Medicaid is paid for through a partnership between the federal government and state governments, with the federal government covering the majority of costs. In 2024, total Medicaid spending reached $931.7 billion, making it one of the largest items in both federal and state budgets. The money comes from federal tax revenue, state general funds, and a growing share from taxes on healthcare providers themselves.
The Federal-State Cost Split
Every dollar a state spends on Medicaid is matched by the federal government at a rate called the Federal Medical Assistance Percentage, or FMAP. This rate varies by state and is recalculated each year using a formula based on each state’s per capita income compared to the national average. The formula is designed so that poorer states get more federal help: a state with lower average incomes receives a higher federal match.
The minimum federal match is 50%, which applies to wealthier states like New York and California. The maximum is 83%. Mississippi, one of the lowest-income states, consistently receives one of the highest match rates. In practical terms, this means the federal government pays at least half of every state’s Medicaid costs and often much more. For the states that expanded Medicaid under the Affordable Care Act, the federal government covers 90% of costs for the expansion population, those adults who became newly eligible. That 90% rate is significantly more generous than the standard match.
Where the Federal Money Comes From
The federal share of Medicaid comes from general federal revenue, primarily individual and corporate income taxes. Unlike Medicare, which has a dedicated payroll tax, Medicaid has no earmarked funding stream. Congress appropriates Medicaid funding each year as an entitlement, meaning the federal government is obligated to match whatever qualifying expenses states incur. There is no cap on federal Medicaid spending for the 50 states and Washington, D.C. If enrollment rises or healthcare costs increase, federal spending automatically rises with it.
U.S. territories like Puerto Rico, Guam, and the U.S. Virgin Islands are treated differently. Their federal Medicaid funding is capped at a fixed annual amount rather than being open-ended, and their match rates are set by statute rather than calculated through the income-based formula.
How States Fund Their Share
States use several revenue sources to cover their portion of Medicaid costs. The largest source is state general funds, which come from income taxes, sales taxes, and other broad-based revenue. But a growing and increasingly important source is healthcare provider taxes.
Provider taxes are fees that states impose on hospitals, nursing homes, managed care organizations, and other healthcare entities. In state fiscal year 2018, these taxes generated $36.9 billion and accounted for 17% of all state Medicaid funding, up from just 7% a decade earlier. The mechanics work like this: a state collects a tax from hospitals, uses that revenue as its share of Medicaid spending, and then draws down the federal match on top of it. Federal rules require these taxes to be broad-based (applied to all providers in a category, not just a few), uniform, and structured so that providers aren’t simply guaranteed to get all their tax money back.
States also use intergovernmental transfers, where local governments like counties or public hospital systems contribute funds that the state then uses to draw federal matching dollars.
How Medicaid Pays for Care
Once the money is pooled from federal and state sources, it flows to healthcare providers in two main ways. In traditional fee-for-service Medicaid, the state pays doctors, hospitals, and other providers directly for each service they deliver. But the majority of Medicaid enrollees today are covered through managed care organizations, private insurance companies that contract with the state.
States pay these managed care plans a fixed amount per enrollee per month, known as a capitation payment. These rates must be certified by actuaries and set high enough to ensure enrollees can actually access the services they need. Federal rules also require that managed care plans spend at least 85% of the payments they receive on actual medical care rather than administrative costs or profit.
Extra Payments to Safety-Net Hospitals
On top of regular payments to providers, federal law requires states to make additional payments to hospitals that serve a disproportionately large share of Medicaid patients and uninsured people. These are called Disproportionate Share Hospital payments. Each state receives a federal allotment that caps how much it can spend on these payments, and individual hospitals can’t receive more than the actual cost of the uncompensated care they provide. States must submit independent audits to verify these payments, which helps prevent overpayment.
Administrative Cost Sharing
Running Medicaid costs money beyond direct medical care. Processing claims, determining who qualifies, conducting fraud investigations, and maintaining IT systems all carry administrative costs. The federal government matches these expenses too, but at different rates depending on the activity.
- General administration: 50% federal match
- Operating claims processing and eligibility systems: 75% federal match
- Building or upgrading those systems: 90% federal match
- Translation and interpretation services for enrollment: 75% federal match
The higher match rates for technology are intentional. They give states a financial incentive to modernize their systems, which can reduce errors and speed up enrollment.
The Part D “Clawback”
There’s one unusual flow of money that runs in the opposite direction. When Medicare Part D launched in 2006, it took over prescription drug coverage for people enrolled in both Medicare and Medicaid (known as dual-eligible beneficiaries). Before that, Medicaid had been paying for their medications. To account for the savings states received from no longer covering those drugs, Congress required states to make monthly payments back to the federal government. These payments, informally called the “clawback,” represent a portion of what states would have spent on prescriptions for dual-eligible individuals. The amounts are calculated on a per-person basis and have been phasing down gradually over time, though states continue making these payments today.
Why Medicaid Costs Keep Growing
Medicaid spending grew 6.6% in 2024 alone, reaching nearly $932 billion. That growth reflects rising healthcare prices, an aging population that increasingly needs long-term care (which Medicaid covers more than any other payer), and the expansion of eligibility in states that adopted the ACA’s broader income thresholds. National health spending overall is projected to grow at an average of 5.8% annually through 2033, and Medicaid is expected to follow a similar trajectory. For state budgets, Medicaid is typically the single largest spending category, often exceeding even K-12 education. The open-ended federal match means states always have a financial partner, but it also means any policy change at the federal level, like adjusting match rates or capping spending, would immediately ripple through every state budget in the country.