Tag Archives: Rhode Island

Are state lotteries good sources of revenue?

By Olivia Gonzalez and Adam A. Millsap

With all the hype about the Powerball jackpot, we decided to look at the benefits and costs of state lotteries from the taxpayer’s perspective. The excitement around yesterday’s drawing is for good reason, with the jackpot reaching $1.5 billion – the largest thus far. But most taxpayers will never benefit from the actual prize money, with odds of winning as low as one in 292.2 million for the jackpot. So if few people will ever hit it big, there must be other benefits for taxpayers to justify the implementation of lotteries, right?

Of the 43 states that implement lotteries, the majority of lottery revenues – about 58% on average – go to awarding prizes. A relatively small proportion (7%) is used to pay for administration costs, such as salaries of government workers and advertising. The remaining category, and the primary purpose of implementing state lotteries, is revenue for government services. On average, about one third of state lottery revenues is directed to state funds for this purpose. The chart below displays the state-level breakdown of lottery revenue for the most recent year that data are available (2013).

lottery sales breakdown

It is surprising that such a small portion of state lottery sales actually make it to state funds, especially considering how much politicians advertise the benefits of state lotteries. A handful of states direct more than 50% of lottery revenues towards state funds: Rhode Island, Delaware, West Virginia, Oregon, and South Dakota. The other 38 states allocate significantly less with Arkansas and Massachusetts contributing the smallest percentage, only 21%.

Many states direct their lottery revenues towards education programs. The largest lottery system, New York’s, usually directs about 30% of their lottery sales to this area. Similarly, Florida’s lottery system transferred about one third of their funds, totaling $1.50 billion, to their Educational Enhancement Trust Fund (EETF) in 2013.

The data presented here are from 2013, so it will be interesting to see how the recent Powerball jackpot revenues will affect lottery revenues more broadly in the future, especially since the Multi-State Lottery Association reduced the odds of winning in October of 2015 in the hope of boosting revenues. State officials argue that reducing the chances of winning allows the prize to grow larger, which increases the demand for tickets and revenue.

The revenue-generating function of state lotteries makes them implicit taxes. The portion of revenue generated from a state lottery that is not used to operate the lottery is just like tax revenue generated from a regular sales or excise tax. So even if lotteries are effective at raising revenue, are they effective tax policy?

Effective tax policy should take into account the tax’s ability to generate revenue as well as its efficiency, equity, transparency, and collectability. Research shows that state lotteries fall short in most of these categories.

The practice of dedicating portions of tax revenue to specific expenditure categories, also known as earmarking, can be detrimental to state budgets. Research that looks specifically at the earmarking of lottery revenues finds that educational expenditures remain unaffected, and sometimes even decline, following the implementation of a state lottery.

This result is due to how earmarking changes the incentives facing politicians. A 1999 study compares the results of lottery revenues directed specifically to fund education with revenues going to a state’s general fund. Patrick Pierce, one of the co-authors, explains that when funds are earmarked for education they go to the intended program but, “instead of adding to the funds for those programs, legislators factor in the lottery revenue and allocate less government money to the program budgets.”

Earmarking also affects total government expenditures, even though from a theoretical perspective it should have little effect since one source of funding is just as good as another. Nevertheless, many empirical studies find the opposite. Mercatus research corroborates this by demonstrating that earmarking tends to result in an increase in total government spending while having little effect on the program expenditures to which the funds are tied. This raises serious transparency concerns because it obscures increases in total government spending that voters may not want.

Last but not least, about four decades of studies have examined lottery tax equity and the majority of them find that lottery sales disproportionately draw from lower-income groups, making them regressive taxes. This only adds to the aforementioned concerns about the transparency, collectability, and revenue raising capabilities of lottery taxes.

Perhaps the effectiveness of lottery taxes can be best summed up by the authors of a 1993 study who wrote that “lotteries as a source of funding are neither efficient nor equitable substitutes for more traditional tax sources.”

Although at least three people walked away with millions of dollars yesterday, many taxpayers are not getting any benefits from their state’s lottery system.

Rhode Island to unionize daycare workers

Last week, the Rhode Island legislature passed a law to permit daycare workers who receive any subsidies from the state to either form a union, or join an existing union such as the SEIU. While they would not be eligible for state pensions or health benefits, and not permitted to strike, the law allows workers to collectively bargain over subsidies, training and professional development and “other economic matters.”

Daycare workers represent a target population for unions. A new law in Minnesota permits daycare workers to unionize so home providers can advocate for higher subsidy payments from the state. In New York in 2010, Governor Paterson pushed for daycare workers to pay union dues to the teachers’ unions in his 2011 budget proposal.

With Rhode Island in the mix, 17 states now permit or strongly encourage daycare workers to unionize. In the rush to unionize private business owners, the ostensible benefits – a voice in the legislature to lobby for higher state subsidies – are touted – and the costs are ignored For example, in Massachusetts, if a private daycare owner accepts clients who pay with state daycare vouchers, the daycare provider must be represented by a union and pay dues. These dues are skimmed off of the state subsidy for low-income parents which is paid directly to the daycare provider. To avoid unionization, the provider would have to turn away low-income families who receive state subsidies for childcare.

The SEIU claims unionization will improve the quality of childcare and offers economic justice for workers. But, the most dramatic result seems to be this:  where daycare workers unionize, the SEIU immediately gains a windfall of new dues transferred from a program meant to help low-income families pay for daycare, (to the tune of $28 million in Michigan, where similar legislation was recently passed).

As James Shrek writes in National Review, one of the more remarkable things about this effort is that it represents a new strategy by unions. The target group for unionization are private individuals or business owners who are also the recipients of government benefits. For instance, at one point in Michigan, a parent receiving Medicaid to care for a disabled child could receive SEIU representation. Some parents found the only result was a reduction in their monthly Medicaid payments and no representation, effectively, “forcing disadvantaged families to pay union dues out of their government benefits.”

As Shrek notes, the Minnesota law, which authorizes AFSCME to unionize in-home daycare providers, also potentially covers short-term summer camps, and grandparents watching their grandkids, or “relative care.”

Shrek asks, does this tactic represent a sign of desperation on the part of unions who are actively seeking new members to the point of organizing, “unions of one”? With a growing number of states joining the trend, it is worth watching how these laws affect those people and families that the unions are claiming to help.

 

 

 

 

Varying Priorities in Municipal Bankruptcy

On Monday Reuters reported that a federal judge has found Stockton, CA to be eligible for bankruptcy protection. This decision came despite protests from Wall Street arguing that the city had options available that would have allowed it to pay its creditors in full, such as raising taxes or cutting benefits for city employees:

Creditors have claimed a lack of good faith by Stockton in its decision to fully pay its obligation to the $254 billion Calpers system but impose losses on bondholders and bond insurers.

The expected move by the California city of 300,000 – along with Jefferson County in Alabama and San Bernardino in California – breaks with a long-standing tradition to fully repay bondholders the principal in most major municipal bankruptcies.

While both the judge and city manager Bob Deis have harshly criticized bondholders who refused to negotiate with the city before bankruptcy proceedings began, other cities have taken a very different approach to their creditors in the bankruptcy process. In 2011, the Rhode Island policymakers adopted a law that puts municipal creditors at the head of the line in municipal bankruptcy proceedings. In the state’s  Central Falls bankruptcy, the requirement to pay bondholders 100 cents on the dollar has meant that the city’s pensioners have taken steep benefit cuts, in some cases losing nearly half of their defined benefit pensions.

After Rhode Island enacted this law, the Wall Street Journal explained:

Despite the financial failure, Central Falls suddenly is attractive to some investors because the law makes them more confident about getting paid.

“If we can find someone selling, we will be a buyer” of Central Falls bonds, says Matt Dalton, chief executive of Belle Haven Investments, a White Plains, N.Y., firm with $800 million in municipal-bond investments under management.

The difference in legal climates for bondholders in Rhode Island and California unsurprisingly fosters different attitudes from creditors.  Former Los Angeles Mayor Richard Riordan explains the dangers of cutting off a city’s access to credit by failing to pay bondholders in full:

“I think the unions ought to be scared stiff. This could be a lot worse than just the pensions. What about government bonds? If government bonds can also be restructured, who will buy them?

“The city and the state all issue tax anticipation bonds to meet their payrolls, but if those can be restructured, no one will buy them. Think about what that means for libraries, parks, street paving, police. It will all be on the line.

While cities on both coasts are facing insolvency in their efforts to meet their obligations to their employees and their creditors, they vary in their approaches as to who is first in line for scarce tax dollars.

Third Edition of Freedom in the 50 States

Today the Mercatus Center released the third edition of Freedom in the 50 States by Will Ruger and Jason Sorens. In this new edition, the authors score states on over 200 policy variables. Additionally, they have collected data from 2001 to measure how states’ freedom rankings have changed over the past decade. While several organizations publish state freedom rankingsFreedom in the 50 States is the only one that measures both economic and personal freedoms.

Ruger and Sorens have implemented a new methodology for measuring freedom. While previously the authors developed a subjective weighting system in which they sought to determine how significantly policies limited the freedom of how many people, in this edition they have use a victim-cost method, assigning a dollar value to each variable that restricts freedom measuring the cost of restricting freedom for potential victims. The authors’ cost calculations are designed to measure the value of the states’ freedom for the average resident. Since individuals measure the cost of policies differently, readers can put their own price on each freedom variable on the website to find the states that best match their subjective policy preference.

In addition to an overall freedom ranking, Freedom in the 50 States includes a breakdown of states’ Fiscal Policy Ranking, Regulatory Ranking, and Personal Freedom Ranking. On the overall freedom ranking, North Dakota comes in first followed by South Dakota, Tennessee, New Hampshire, and Oklahoma.  At the bottom of the ranking, New York ranks worst by a significant margin, with rent control and burdensome insurance regulations dragging down its regulatory freedom score. New York is behind California at 49th, then New Jersey, Hawaii, and Rhode Island.

The authors note that residents respond to the costs of freedom-reducing policies by voting with their feet. Between 2000 and 2011, New York lost 9% of its population to out-migration. In addition to all types of freedom being associated with domestic migration, the authors find that regulatory freedom in particular is associated with states’ growth in personal income. They conclude:

Freedom is not the only determinant of personal satisfaction and fulfillment, but as our analysis of migration patterns shows, it makes a tangible difference for people’s decisions about where to live. Moreover, we fully expect people in the freer states to develop and benefit from the kinds of institutions (such as symphonies and museums) and amenities (such as better restaurants and cultural attractions) seen in some of the older cities on the coasts.

[…]

These things take time, but the same kind of dynamic freedom enjoyed in Chicago or New York in the 19th century — that led to their rise — might propel places in the middle of the country to be a bit more hip to those with urbane tastes.

Central Falls bankruptcy exit plan approved

In what is described as, “the quickest bankruptcy adjustment in U.S. history,” Central Falls, Rhode Island has reached an agreement to exit from bankruptcy with a plan that will fully repay bondholders (including any legal fees incurred), while slashing worker pensions by as much as 55 percent. None of Central Falls’ workers will get less than $10,000 and all will have to contribute 20 percent more for their health care until they are 65 and eligible for Medicare, according to Bloomberg News. The agreement was reached when the state promised to help supplement retiree pensions for five years.

Bondholders will be repaid via higher municipal taxes, or a four percent increase in property taxes each year for the next five years. No one escapes unscathed, except the bondholders, which is attributable to the fact that Rhode Island passed a law explicitly protecting them from municipal default last year. The bondholder protection law appears to have the intended effect with Moody’s promising to increase Central Falls’ credit rating.

Retirees are understandably upset but it’s important that the cause for plan underfunding be properly diagnosed. Accounting distortions rooted in risky discount rates are to blame. Central Falls’ Police and Fire Plan was deeply underfunded based on numbers that underestimated the liability. That is the lesson to be learned and the inescapable problem facing many other jurisdictions with defined benefit plans in the US. It is in the best interest of governments to accurately calculate their unfunded liabilities with reference to a risk-free discount rate and come up with a plan today. Waiting and gambling on a future market boom doesn’t do retirees any favors.

Waking Up Warwick, Rhode Island

Last week an article ran in the Warwick Beacon that was based on a chart I produced. I have since updated the chart to reflect the most recent FY 2011 numbers contained in the FY 2013 budget. (The first chart was based on the original FY 2011 budget.)

The chart shows Warwick, Rhode Island’s municipal budget (excluding the school budget) carved up according to current costs for funding the town’s pension benefits, Other Post Employment Benefits (OPEB), current employee healthcare costs and General Obligation bond payment. The figures come from official budget documents.

My value-added is that I estimate the additional amount needed to fully fund pensions based on the risk-free discount rate. It’s a ballpark estimate backed into based on the plans’ valuation reports. The actuaries, with access to all the plan data, can model the effect of applying the risk-free rate to plan costs more precisely.

It caused quite a stir.

I think the Beacon article shows the myriad problems with how public sector benefits have been valued, accounted for and funded. The piece underscores the misconceptions and cloudy thinking that surround pension finance.

Let’s go through it.

Here’s the question the chart addresses:  If Warwick, Rhode Island were to fully fund employee benefits while paying healthcare costs for current retirees and active employees and make its annual bond payment, how much would be left over to fund everything else in the city budget?

Warwick operates four public pension plans. They are the locally-funded: Firefighters/Police I Pension Plan, Fire II Pension Fund, and Police II Fund. The fourth plan, the Municipal Employees Retirement System (MERS) is jointly funded by the state and participating local governments. (correction: the MERS plan is also locally operated and funded and is distinct from the state-run MERS plan).

Using these plans’ assumed 7.5 percent discount rate to value the liability, only one plan appears to be in deep distress. The Police/Fire I plan is 22 percent funded and requires an annual contribution of around $14 million. The remaining plans seem to be relatively well-funded. Together they add a further $12 million in annual contributions. In total, according to the pension valuation reports for the town of Warwick, fully funding these four pension systems requires an annual contribution of $26.4 million from the city.

Now, when valuing these four systems using the risk-free discount rate, the picture changes. The risk-free rate adds a further $29 million to the annual required contribution. Valuing these plans on a market basis doubles the annual contribution to $55.7 million. That’s 48 percent of the town’s municipal budget in FY 2011.

Employees also receive Other Post Employment Benefits (OPEB) – largely comprised of healthcare – in their retirement. According to the OPEB valuation Warwick spends $7.2 million to pay for current retirees who are now receiving these benefits. (Note, that the budget gives a slightly different total than the OPEB valuation. In the budget,  OPEB ran about $6.68 million in FY 2011)  If the town were to fully fund OPEB benefits for their current workers they would need to contribute a further $14 million. That represents the amortization of OPEB taken from the valuation report.

On top of this Warwick is contributing $12.5  $11.8 million to pay for current employee healthcare benefits in FY 2011 (see, Annual Budget, FY 2013). I added in General Obligation debt (principle and interest payments) of $8.5 million, since I assume this is a non-negotiable expense for the municipality. That leaves Warwick with about 18 percent of its FY 2011 budget remaining.

(Are my numbers wrong? have a look at their reports and let me know if I have made a mistake.)

On the Beacon article, I will underscore three points.

1) The risk-free rate and why it matters. To value and fund a pension plan requires figuring out how much is needed to be set aside today to fund a promised benefit to be paid in future. One must equate the value of a pension to be paid in the future with its value today (the time value of money). That means one must assume a discount rate (i.e., rate of interest) to convert the future value into the present. That enables one to figure out the amount needed to be set aside today to fund tomorrow’s payments.

As most followers of the pension story know, in choosing that discount rate, public sector pension plans look to what rate of return they expect the plan’s assets will return when invested. Most public plans have assumed a rate of return of 8 percent on their assets.

This approach, embedded in GASB 25 and ASOP 27 has been strongly criticized by financial economists as violating several established precepts of economics. Firstly, assets and liabilities should be kept separate for the purpose of valuation, otherwise known as the Modigliani-Miller theorem.

Public pensions represent a secure, government-guaranteed benefit and are not likely to be defaulted upon. Public pensions should be valued like a government bond. The rate to use is the return on Treasury bonds, currently 2.3 percent.

But what policymakers are worked up over is not the economic principles behind discount rate selection. It’s the practical effect that many politicians and plan sponsors protest, as The New York Times story of yesterday highlights.  Lowering the discount rate increases the liability and the amount needed to fund the plan. That has a real impact on the budget, as the Warwick chart shows.

The best and most lucid explanation for market valuation of pensions, I think, can be found in Pension Finance, by M. Barton Waring. (whose intent, I might add, is to save the defined benefit plan.) Other excellent explanations are provided by Douglas Elliot of the Brookings Institute, economists Joshua Rauh and Robert-Novy Marx, Andrew Biggs, and Jeffrey Brown.

David W. Wilcox, the director of research and statistics for the Federal Reserve Board has stated:

 These [public pension benefits] happen to be really simple cash flows to value. They’re free of credit risk. There’s only one conceptually right answer to how you discount those cash flows. You use discount rates that are free of credit risk. This is one of those things where it just really is that simple.*

Now for a few common objections to the risk-free rate. These are perennial and have been very elegantly addressed elsewhere by economists.

2) “But, the private sector uses…”

Private sector defined benefit plans suffer from their own set of accounting and moral hazard problems; and, they use a variety of discount rates for a variety of reasons.

Pension plans governed by the Taft-Hartley Act are collectively bargained-for plans. These plans use the return on assets (7.5%) to value the actuarial liability. According to a March 2012 analysis by Credit Suisse, such discount rate “hocus pocus” means Taft-Hartley plans are now “crawling out of the shadows” with an unfunded liability of about $369 billion when using the corporate bond rate.

Other corporate pension plans are covered by the Pension Protection Act of 2006 and governed by FASB guidance 158. They use a composite return on corporate bonds to value their pensions, currently in the 5 percent range, which is lower than the rate used by public plans. The corporate bond is closer to a low-risk (though not a guaranteed) rate. Public plans carry a stronger guarantee, as they are backed by government, and therefore should be discounted using lower rates than used by the private sector – not a higher one – as is current practice.

 These different guidances explain the plethora of discount rates cited by public plan officials as justification for their current assumptions. And that leads to a great question.

So, why do public and private plans get to value their pension liabilities differently?” (Quick answer: exactly!)

If the Law of One Price is correct (which holds that in an efficient market there must be only one price for similar assets, otherwise opportunities for arbitrage exist) then then salad bar approach to selecting the discount rate is absurd.

The Long Answer:

Actuarial practice has not incorporated the lessons of modern portfolio theory into pension accounting. In the 1960s and into the 1970s the harm was not visible. Pensions were more heavily invested in bonds. The ticking time bomb that ‘high risk’ discount rates  presented to defined benefit plans was not really revealed until the behavior it encouraged began to manifest. These behaviors included the shifting of pension asset portfolios into more risky investments, enhancing benefits, and skipping payments during the 1980s and 1990s. The result was growing funding gaps that accompanied market downturns in the late 1990s, the early 2000’s, and lastly in 2008. Each of these episodes is a demonstration of the problem of valuing liabilities based on risky asset returns.

For some insight into how actuarial science remained largely frozen in time, Jeremy Gold and Lawrence Bader discuss the gap between corporate finance and actuarial practice.

3) “We’ll get the expected 7.5 percent”.

This is another recurring defense of the current public sector accounting. But, an investor doesn’t “get” the expected return. The investor realizes a random and uncertain draw from an increasingly wide distribution of possible realized returns (Waring, 2012).

An oft-expressed rejoinder is,  “…but the market returned an average of 8 percent over the past 20 years.”

This statement alone should be cause for alarm. There is always a chance you will either do better, or worse, than expected. Yet, by virtue of ASOP 27 and GASB 25 the risk of not achieving 8 percent annually, is simply ignored. (Or more accurately it is borne by future taxpayers and younger retirees.) Discounting benefits at a risk-adjusted interest rate captures the cost to taxpayers of having to supplement pensions should projected returns not be realized and the plan’s assets fall short.

The coming years will satisfy a proposition of Waring’s that I think is worth stating again:

Measures of the pension plan based on conventional accounting methods will always follow measures based on economic accounting, even with a lag. The accounting will follow the economics, sooner or later.

The economics on this issue is non-controversial. One can review the work of Nobel-Prize economists Bill Sharpe (one of the developers of the Capital Asset Pricing Model), Robert Merton, (expansion of Black-Schoeles option pricing model), as well as the contributions of finance professors Roger Ibbotson (Yale) and Olivia Mitchell (Wharton, UPenn) for further reading.

The policy message the economics points to is unsettling. Defined benefit plans are in trouble and they will require more funding and difficult budget and policy decisions starting now.

And, who really wants to hear that?

So, the best I can do to drive home the importance of market valuation is to re-state the analogy. You don’t calculate the employer’s annual payment to the pension system based on how the plan’s assets are expected to perform.  Just as you don’t value your home mortgage based on what you think your 401K might do. This video developed by Nobel-Prize winning economist Bill Sharpe makes the case perhaps better than I can do in this blog.

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*Wilcox, David. Testimony before the Public Interest Committee Forum sponsored by the American Academy of Actuaries, September 4, 2008. Novy-Marx and Rauh present a similar argument; see Novy-Marx, Robert, and Joshua Rauh, “The Liabilities and Risks of State-Sponsored Pension Plans,” Journal of Economic Perspectives, vol. 23, no. 4 (Fall 2009), pp. 191–210. In analyzing federal employee pensions, the CBO used a discount rate 1 percentage point above the Treasury rate. However, the CBO explicitly noted that this was because federal pensions lack the legal protections that state pension plans like the WRS are entitled to.

Do video game makers need subsidies from Rhode Island?

Curt Schilling is a former Red Sox pitcher. In 2010, his video game production business, 38 Studio was enticed to move from Massachusetts to Rhode Island with a $75 million loan guarantee from the state’s Economic Development Corporation (EDC). The bet Rhode Island placed was that 38 Studio (named after Schilling’s Red Sox number) would bring 450 jobs to the Ocean State. On May 1, the company failed to make a $1.1 million payment to the EDC. If the company tanks, Rhode Island taxpayers must pay for the loan. Schilling would like another chance and met with the Governor today to discuss further subsidies for the company’s second game, Copernicus. To his credit, Governor Lincoln Chafee was opposed to the initial loan guarantee which was made by his predecessor.

Rhode Island is of course not the only state with Economic Development Corporations offering taxpayer-subsidized corporate bait to lure companies into their states with the promise of jobs and prosperity. Policymakers simply do not think there’s any harm in it. But as Rhode Island’s bet on Schilling’s company shows – unless the party making the loan (the EDC and former Governor Carcieri) has skin in the game (in the form of their own capital) the potential for moral hazard exists. That is, the risks of a potential loss are downplayed or ignored by government officials because they are being borne by another party – the taxpayer. Moral hazard may also encourage the company getting the subsidized loan to take on undue risk.

Put this subsidy in the context of what taxpayers are already facing in Rhode Island. Pension and health care obligations rising quickly at both the state and municipal levels. Providence, West Warwick and Woonsocket are all perilously close to bankruptcy.

Scott Shackford at Reason sums it up thusly, “And while Rhode Island is throwing taxpayer money at elves and faeries, its cities are going bankrupt.”

And for more on how targeted subsidies produces distorted decision making read Matt’s work: Why Favor Manufacturing? and listen to his discussion with Kojo Nnamdi on Targeted Business Incentives and Transparency.

 

 

Potential Pension Cuts for Retired Teachers in Illinois

There was an interesting op-ed in the Chicago Tribune recently that points to the severity of Illinois’s pension mess. According to the Teachers’ Retirement System (TRS) in Illinois, if new revenues are not generated then benefits for current retirees may need to be cut via COLA reductions. This statement should not come as a surprise considering the state’s pension system is slated to run out of assets within the next decade.

As expected, however, teacher unions are unhappy with this discussion and have already deemed it unconstitutional. Unfortunately, because current benefits are protected in Illinois’s state constitution, this is a common fall back for nearly every argument against changes to the pension system.

Reducing COLA benefits may sound extreme but, as we already know, this type of reform was celebrated as a bipartisan success in Rhode Island last year. Unfortunately, during the same time, the Illinois TRS was releasing statements like this one:

The Tribune’s July 5 editorial ‘Rescuing public pensions’ is centered on the false premise that Illinois’ current pension plans for public employees are ‘doomed’ and unsustainable. The truth is that the state’s pension plans are sustainable.

One word comes to mind after reading that… scary. Illinois’s pension system is surely not sustainable. If the state continues to tell people that it is then the possibility for serious structural reform will become less likely. Reducing or suspending the COLA is one of many important steps that Illinois needs to consider.

Monday morning links

Demographic shifts in American metropolitan areas since 1950 via Demographia

Public Sector Inc post: The consequences of investment risk in public sector plans

Woonsocket, Rhode Island and talks of bankruptcy 

New federal school lunch rules: students must buy fruit and vegetables (even if they throw it in the trash)

Federal Medicaid Proposal Could Help State Budgets

Representative Todd Rokita (R-IA) has proposed a new bill, the State Health Flexibility Act that could vastly improve incentives in state Medicaid administration. The bill would convert Medicaid and the Children’s Health Insurance Program (CHIP) into a block grant program under which states would have the freedom to shape the program as they see fit. Additionally, up to 30% of the block grant could be transferred into the state general fund if state lawmakers could administer the program for less than the grant amount.

Currently, Medicaid operates a little bit differently in each state, but most states receive matching funds from the federal government at levels between 50% and 74% of what they spend out of the state budget. This set up encourages states to overspend on this program because the federal government pays them to increase spending.

This program would bring all states in line with reforms already implemented in Rhode Island and Washington. In a recent podcast, Scott Beaulier discusses some of the benefits that these states have acheived through reform, both in their budgets and in their healthcare outcomes.

The State Health Flexibility Act would save money for taxpayers at the state and federal levels by capping federal spending at its current nominal amount. Both inflation and GDP growth would serve to reduce real Medicaid spending at the federal level. By removing the incentive for states to increase Medicaid spending to receive federal dollars, the bill would also reduce spending at the state level. Furthermore, states would enjoy freedom to determine Medicaid and CHIP spending for themselves, better tailoring the program to meet their citizens’ specific needs.

Despite reducing Medicaid spending, this reform bill would provide better incentives for improved outcomes by shifting state focus from matching funds to better healthcare. In Rhode Island and Washington, Beaulier found that states used cost saving measures such as not allowing Medicaid patients to use emergency rooms for non-emergency care and encouraging preventative care, improving healthcare while saving money.

Current Medicaid spending patterns are unsustainable. The State Health Flexibility Act provides an opportunity to save taxpayers money, put state budgets on a saner trajectory, and improve health outcomes for benefit recipients.