Last Thursday, the Senate Leadership released a draft bill to “repeal and replace” the Affordable Care Act. The draft is even worse for the 37 million children that Medicaid covers and the providers who serve them than the bill that narrowly passed the House. Not only would the draft dial down the federal payments to state Medicaid programs even lower than the House bill, but it also adds another dial that would allow the federal government to ratchet down its spending on health care for children in states with more generous payments to providers.

We’ve explained how the cap in the House bill is a budget platform that the federal government can use to dial down its spending on Medicaid, shifting costs to states. The Leadership draft shows just how easy it is, lowering the annual growth rate in the different pieces of the aggregate cap from the medical inflation (CPI-M, projected at 3.7%) and CPI-M plus 1 to general inflation (CPI-U, projected at 2.4%). Look Ma! No hands!

But the Leadership draft adds an entirely new dial. Starting in 2022, the draft instructs the Secretary of Health and Human Services to reduce the amount of per capita spending allowed for children if a state’s spending for children is 25 percent or more above than the national average. States with spending 25 percent or more below the national average would have their per capita allowance increased. (These adjustments would apply to the other enrollee groups—seniors, individuals with disabilities, and non-disabled adults—as well).

The amounts of the annual reductions appear small—at least 0.5 percent and up to 2.0 percent—but over time they will drive down federal Medicaid spending on children (and other enrollee groups) even further than the aggregate cap would by itself. We are still working through the newly released Congressional Budget Office, but here’s an oversimplified example to show how this will work.

Remember that the amount of the aggregate cap in any year is the sum of the per capita spending on each enrollee group times the number of enrollees in that group. (Per capita spending on children times the number of children plus per capita spending on seniors times the number of seniors, etc.). So if a state spent $150 per capita on children and enrolled 1,000 children, the state’s cap would reflect $150,000 for children.

Assume that the national average per capita spending on children that year is $100. In this case, the state would be subject to the reduction because its spending exceeds 25% of the national average. If the Secretary applies the full 2% reduction—and why not?—the allowable per capita payment will be $147, not $150. The amount that the state’s cap reflects for children will now be $147,000, not $150,000.

In other words, the states that spend more on children will find their aggregate caps lowered. Let THAT be a lesson to them!

Why would a state want to spend more money on children than the national average? Health care costs in the state might be higher than the national average. The health of its children might be lower than the national average, requiring more spending. The state as a matter of public policy may want to pay its providers better than the national average. Under the Senate draft, all of these considerations are irrelevant. It matters only where the state’s per capita spending is in relation to the national average.

(It also matters if the state has a population low population density, like Alaska, Montana, North Dakota, South Dakota, and Wyoming, in which case the state is exempt).

Of course, the incentive for states is to stay within 25% of the national average so as to avoid the 2% reduction. That over time will drive the national average spending on children (and other enrollee groups) down, as all but the lowest-spending states look for additional ways to reduce per capita spending so as not to get dinged. (Note that the lowest spending states would still have to put additional state funds into services for children in order for children or their providers to derive any benefit from an upward adjustment in the per capita limits).

From the federal government’s standpoint, it can always dial down for more savings by lowering the threshold that triggers the reductions from 25% to 20% or lower or by increasing the allowable reductions to 3% or more. And it can argue that it is making these adjustments to encourage high-spending states to be more efficient.

This is how to gut the nation’s largest health insurer for children. Parents face big problems in this bill but we will blog on that at a later time.