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Why The Supreme Court Decision on Obamacare May Dramatically Increase the Deficit

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An unappreciated point about today’s Supreme Court ruling is that it will have significant consequences for the federal deficit. It all comes out of the Court’s opinion that states have the ability to opt out of Obamacare’s expansion of Medicaid. Paradoxically, this decision by the Court could lead to dramatically higher government health-care spending. Here’s why.

The Affordable Care Act, as passed, expanded Medicaid to cover all adults below 138 percent of the federal poverty level (100 percent of FPL is $23,050 for a family of four). In addition, the law created state-based exchanges, which sell subsidized private insurance, for people between 100 and 400 percent of the federal poverty level. Roughly half of the law’s coverage expansion—17 million, according to the Congressional Budget Office—comes from Medicaid, and the other half—16 million—comes from the exchanges and other instruments.

Democrats structured the law this way because Medicaid is much less expensive, on a per-person basis, than are the subsidized exchange plans. In addition, Medicaid is partially funded by the states.

However, now that states can opt out of the law’s Medicaid expansion, states that currently cover people above 100 percent of FPL with Medicaid now have a significant financial incentive to shrink Medicaid eligibility down to 100 percent of FPL, and let the federal government (read: taxpayers in other states) pay for the rest.

This, again, will lead to substantially higher costs for the federal government, because exchange subsidies are much more generous than Medicaid is.

A countervailing aspect to the ruling is that, for the 23-24 states that have minimal Medicaid programs, many people below 100 percent of FPL may not get any insurance coverage at all, and the federal government pays for the majority of that spending under the Affordable Care Act. But several big states like New York have expansive Medicaid programs, and would now have the option to pare back their Medicaid programs.

Expect the Congressional Budget Office to issue a report evaluating just this scenario very soon. That report will tell us a lot about how much the Supreme Court has changed the fiscal trajectory of Obamacare.

Follow Avik on Twitter at @avik.

UPDATE: Douglas Holtz-Eakin, former director of the Congressional Budget Office, estimates that the change would result in increased annual expenditures of up to $100 billion:

The American Action Forum ran the numbers. Suppose that every state takes advantage of this opportunity, and that every individual who is either on Medicaid or would be eligible for the expansion actually moves to the exchanges. The federal government would save as much as $130 billion in Medicaid in 2014, but it would be on the hook for $230 billion in new insurance subsidies. The net bottom line: a $100 billion annual expansion in federal costs.

Of course, not all states may forego the expansion, without doubt fewer than 100 percent of those eligible will take up subsidies, and actual insurance choices are impossible to foresee perfectly. Accordingly, the net cost will be lower than the full $100 billion, but it seems safe to say that the ACA will leave the taxpayer on the hook for an additional $500 billion or so in federal costs over the first 10 years.

How does this work? The Supreme Court ruled that the federal government could not punish states that refused to expand Medicaid (to 133 percent of the federal poverty line) by yanking their existing Medicaid funding. They would not, of course, get any new federal Medicaid money.

But, states would be able to get piles of federal money. Specifically, beginning in 2014 they could pare their Medicaid program back to the federally-designated minimum (100 percent of poverty), saving the state a lot of money. Everybody between 100 percent and 133 percent would be eligible for insurance subsidies – with the federal government (read: taxpayer) picking up the entire tab.

For states, this is a clear winner – covering more individuals and saving budget dollars at the same time.

Chuck Blahous notes the same problem, and describes how slight changes in CBO's estimates can produce substantially different spending projections. Elsewhere, Paul Howard and Nicole Gelinas discuss other aspects of the Medicaid dilemma.

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