Medicaid is funded through a partnership between the federal government and individual state governments, with the federal share covering at least half of every state’s program costs. The exact split varies from state to state based on a formula tied to per capita income, meaning poorer states receive a larger federal contribution. This open-ended matching structure has defined Medicaid since its creation in 1965, and it remains the backbone of how the program is financed today, though recent expansions, state funding strategies, and recurring proposals to restructure the program make the picture considerably more complex than a simple percentage split.
The Matching Formula That Drives Everything
The federal government’s share of Medicaid costs is set by a metric called the Federal Medical Assistance Percentage, or FMAP. The formula compares a state’s per capita personal income to the national average: the lower a state’s income relative to the country as a whole, the higher the federal match. By law, the FMAP can never drop below 50 percent, so even the wealthiest states get at least half their Medicaid costs covered by federal dollars.1Journal of Public Economics. State responses to federal matching grants: The case of medicaid In practice, the FMAP ranges from that 50 percent floor in states like New York, California, and Connecticut to roughly 77 percent in Mississippi, which has the lowest per capita income in the nation.
The matching grant is open-ended, meaning there is no cap on how much the federal government will reimburse. If a state’s Medicaid costs rise because more people enroll or because health care gets more expensive, the federal contribution automatically rises in step. This design was intentional: it ensures that states facing economic downturns, which typically push more residents into Medicaid eligibility, don’t hit a federal funding ceiling right when they need support the most. It also creates a built-in incentive for states to spend on Medicaid, because every dollar a state puts in draws at least one additional federal dollar, and often more.
The ACA Expansion and a Different Match Rate
The Affordable Care Act added a separate, much more generous match rate for a specific group of Medicaid enrollees: adults with incomes up to 138 percent of the federal poverty level who were not previously eligible in most states. For this expansion population, the federal government currently pays 90 percent of the costs, compared to the standard FMAP that averages around 60 percent or so for traditional enrollees.2KFF. Eliminating the Medicaid Expansion Federal Match Rate: State-by-State Estimates This enhanced rate was a key inducement for states to expand their programs, and as of early 2025, 40 states plus the District of Columbia have adopted the expansion.
The financial stakes of that enhanced rate are enormous. Analysis of what would happen if the 90 percent expansion match were eliminated illustrates the point. Under one scenario, if states kept their expansion populations enrolled and absorbed the new costs themselves, state Medicaid spending across the country would jump by about 17 percent, while federal spending would fall by roughly 10 percent. Under a more likely scenario, states would drop the expansion altogether, resulting in about 20 million people losing coverage and total Medicaid spending shrinking by nearly one-fifth.2KFF. Eliminating the Medicaid Expansion Federal Match Rate: State-by-State Estimates The gap between what states pay now for expansion enrollees (10 percent) and what they would owe under the standard FMAP (roughly 40 percent on average) is simply too large for most state budgets to absorb.
How the Expansion Affected State Budgets
One of the persistent fears about Medicaid expansion was that it would strain state budgets even with the enhanced federal match. The evidence from the first several years tells a more nuanced story. Research examining the period from 2014 through 2017 found that expansion was associated with a roughly 4.4 to 4.7 percent reduction in state spending on traditional Medicaid categories, partly because people who had been enrolled under more expensive eligibility pathways shifted into the expansion group with its higher federal match.3The Commonwealth Fund. The Impact of Medicaid Expansion on States’ Budgets
States also saw savings in areas outside Medicaid itself. Reduced spending on state-funded mental health services, lower corrections costs, and less uncompensated hospital care all partially offset expansion expenses. Those savings ranged from about 14 percent of expansion costs in Kentucky to 30 percent in Arkansas. In aggregate, expansion increased total Medicaid spending by about 23 percent and federal spending by about 38 percent, but did not increase state Medicaid spending through the first five and a half years.3The Commonwealth Fund. The Impact of Medicaid Expansion on States’ Budgets Put plainly, the federal government absorbed the spending increase while states either held steady or came out slightly ahead once you counted the ripple effects.
Where States Get Their Share of the Money
Every state has to come up with its portion of Medicaid spending, but general tax revenue is only part of the story. States use a mix of funding mechanisms that can look creative and, in some cases, have drawn scrutiny from federal regulators.
The most common supplement to general revenue is provider taxes, sometimes called provider assessments. States levy taxes on hospitals, nursing homes, managed care organizations, and other health care providers, then use that revenue to fund Medicaid payments. The arrangement can seem circular: the state taxes a hospital, uses the tax money as its share of a Medicaid payment, draws down federal matching funds on top of it, and sends the combined amount back to the hospital. Federal rules limit these taxes to prevent the most aggressive versions of this cycle, but provider taxes remain a significant share of state Medicaid funding in most states.
Two other mechanisms work similarly. Intergovernmental transfers, or IGTs, involve a public entity like a county government or a state university hospital transferring funds to the state Medicaid agency. The state then uses those transferred funds to draw down federal matching dollars. Certified public expenditures, or CPEs, work a bit differently: a governmental entity such as a county hospital or school district certifies that it has already spent money on Medicaid-covered services, and the federal match is applied to that certified spending without the money being routed through the state first.4KFF. Medicaid Financing: The Basics Both of these let states access federal funds without necessarily raising new revenue through taxes on their general population.
Disproportionate Share Hospital Payments
A separate stream of federal Medicaid money flows to hospitals that serve a disproportionately large share of uninsured and Medicaid patients. Known as the Disproportionate Share Hospital program, or DSH, this funding is meant to keep safety-net hospitals financially viable despite the higher volume of low-reimbursement and uncompensated care they provide.
Unlike the standard FMAP matching mechanism, DSH payments come with state-specific caps set by Congress. Federal law has been reformed multiple times to rein in how DSH dollars are used. A survey of 40 states found that while the overall size of the DSH program did not grow between 1993 and 1997, the composition changed substantially: a much higher share of DSH funds went to local hospitals and relatively less was retained by states themselves.5PubMed Central. Reforming the Medicaid disproportionate share hospital program That shift reflected federal concern that some states had been using DSH payments less as hospital support and more as a way to draw down extra federal dollars. The tension between legitimate safety-net funding and fiscal gamesmanship has made DSH a recurring target for reform.
Waivers and the Budget Neutrality Requirement
States that want to experiment with their Medicaid programs beyond what federal law normally permits can apply for Section 1115 demonstration waivers. These allow significant changes to eligibility, benefits, or delivery systems. The catch, from a financing perspective, is that the federal government requires these demonstrations to be “budget neutral” with respect to federal Medicaid expenditures. In other words, the waiver cannot cost the federal government more than it would have spent without the waiver in place.6PubMed Central. Missed Opportunities: Using Medicaid Section 1115 Projects to Improve the Health of Medicaid and Medicare Beneficiaries
Budget neutrality sounds straightforward, but determining what the federal government “would have spent” involves projections and assumptions that can be generous or strict depending on the political climate. Some administrations have interpreted budget neutrality loosely, allowing states to count hypothetical spending that would never have occurred. Others have tightened the definition. The result is that the same waiver proposal can be deemed budget-neutral or not depending on who is running the numbers, making 1115 waivers as much a political negotiation as a technical evaluation.
Block Grants and Per Capita Caps
Proposals to fundamentally restructure Medicaid financing surface regularly in federal budget debates. The two most commonly discussed alternatives to the current open-ended matching system are block grants and per capita caps. Both would set a fixed amount of federal funding rather than matching whatever states spend.
Under a block grant, each state would receive a predetermined lump sum regardless of how many people enroll or how much care costs. Under per capita caps, the federal government would set a fixed amount per enrollee, adjusting for the number of people in the program but not for changes in the cost of care itself. Both approaches would achieve their goal of reducing federal spending by creating fixed-funding formulas that are divorced from actual costs. Research on these proposals has found that they would most likely reduce the number of Americans eligible for Medicaid and narrow coverage for people who remain enrolled, since states facing funding shortfalls would have to cut eligibility or benefits to stay within the caps.7PubMed. What Would Block Grants or Limits on Per Capita Spending Mean for Medicaid?
The fundamental tension is between fiscal predictability for the federal government and financial security for enrollees and states. The current matching system guarantees federal dollars will flow when need rises, but it also means federal Medicaid spending is difficult to control or forecast. Block grants and per capita caps give Congress more control over spending projections at the cost of transferring financial risk to states and, ultimately, to the people who depend on the program.
Territories and a Different Funding Structure Entirely
U.S. territories already operate under something resembling a block grant, and the results illustrate what fixed federal funding looks like in practice. Puerto Rico, Guam, the U.S. Virgin Islands, American Samoa, and the Northern Mariana Islands receive capped Medicaid allotments rather than open-ended matching funds. Their FMAP is set by statute at 55 percent, but the total federal contribution is capped regardless of how many residents qualify.
Puerto Rico’s experience has been the most scrutinized. Research comparing Medicaid access for low-income Latinos in New York, Florida, and Puerto Rico found that Puerto Rico’s capped Medicaid block grant contributed to reduced health care access over time, particularly for citizens in low-income households.8Health Services Research. The impact of Medicaid funding structures on inequities in health care access for Latinos in New York, Florida, and Puerto Rico When the cap is hit, even eligible residents may face waitlists or reduced benefits. Congress has periodically provided supplemental funding to prevent Puerto Rico’s Medicaid program from running out of money entirely, but the need for repeated emergency infusions underscores how poorly a fixed cap accommodates real-world health care demand.
Federal Oversight and the Cost of Errors
The federal government does not simply write matching checks and walk away. The Payment Error Rate Measurement program, known as PERM, audits a rotating sample of states to estimate how much Medicaid spending goes to ineligible beneficiaries or is incorrectly calculated. This matters for financing because erroneous payments still draw federal matching dollars: if a state pays a claim it shouldn’t have, the federal government has matched that payment at the FMAP rate.
Upcoming changes to the PERM program will sharpen the financial consequences for states. Beginning in October 2029, states with eligibility error rates above three percent will be required to repay the federal portion of improper payments exceeding that threshold. The rules are also expanding to count insufficient documentation as an eligibility error, meaning that even cases where the enrollee may actually be eligible but the paperwork is incomplete will count against the state. The Congressional Budget Office estimates these changes could reduce federal Medicaid spending by about $7.6 billion over ten years.9KFF. A Look at the Medicaid Payment Error Rate Measurement (PERM) Program and Upcoming Changes and Impacts For states, this creates a strong financial incentive to invest in eligibility verification systems and documentation, since sloppy paperwork now has a direct dollar cost.
Long-Term Care and Where the Money Goes
Understanding how Medicaid is paid for also requires understanding what it pays for, because the spending mix shapes the financing debate. Medicaid is the nation’s largest payer for long-term services and supports, covering nursing home care, home health aides, and community-based services for elderly and disabled enrollees. This category of spending is far more expensive per person than covering a relatively healthy adult or child, and it accounts for a disproportionate share of total Medicaid costs.
Federal policy has increasingly pushed states to shift long-term care spending from institutional settings like nursing homes toward home- and community-based services, which tend to be both less expensive and preferred by the people receiving care. The Balancing Incentive Program, for instance, offered states an enhanced FMAP for home- and community-based services to encourage the transition. Stakeholders involved in the program reported that participation shifted the culture of home-based care in some states, improving communication between agencies and providers and making states more responsive to consumers’ unmet needs.10Health Services Research. Perceived impacts of a Medicaid rebalancing initiative to increase home- and community-based services These rebalancing efforts show how the federal government uses the matching rate itself as a policy lever, temporarily sweetening the match to steer state spending in a particular direction.
The pattern extends beyond long-term care. The enhanced ACA expansion match, the DSH program, and various waiver incentives all demonstrate the same principle: by adjusting the share it pays, the federal government can encourage, discourage, or reshape state Medicaid spending without directly mandating changes. The FMAP is not just a financing mechanism. It is the primary tool the federal government uses to influence a program that is, by design, administered by 50 different states making 50 different sets of choices about who gets covered and what care they receive.