Brief Medicaid Financing 101

The Medicaid program is jointly funded by both the federal government and state or territorial governments. Medicaid is one of single largest expenditures for states, accounting for almost 30% in total spending (including federal funds) and 18% of state-funded spending. This resource describes how the Medicaid program is financed and the counter-cyclical nature of the program. 

The Federal Share

State Medicaid financing is an open-ended reimbursement categorical grant where the amount of federal funding fluctuates to cover actual program costs based on the number of program participants. These costs are shared between the federal and state governments pursuant to Section 1903 of the Social Security Act.

The federal share of program expenditures is known as the federal medical assistance percentage (FMAP) or the federal matching rate. Each state’s FMAP rate is calculated using a statutory formula from Section 1905(b) of the Social Security Act that takes into account the state’s average per capita income relative to the national average. By law, the FMAP cannot be less than 50%. FMAP percentages not only vary by state but based on the type of service, population covered or state activity.  

Federal and state financing of Medicaid covers the actual costs of administering the program. Because states do not know in advance the total number of beneficiaries or volume or types of services provided for a given year, financing is a multi-step process.

Figure 1: Federal Review and Matching of Estimated State Medicaid Expenditures

The State Share

Most state spending on the Medicaid program comes from the state general fund. However, the state’s share of Medicaid program expenses can be funded through other mechanisms. These mechanisms include health care-related taxes, certified public expenditures, and intergovernmental transfers.   

• Health care-related taxes (also known as provider fees or taxes), are taxes levied against all private providers within a category (like hospitals, nursing homes or EMS providers), regardless of whether the provider accepts Medicaid patients.  
• Certified public expenditures occur when a governmental provider (like a county hospital or nursing facility operated through a municipality) pays for Medicaid-covered services eligible for the financial match. The actual costs incurred by the non-state entity can be used to support the state’s share.  
• Intergovernmental transfers occur when one governmental entity (like a county or local education agency) transfers funds to the Medicaid agency before a Medicaid payment is made to increase the state’s share. 

States can use these mechanisms to increase the state share—and subsequently draw down more federal funding—without increasing state general fund expenditures. States may use these mechanisms to make investments in the Medicaid program or increase payments to certain providers through supplemental payments.

At least 40% of the state’s share must be financed by the state directly and up to 60% may come from local governments. Each state decides how to finance its share of the Medicaid program and state legislatures play a key role in choosing which financing mechanisms to leverage.

Medicaid Financing in the Territories

While Medicaid is still jointly financed in the territories by both the federal and territorial governments, there are significant differences between state and territorial financing. Territorial Medicaid programs are subject to statutory caps on total federal spending and federal funding does not fluctuate with actual program costs. This means that when program expenses exceed the federal cap, the territory is responsible for the full costs of operating the Medicaid program.

Additionally, the territorial FMAP is set in federal statute at 55% and is not adjusted annually. Only an act of Congress can change the territorial FMAP.

While territories have fewer options to finance the territorial share, they can use certified public expenditures. Both American Samoa and the Northern Mariana Islands use certified public expenditures to help finance the territorial share.

Because the Medicaid program is designed to serve people with low incomes, the program is considered to be countercyclical This means that Medicaid enrollment and spending grows during economic downturns, when more individuals face economic hardships and may become newly eligible for Medicaid. When this happens, states and territories face increasing demand for Medicaid services but have less revenue to pay for it.

Congress has acted on several occasions to temporarily increase the federal match for Medicaid during economic downturns. For example, Congress acted in 2009 to respond to the financial crisis and in 2020 to respond to the COVID-19 pandemic.