dollars, and account for billions of dollars each year for additional hospital revenues (DSH spending was $17B in FY 2011). There are caps on total DSH payments set by Congress. One of the more impactful components of ACA (The Affordable Care Act, aka “ObamaCare”) is the incremental reduction in DSH payments over a period of several years.


Q8: What are Medicaid Provider taxes?


States can use a certain percentage of contributions from providers in order to fund the state share of Medicaid. Providers such as hospitals often agree to be “taxed” because the money they contribute is then matched by the federal government. In many cases, the providers then receive much more than they put in via the tax once the federal matching funds are applied and payments then distributed back to the providers from the Medicaid agency. There are federal regulations limiting the level of “tax” and there are often challenges in remaining compliant.

Q9: What are Intergovernmental Transfers (IGTs)?


IGTs are a funding mechanism where another governmental entity (for example a city or county government) transfers funds to the state Medicaid agency. These types of transfers are used as part of the state (or non-federal) share of Medicaid costs. IGTs are thus then eligible for federal matching funds.

Medicaid Dictionary

 New Terms from this lesson:

FMAP Federal Matching Assistance Percentage. A calculation used to determine how much money the state pays and how much money the federal government pays for a state Medicaid program.

State Share How much a state will pay for its Medicaid program each year.

GAO Government Accountability Office. A government agency that provides auditing and investigation services for the federal government.

DSH Disproportionate Share Payments. Additional monies that hospitals receive for serving a higher percentage of Medicaid or uninsured patients.

IGT Intergovernmental Transfers. Funding mechanism where another governmental entity transfers funds to the state Medicaid agency.

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