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John Hanna/AP

(Read caption) Mark Dugan, left, an assistant secretary in the Kansas Department of Health and Environment, discusses contracts awarded to private companies to manage the state's Medicaid program, as Susan Mosier, right, KDHE Medicaid services director, watches in this June 2012 file photo. States are now deciding if and how to adapt their Medicaid programs in light of the Supreme Court's ruling on health care reform.

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For months, astute observers called Medicaid the “sleeper issue” of the Supreme Court’s Affordable Care Act deliberations.  Last Thursday, they were proven correct.  A majority of the Supreme Court struck down a provision of the law giving the Health and Human Services Secretary authority to pull all federal Medicaid funds from states refusing to extend eligibility to low-income, non-elderly adults.

The ruling was surprising for several reasons.  First, starting with land grants for public colleges and universities and continuing through to the interstate highway system and social safety net, the federal government has a long history of conditioning state and local grants on acceptance of its rules.  A prime example is federal funding for K-12 education under the No Child Left Behind program.

This is also how Medicaid has operated since its inception in 1965.  At the time, Congress explicitly reserved to itself the “right to alter, amend, or repeal any provision.”  Indeed, it has exercised this right several times, expanding eligibility to low income pregnant women and various groups of children in the 1980s and 1990s.  Some expansions came with carrots (promises of extra money) and some with sticks (threats to existing funds).

But the majority held that this expansion was different, not just tinkering around the edges but fundamentally changing the program’s identity.  What’s more, because Medicaid has grown so big (it was states’ single largest budget item in FY 2010, including federal funds) and so much a part of state law, giving the HHS Secretary discretion to yank federal funds amounted to an order, even an existential threat (a “gun to the head” or “your money or your life” proposition). 

But the same could be said of the federal tax code, which provides states with various expensive goodies (deductibility of state and local taxes, exemption of muni bond interest from federal income taxes) and whose very existence is a huge subsidy (because states can piggy back off of federal definitions and administration).  Numerous budget commissions and task forces have put these subsidies on the chopping block, and at a recent hearing Senator Max Baucus suggested he might do the same.  Are these changes now also off the table?

Moreover, in both cases, this symbiosis between states and the federal government developed over time because states said “yes” to federal support.  With Medicaid, this relationship was severely tested in the Great Recession, when states had to plug massive budget holes but could not cut Medicaid eligibility because of federal program requirements.  Several state Medicaid finance directors openly discussed rejecting federal funds to get out from under these requirements.

However, quitting Medicaid was never a real possibility. States needed the money to take care of individuals who would otherwise go untreated and care that would go uncompensated. 

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Now, as then, states will take the federal money, especially in light of longer term fiscal strains like rising health care and retirement costs.   This won’t be easy.  As with any federal grant program, subsidies set out in the Affordable Care Act (100 percent, declining to 90 percent in 2020 and thereafter) are not guaranteed over time. 

Another source of uncertainty is what the newly eligible population, and others who come out of the wood work, will look like.  Evidence from Arizona suggests some low cost young adults and some higher cost near-elderly with chronic health needs.

Some governors and lawmakers have already said their states will decline to participate in the Medicaid expansion.  But eight states have already gotten started on extending eligibility through waivers programs and another three are in the queue.  Notwithstanding the highest court in the land, the whole Medicaid package is still an offer states can’t refuse.