Medicaid: States Use Illusory Approaches to Shift Program Costs to
Federal Government (Letter Report, 08/01/94, GAO/HEHS-94-133).

Medicaid, which provides health insurance for qualified low-income
persons, is jointly funded by the federal government and the states.
Because of soaring health care costs during the past decade, states have
been searching for new ways to help finance the $125 billion Medicaid
program. Some states are now using dubious financial arrangements to
collect federal funds without committing their own matching amounts,
thus increasing the share of Medicaid costs borne by the federal
government. This report (1) examines the financial arrangements used by
states to inflate the federal share of Medicaid program expenditures,
(2) describes the various techniques that states use to obtain federal
funds for their basic Medicaid and disproportionate share hospital
programs, and (3) looks into whether states are using their federal
matching funds to provide medical services to Medicaid patients.

--------------------------- Indexing Terms -----------------------------

     TITLE:  Medicaid: States Use Illusory Approaches to Shift Program 
             Costs to Federal Government
      DATE:  08/01/94
   SUBJECT:  Medicaid programs
             State-administered programs
             Funds management
             Federal/state relations
             Federal aid to states
             Cost sharing (finance)
             Health care services
             Questionable payments
             Program abuses
             Texas Disproportionate Share Program for State-Owned 
             Teaching Hospitals
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================================================================ COVER

Report to the Chairman, Subcommittee on Oversight and Investigations,
Committee on Energy and Commerce, House of Representatives

August 1994



Medicaid Financing

=============================================================== ABBREV

  DISPRO II - Disproportionate Share Program for State-Owned Teaching
  DSH - disproportionate share hospital
  FMAP - federal medical assistance percentage
  FY - fiscal year
  HCFA - Health Care Financing Administration
  HHS - Department of Health and Human Services
  OBRA-93 - 1993 Omnibus Budget Reconciliation Act
  PROPAC - Prospective Payment Assessment Commission

=============================================================== LETTER


August 1, 1994

The Honorable John D.  Dingell
Chairman, Subcommittee on Oversight
 and Investigations
Committee on Energy and Commerce
House of Representatives

Dear Mr.  Chairman: 

Because of increasing health care costs over the past decade, states
have been searching for new ways to help finance the $125 billion
Medicaid program, a jointly funded federal/state entitlement program
that provides medical assistance to low-income people.\1 For example,
states have used provider donations and imposed provider health care
taxes to obtain matching federal funds to help pay for services to
Medicaid patients. 

Since the late 1980s, the Health Care Financing Administration (HCFA)
has been concerned that the use of such funding mechanisms is
reducing the states' percentage share of Medicaid spending and, thus,
placing an inappropriately large share of the cost of the Medicaid
program on the federal government.  As a result, the Congress passed
the Medicaid Voluntary Contribution and Provider-Specific Tax
Amendments of 1991 (1991 amendments).  These amendments severely
restricted the use of provider-specific taxes and donations as a
source of state matching funds.  However, recent concerns have been
raised in the media and by others that states continue to benefit
from similar financing arrangements. 

Because of your concerns, we sought to (1) determine if states are
using financial arrangements that inflate the federal share of
Medicaid program expenditures, (2) describe various techniques that
states use to obtain federal funds for their basic Medicaid and
disproportionate share hospital (DSH) programs, and (3) determine if
states are using their federal matching funds to provide medical
services to Medicaid patients. 

As agreed with your office, we reviewed Medicaid records in Michigan,
Tennessee, and Texas.  In fiscal year 1993 these states accounted for
about 11 percent of federal and state Medicaid medical expenditures. 
In addition, we interviewed officials from HCFA, the three state
Medicaid offices, and the Prospective Payment Assessment Commission

In each state, we focused primarily on financing practices that were
allowed after the effective dates of the 1991 amendments.  Our work
was performed between June 1993 and March 1994 in accordance with
generally accepted government auditing standards. 

\1 Included in these expenditures are payments made under the
disproportionate share hospital (DSH) program that have increased
dramatically, from about $1.1 billion in fiscal year 1991 to about
$16.6 billion in fiscal year 1993.  This program provides
supplemental payments to hospitals that serve large numbers of
Medicaid and other low-income patients. 

\2 PROPAC, established by the Social Security Act Amendments of 1983,
advises the Congress and the Secretary of Health and Human Services
on Medicare and Medicaid issues. 

------------------------------------------------------------ Letter :1

On October 2, 1993, the state of Michigan made a Medicaid payment of
$489 million to the University of Michigan hospital that included
$276 million in federal matching funds.  Within hours, the entire
$489 million was returned to the state by the hospital.  In fiscal
year 1993, this and other such financial arrangements enabled
Michigan, Tennessee, and Texas to obtain about $800 million in
federal Medicaid funds without effectively committing their share of
matching funds. 

These types of transactions, which affect the amount of federal
dollars provided to match state funds in the Medicaid program,
effectively increased the federal share of Medicaid expenditures in
the three states.  In Michigan, for example, the federal share of
Medicaid expenditures effectively increased from 56 percent to 68
percent in 1993.  Although we concentrated our work in these three
states, HCFA and PROPAC officials told us that such practices are
also occurring in other states. 

Although the various financial arrangements generated about $1.3
billion in federal and state Medicaid funds, each state treated these
funds differently.  In Michigan and Texas, funds totaling about $1.2
billion were used to finance the states' Medicaid programs.  Without
these funds, the states would have had to appropriate additional
state funds or, given reduced federal funds, make cuts in their
Medicaid program.  In Tennessee, over $110 million went into the
state treasury where it lost its identity. 

HCFA has been concerned about these practices for several years and
has requested Michigan and Tennessee to provide additional
information on several of their financing arrangements.  Further,
recently enacted legislation will limit some of these practices. 
However, Michigan has already taken steps to ensure continuation of
its current federal Medicaid funding levels in 1995.  Rather than
making a single payment to the University of Michigan, the state is
proposing to make payments totaling about $590 million to over 90
government-owned hospitals and community health boards and have these
entities transfer almost all the funds back to the state. 

In our view, the Medicaid program should not allow states to benefit
from illusory arrangements where federal funds purported to be used
to benefit providers are given to providers with one hand only to be
taken back with the other.  Prohibiting such arrangements would
direct federal funds intended to cover costs of medical care to those
medical facilities that provide the care. 

------------------------------------------------------------ Letter :2

In 1965, Medicaid was established as a jointly funded federal/state
program providing medical assistance to qualified low-income people. 
At the federal level, the program is administered by HCFA, an agency
within the Department of Health and Human Services (HHS).  Within a
broad legal framework, each state designs and administers its own
Medicaid program.  States decide whether to cover optional services
and how much to reimburse providers for a particular service. 

States continue to face challenges in funding their Medicaid program. 
Increases in Medicaid costs have been attributed to several factors,
including high inflation in medical costs, new medical technologies,
expanded eligibility, increases in the use of services, and growth in
the number of poor and unemployed people.  In addition, almost all
states are required to balance their budgets. 

Each state operates its Medicaid program under a state plan that HCFA
must approve for compliance with current law and regulations.  States
also must obtain HCFA approval for any amendments to their plans. 
However, a state can operate under a proposed amendment and receive
federal matching funds for distribution to Medicaid providers pending
HCFA's final approval. 

Besides payments to reimburse medical providers for services
rendered, states are required to make additional Medicaid payments to
hospitals that serve large numbers of Medicaid and other low-income
patients.  Within federal guidelines, states determine if a hospital
qualifies for additional Medicaid DSH payments.  There are no federal
restrictions on how hospitals may use the DSH payments. 

The federal and state governments share in the cost of
Medicaid--including DSH payments--with the federal government paying
at least 50 percent and no more than 83 percent of a state's costs,
as determined by a formula.  This formula considers a state's average
per capita income against the national per capita income and is
intended to reduce differences among the states in medical care
coverage to the poor and distribute fairly the burden of financing
program benefits among the states.  The formula-derived rate that the
federal government pays for Medicaid reimbursement is called the
federal medical assistance percentage (FMAP).  In fiscal year 1993,
federal Medicaid payments accounted for 58 percent of all Medicaid
medical expenditures. 

------------------------------------------------------------ Letter :3

Michigan, Texas, and Tennessee used several financing approaches to
maximize federal Medicaid contributions without effectively
committing their share of matching funds.  Under these approaches,
facilities that received increased Medicaid payments from the states,
in turn, paid the states almost as much as they received. 
Consequently, the states realized increased revenue that was used to
reduce their state Medicaid contributions, fund other health care
needs, and supplement general revenue funding. 

Michigan obtained federal Medicaid matching funds of over $430
million by (1) increasing payments to certain county nursing homes,
(2) making DSH payments to a state university in excess of the
university's charges for charity care, and (3) increasing payment
rates for hospital outpatient services.  In Texas, funds provided by
three state-owned universities were used to obtain $271 million in
federal matching funds.  In Tennessee, taxes paid to the state by
providers for nursing home beds and hospital services were considered
as an allowable Medicaid cost and resulted in federal expenditures of
$75 million.  We describe these financial practices below. 

---------------------------------------------------------- Letter :3.1

Michigan nursing homes that received increased Medicaid payments of
$277 million in fiscal year 1993\3 returned $271 million to the
state.  To make the payments to the nursing homes, Michigan obtained
about $155 million in federal Medicaid funds by increasing Medicaid
reimbursement payments to county nursing facilities\4 by about 200
percent.  Due to this rate increase, the state paid $122 million as
its share of the increased reimbursement. 

On July 20, 1993, the state transferred the combined federal and
state funds of $277 million to the county nursing facilities.  Later
that day, however, the county facilities wired $271 million back to
the state.  The county nursing homes were allowed to keep a total of
$6 million.  A state document indicated that this financial
arrangement would produce a significant benefit to the state--funds
returned to the state would reduce the state's Medicaid

In originally seeking HCFA's approval for the increased rates,
Michigan did not have to justify that the county nursing facilities
needed increased reimbursements.  However, Michigan did have to show
that the increase would not exceed the upper limit of what Medicare
would pay for nursing home services.\5 Although the average daily
Medicaid payment for the affected nursing facilities in Michigan
increased from $90 to $269, the average rate of all nursing homes in
the state remained below the Medicare upper limit of $99.  This was
accomplished because reimbursements to all other nursing facilities,
that accounted for 86 percent of all Medicaid inpatient days,
remained the same. 

Michigan was able to benefit from this transaction because after a
state provides its share of Medicaid funds and makes payments to
providers for their Medicaid services, HCFA does not look at
subsequent transactions between the state and such providers.  There
appears to be at least three reasons that led HCFA to this approach. 
First, no restriction prohibits nursing homes or health facilities
from transferring funds back to the state; second, tracing funds
through intergovernmental transfers is difficult because such funds
lose their identity; and last, the congressional conference report
for the 1991 amendments directs HCFA not to change its treatment of
intergovernmental transfers, such as this, without going through a
lengthy administrative process. 

On July 30, 1993, HCFA requested more information from Michigan to
explain its computation showing that the increase was within the
Medicare upper limit test.  HCFA received a response from Michigan on
March 1, 1994, and additional information on April 8, 1994.  HCFA
approved the practice on May 20, 1994, effective to June 10, 1993. 
However, the arrangement with the county nursing homes would not be
allowed were these state-owned facilities.  Federal regulations do
not allow reimbursements to state facilities to be averaged with
reimbursements for nonstate facilities.  Figure 1 illustrates the
flow of monies between the nursing homes and the state. 

   Figure 1:  Transactions
   Relating to Increased
   Reimbursement Rates for County
   Nursing Homes (Dollars in

   (See figure in printed

\3 Throughout this report, any reference to years relates to a
state's fiscal year. 

\4 In addition to 41 county nursing facilities, 4 other local
government long-term care facilities are also included. 

\5 While states set Medicaid reimbursement rates, they must assure
HCFA that such rates are reasonable and adequate and do not exceed
what Medicare would pay for the service.  Medicare is a federal
health insurance program for people 65 years of age or older, certain
disabled persons, and most persons with end-stage renal disease. 

---------------------------------------------------------- Letter :3.2

Michigan has also used other financing arrangements to generate
additional federal matching funds, including making payments to
hospitals through its DSH program.  While legislation has prohibited
certain financing mechanisms, Michigan has adjusted its program to
meet new legislative requirements, and its 1995 program is still
expected to generate an estimated $335 million in federal funds. 

In fiscal year 1993, Michigan used hospital donations to help raise
funds for its Medicaid program.  Michigan made DSH payments of $458
million, including $256 million in federal matching funds to 53
hospitals; however, the hospitals returned all but $6 million to the
state.  As a result, the state received a $250 million net benefit
from the federal share of the DSH payments.  Michigan stopped this
practice because the 1991 amendments, which took effect in Michigan
on January 1, 1993, severely limited provider donations. 

In response to these limitations, Michigan's 1994 DSH program
included $489 million for those hospitals that provide many medical
services to the state's indigent population.  To be eligible for 1994
DSH payments, hospitals had to provide at least 6 percent of
inpatient services to indigent patients in the state.  State-owned
mental hospitals were not eligible for this payment. 

State officials determined that only one hospital would qualify--the
state-owned University of Michigan hospital.  On October 2, 1993,
Michigan made a DSH payment of $489 million to the University of
Michigan hospital.  This included $276 million in federal matching
funds and $213 million in state funds.  Later that day, the hospital
returned the entire payment to the state through an intergovernmental
transfer.  As a result, the state realized a net benefit from the
federal share of the DSH payment equal to $276 million.  Figure 2
shows the transactions related to the 1994 DSH payment to the
University of Michigan.\6

   Figure 2:  Transactions
   Relating to the University of
   Michigan Hospital DSH Payment
   (Dollars in millions)

   (See figure in printed

Beginning in 1995, the University of Michigan DSH payment will be
severely restricted by the 1993 Omnibus Budget Reconciliation Act
(OBRA-93).  This legislation limits such payments for 1995 to 200
percent of each qualifying hospital's costs for Medicaid and
uninsured patients, less the hospital's total Medicaid reimbursement
and payments received from the uninsured.  State officials have
calculated that the state can make a 1995 DSH payment to the
University of Michigan hospital of $136.3 million.\7 In subsequent
years, OBRA-93 limits DSH payments to 100 percent of a hospital's
uncovered costs. 

To make up for the shortfall from the restrictions on the payments to
the University of Michigan in 1995, the state has proposed making
payments of about $590 million, including federal funds of $335
million, to 92 government-owned hospitals and community health
boards.  According to the proposal, these governmental entities will
then make intergovernmental transfers back to the state, thereby
allowing the state to continue to benefit from federal Medicaid
matching funds. 

\6 HCFA approved the DSH payment because the proposed payments and
other DSH spending did not exceed the state's DSH spending limit. 
However, the DSH payment of $489 million is 79 percent of the state's
total preliminary 1994 DSH allocation of $622 million.  At the time,
HCFA officials said that they did not know how many hospitals would
qualify for the payments. 

\7 HCFA has not yet determined whether the 200 percent should be
computed by (1) first reducing hospital costs incurred by Medicaid
and uninsured patients by payments received from these patients and
then multiplying by 200 percent or (2) multiplying the hospital costs
incurred by Medicaid and uninsured patients by 200 percent and then
reducing this amount by payments received from these patients. 
Michigan's calculation is based on the latter.  Using the first
method would result in a DSH payment of $69.8 million or $66.5
million less than what the state calculated. 

---------------------------------------------------------- Letter :3.3

In 1992, the Director of Michigan's Department of Social Services
advised HCFA that the department planned to increase Medicaid
payments to seven hospitals, which in turn would make payments to a
nonprofit organization to purchase managed-care coverage for people
not eligible for Medicaid.  In 1993, the seven hospitals were paid
$51 million, which included $28.5 million in federal funds, $7
million in state funds, and $15.5 million contributed by Wayne
County.\8 In prior years, a similar program was funded entirely by
the state and county. 

In response to HCFA's request for more information, Michigan
documented that the total payments to 190 providers, including the
increased payments, would not exceed what Medicare would pay for such
services.  However, our analysis of the state's data for the seven
hospitals showed that the increased payments were 146 percent of the
hospitals' estimated costs, which were already substantially covered
by Medicaid reimbursements.  HCFA approved the program on November
16, 1992. 

On July 27, 1993, HCFA requested more information on the relationship
between the increased payments and the Medicare payment limit, but as
of May 3, 1994, Michigan had not yet responded.  Figure 3 traces the
flow of monies for the indigent care program for Wayne County. 

   Figure 3:  Medicaid Funding of
   Michigan's Indigent Care
   Program in Wayne County
   (Dollars in millions)

   (See figure in printed

\8 Wayne County includes the city of Detroit. 

---------------------------------------------------------- Letter :3.4

In 1993, under the Texas Disproportionate Share Program for
State-Owned Teaching Hospitals (DISPRO II), actual charity care
charges at three state-owned university hospitals were considered as
state expenditures and, therefore, eligible for federal matching
funds.  The hospitals transferred $149 million (representing their
charity care charges) to the Texas Department of Human Services,
which received another $271 million in federal matching funds.  The
entire $420 million was then used to make monthly DSH payments to the
three hospitals; however, a large part of these funds was
subsequently returned to the state. 

The hospitals returned to the state that part of their DSH payments
that exceeded their charity care charges, minus any amount authorized
by the state legislature.  In 1993, the hospitals kept $194 million
of the DSH payments, which included $45 million more than their
actual charity care charges.\9 The hospitals returned the remaining
$226 million to the state general revenues, through intergovernmental
transfers, to be appropriated for health care services to low-income
individuals.  Under OBRA-93, beginning in 1996, Texas will not be
allowed to make DSH payments in excess of 100 percent of a hospital's
unreimbursed cost of providing care to Medicaid recipients and the

Figure 4 illustrates the flow of funds under this financial

   Figure 4:  Transactions
   Relating to Texas DISPRO II
   (Dollars in millions)

   (See figure in printed

\9 Texas legislation authorizing the hospitals to keep the $45
million, in addition to the actual charity care charges, expired at
the end of the state's 1993 fiscal year. 

---------------------------------------------------------- Letter :3.5

In Tennessee, certain medical providers were required to pay state
taxes on their nursing home beds and hospital services.  However,
that portion of the taxes related to Medicaid patients was considered
as a reimbursable Medicaid expenditure,\10 which cost the federal
government an estimated $75 million in 1993.  These federal funds,
along with $37 million in state funds, were, in effect, used to
reimburse medical providers for their state taxes.  These taxes went
into the state's treasury where they were commingled with other state

In 1993, Tennessee enacted a nursing home tax of $2,600 per bed on
all beds--both Medicaid and non-Medicaid--that provided the state
with $93 million in tax revenues.  Tennessee estimates that it
reimbursed nursing homes $67 million in federal and state funds for
the portion of the taxes related to their Medicaid patients.  This
reimbursement included an estimated $45 million in federal dollars. 
Figure 5 shows the flow of Medicaid funds associated with these

   Figure 5:  Transactions
   Relating to Tennessee's Nursing
   Home Tax (Dollars in millions)

   (See figure in printed

HCFA approved the nursing home tax on June 22, 1993, effective
retroactively to July 1, 1992.  Despite this, HCFA is still reviewing
the state's nursing home tax for compliance with the hold-harmless
provisions of the 1991 amendments.  These provisions reduce federal
reimbursements by the amount of the tax revenues when a state
directly or indirectly guarantees reimbursement of any part of a tax
to medical providers or patients not related to Medicaid. 

The focus of HCFA's review is Tennessee's granny grant program, which
provides payments to indigent nursing home patients.  These payments
are slightly less than the tax that the nursing homes pay.\11
According to HCFA, because nursing homes can effectively pass on the
tax to their patients and some patients receive grants for amounts
almost equal to the tax, the nursing homes are virtually guaranteed a
return of a major portion of the cost of the tax.  The Tennessee
Medicaid director stated that the granny grant was never designed as
an offset to the nursing home tax and would have been implemented
even if there was no nursing home tax. 

In 1993, Tennessee also enacted a service tax or privilege tax of
6.75 percent on the purchase of services, including medical services. 
According to Tennessee officials, this new tax replaced a prior tax
on hospitals that was based on Medicaid utilization and did not meet
the conditions for an allowable tax under the 1991 amendments. 
Besides medical services, the privilege tax was levied on motels,
theaters, amusements, and auto repair shops.  These nonmedical
services had been taxed in the prior year at the same rate under what
was then called a sales tax. 

The medical or hospital component of the privilege tax raised $365
million from both Medicaid and non-Medicaid services.  In 1993,
Tennessee used federal and state funds of $45 million to make interim
payments to hospitals to reimburse them for their part of the tax on
Medicaid patients.  These payments were based on 1991 hospital
Medicaid utilization rates and will be adjusted as more current
information is provided by the hospitals.  The federal government
paid an estimated $30 million as its share of the reimbursement of
the privilege tax on Medicaid patients.  Figure 6 shows the flow of
Medicaid funds involved in these transactions. 

   Figure 6:  Transactions
   Relating to Tennessee's
   Hospital Tax (Dollars in

   (See figure in printed

HCFA is reviewing the state's privilege tax to determine if it
qualifies as a nonhealth-care-related tax.  HCFA is concerned that
the tax may not treat health and nonhealth entities the same and,
thus, may not qualify as a nonhealth-care-related tax.  If the tax
does not meet this and other conditions, HCFA may retroactively
disallow federal reimbursement.  Tennessee officials said that they
do not consider this tax to be subject to the 1991 amendments because
it is not limited to hospitals, nor does the tax revenue raised from
hospitals qualify the tax as health-care-related tax as defined by
law.  Despite this, the state stopped the tax January 1, 1994, to
coincide with the implementation of a statewide
program--TennCare--that largely replaced Tennessee's Medicaid

\10 Under the Omnibus Budget Reconciliation Act of 1990, taxes
imposed by the state solely on hospitals, nursing facilities, and
intermediate care facilities for the mentally disabled were not a
reimbursable Medicaid cost.  However, the 1991 amendments repealed
this provision and allowed such taxes to be included as reimbursable
costs for Medicaid. 

\11 Depending on state eligibility criteria, the granny grant
payments are either $6.00 or $6.50 a day.  The annual nursing home
tax of $2,600 a bed is equivalent to a $7.12 a day tax. 

------------------------------------------------------------ Letter :4

The financing arrangements and medical service taxes in the three
states effectively increased the federal percentage share of total
Medicaid payments in the states.  Our analysis shows that for 1993,
the federal share of total Medicaid expenditures in Michigan
effectively increased from 56 percent to 68 percent (see app.  I for
details).  In Texas and Tennessee the increase in the effective
federal share of total Medicaid expenditures was less, increasing
from 65 to 67 percent and 68 to 71 percent, respectively. 

HCFA officials told us that although they do not know the exact
number of states involved, the financing arrangements are not limited
to the three states we reviewed.  Our review of HCFA preliminary data
on states' health-care-related taxes shows that 21 states and the
District of Columbia had such taxes as of December 31, 1993. 
Further, in January 1994, PROPAC reported that some states are using
financing arrangements involving DSH payments to obtain federal
Medicaid funding that is used to supplant state-only spending. 

------------------------------------------------------------ Letter :5

Michigan, Tennessee, and Texas obtained hundreds of millions of
dollars in federal matching Medicaid funds through a variety of
financial arrangements without effectively contributing their share
of funds.  Our computation of effective FMAP rates shows that the
federal government pays more Medicaid costs than its established
formula rate because some providers return increased reimbursements
and DSH payments to the states. 

The practices in Michigan and Texas that involve DSH payments to
state-owned facilities will be restricted by OBRA-93 provisions that
limit DSH payments to unreimbursed Medicaid and uninsured costs. 
However, states can use other financial arrangements to help assure
the continuation of their current federal funding levels.  States
could continue to make DSH payments to local-government-owned
facilities and have the facilities return the payments to the states. 
Further, states can continue to reimburse selected
local-government-owned facilities in excess of the cost of specific
services and have the facilities return the excess payments.  States
are not required to justify the need for increased reimbursements,
nor is HCFA required to verify that monies are used for the purpose
for which they were obtained.  Federal Medicaid funds should only be
used to help cover the costs of medical care incurred by those
medical facilities that provide the care. 

------------------------------------------------------------ Letter :6

The Congress should enact legislation to minimize the likelihood that
states can develop illusory financing mechanisms whereby providers
return Medicaid payments to the states, thus effectively reducing the
states' share of Medicaid funding.  This legislation should prohibit
Medicaid payments that exceed costs to any government-owned facility. 

------------------------------------------------------------ Letter :7

We discussed a draft of this report with HCFA headquarters officials
and Michigan, Tennessee, and Texas Medicaid officials.  HCFA
officials, reacting to the draft report's recommendation that the
Congress require the Secretary of Health and Human Services to
develop regulations limiting the subject financing mechanisms,
suggested that the matter, in their view, would require legislation. 
State officials said that the report accurately reflects the various
funding mechanisms they use and that these mechanisms were in
compliance with federal laws.  We have incorporated the states' and
HCFA's comments where appropriate. 

Michigan officials provided additional comments relating to its
Medicaid program.  They commented that Michigan, like most states,
devoted a significant and growing portion of its discretionary
revenue to the Medicaid program and that a principal reason for the
growth was unfunded federal mandates.\12 They added that should
Michigan be denied access to intergovernmental funding sources, it
would need to commit nearly 25 percent of its discretionary revenue
to subsidize the current Medicaid program, equal to a state funding
increase of about $500 million. 

Michigan officials also noted that terminating funding for other
state programs to support the Medicaid program is highly unlikely;
most likely, Medicaid eligibility and services would be severely
restricted.  Michigan officials do not believe that additional
constraints on states' use of Medicaid funds are necessary.  However,
they added that changes to the federal medical assistance percentage
formula should be considered by the Congress.  They commented that a
prior GAO report suggested alternatives to the current FMAP formula
that would provide Michigan with additional federal Medicaid

As arranged with your office, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 30 days from its issue date.  At that time, we will send copies
to interested congressional committees; the Secretary of Health and
Human Services; the Administrator of HCFA; the Medicaid directors in
Michigan, Tennessee, and Texas; and other interested parties.  We
will also make copies available to others upon request. 

This report was prepared under the direction of Sarah F.  Jaggar,
Director, Health Financing and Policy Issues.  Please contact Robert
F.  Hughes, Assistant Director, at (202) 512-7203 or Daniel S. 
Meyer, Policy Analyst, at (312) 220-7683 if you have any questions
about this report.  Other contributors to this report include Robert
T.  Ferschl, Julian P.  Klazkin, Alfred R.  Schnupp, and Karin A. 
Van Egmond. 

Sincerely yours,

Leslie G.  Aronovitz
Associate Director, Health
 Financing Issues


\12 While these mandates do increase state costs, they are not funded
differently than other Medicaid benefits.  The federal government
pays its share of the increased costs based on FMAP. 

\13 Medicaid:  Alternatives for Improving the Distribution of Funds
to States (GAO/HRD-93-112FS, Aug.  20, 1993)

============================================================== Letter 

As described in this report, financing mechanisms used in each of the
three states we reviewed effectively increased the federal percentage
share of Medicaid medical assistance payments in each state. 
Although federal Medicaid payments were made according to the federal
medical assistance percentage rates, as established by law, our
analysis shows that the federal dollars account for a greater share
of Medicaid expenditures that ultimately benefited providers in these
states.  The financial arrangements we have highlighted resulted in
providers only receiving a net benefit from Medicaid payments,
because they either returned the payments to the state treasury or
directed the payments for use in a non-Medicaid program. 

In calculating an adjusted FMAP, we reduced total Medicaid
expenditures for a state by the dollar amount of Medicaid funds
returned to the state treasury.  This includes the state's benefit
from federal matching funds plus the amount of the state funds that
providers returned.  We also reduced the total state share of
Medicaid expenditures by the same amount because these practices
reduced the amount of money the state had to contribute to Medicaid
expenditures.  We made similar reductions for Medicaid payments that
were ultimately used to fund a program for non-Medicaid patients. 
Using the new figures for total Medicaid medical assistance and the
state's contribution, we then recomputed the federal and state shares
of total Medicaid medical assistance payments in the state. 

As an example, the calculation for Michigan and supporting data for
the adjustments follow.  Note that the federal contribution
percentage of reported fiscal year (FY) 1993 Medicaid expenditures,
56.00 percent, differs slightly from the FY 1993 official FMAP of
55.84 percent.  This is because it includes some services that are
reimbursed at different rates. 

                                    Table I.1
                      Adjusted FMAP Computation for FY 1993
                     Medicaid Medical Assistance Expenditures
                        in Michigan (Dollars in millions)

                    Total       l                      State
                   paymen  paymen                     paymen
                       ts      ts       Percent           ts       Percent
-----------------  ------  ------  -----------------  ------  ------------------
FY 1993 Medicaid   $4,403  $2,466         56          $1,938
Adjustments for      -773       0                       -773
Adjusted FY 1993    3,630   2,466         68           1,165
 Medicaid medical

                          Table I.2
             Adjustment Used in the Adjusted FMAP
              Computation for Michigan Medicaid
           Financing Practices in FY 1993 (Dollars
                        in millions)\a

                                                 Net   g not
                                      Increa  benefi    kept
                                         sed    t to      by
                                      fundin  provid  provid
Description                                g     ers     ers
------------------------------------  ------  ------  ------
Hospital contributions                  $458      $6    $452
County medical care                      277       6     271
Outpatient services                       51       0      51
Total                                   $786     $12    $773
\a Totals may not add due to rounding.