A Theoretical Analysis of Medicaid Supplantation

Abstract

Matching grants inevitably provide lower level governments with an incentive to relabel expenditures so that they become eligible for a match. The author terms such behavior supplantation. Anecdotes and some systematic empirical evidence suggests that supplantation may be widespread in Medicaid—the United States's largest intergovernmental matching grant program. The author develops a theoretical model of Medicaid supplantation. States supplant because it increases their access to resources. Supplantation is costly, however, because it requires states to justify their adherence to federal rules. Supplantation increases with the federal match rate and declines with federal scrutiny but does not change with the total state budget or the state's “taste” for legitimate Medicaid services. Somewhat surprisingly, legitimate Medicaid services risewith the level of supplantation because total state resources are increased. An exploratory normative analysis demonstrates that if supplantation is possible the first-best allocation cannot be achieved through matching grants. Policy implications are discussed briefly.