Medicaid’s budget neutrality rules for section 1115 waivers


Emily Boerger


For decades, a focus in Medicaid has been on state proposals that fall outside what is allowable under the program’s normal rules. The Secretary of Health and Human Services (HHS) has wide discretion under section 1115 of the Social Security Act to “waive” legal or regulatory impediments to state initiatives found to be consistent with the overall objectives of the Medicaid statute. Currently, 47 states and the District of Columbia are administering 76 of these waiver programs, with an additional 40 submissions awaiting a decision.


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A major consideration for the federal government is the financial effects of the state plans. To gain approval, the states must meet neutrality requirements intended to protect the federal budget from higher costs. The Medicaid and CHIP Payment and Access Commission (MACPAC) recently published a useful overview of how “budget neutrality” is defined and enforced in the context of state section 1115 submissions.


  • A Non-Statutory Construct. The federal budget neutrality rules are not anchored in federal law. Section 1115 of the Social Security Act makes no mention of it as a criterion for approving state waiver requests. Rather, the rules have evolved over time in response to the federal government’s expectation that states would use the section 1115 process to leverage more federal funding.

Officials at the federal Office of Management and Budget (OMB) began flagging this concern in the late 1970s and early 1980s. During the Reagan administration, as part of a larger budget negotiation, they secured an agreement with HHS that budget neutrality would be a condition for approval of future 1115 proposals. Further, the agreement specified that the waivers could not be approved without OMB concurrence. The Clinton administration reaffirmed and clarified the federal budget neutrality requirements with a published notification in 1994. In 2018, the Trump administration updated the guidance through a letter sent to all state Medicaid directors.


  • The Per Capita Method. Most states aim to achieve neutrality on a per person basis rather than for aggregate program spending, as this method protects them from being held responsible for unpredictable fluctuations in total program enrollment. States must track how much they are spending for various categories of enrollees, and are accountable for trends that are above what would have occurred without the waiver. However, if the economy softens unexpectedly, the state is held harmless for the added spending from a surge of new applicants.


  • The Without Waiver Baseline. The per capita spending limits against which neutrality is assessed are calculated by trending forward the state’s existing spending per enrollment category by the lower of its historical trend rate, or the expected national average growth rate as reflected in the most recent president’s budget submission to Congress.


  • Rules for Measuring and Using Savings. States have an incentive to pursue section 1115 waivers because, if they can point to cost reductions, they can use what is saved on other priorities (within health care). Federal budget neutrality rules also allow for neutrality assessments across multiple years instead of annually. Thus, for a five-year waiver plan, states need only show that their schemes are neutral across the full timeframe of the waiver agreements. Further, if there are savings at the end of a waiver period, the state can apply them to the period covered by an extension.

Previous rules allowed states to carry over savings across multiple waiver renewals. The 2018 guidance scaled back this flexibility so that states now can only apply savings from a current waiver to one subsequent extension. Further, the baseline for assessing spending trends will be updated based on recent data instead of referring back to trendlines from the initial waiver negotiation.


  • CNOM. As noted, the major advantage of section 1115 is that states can apply federal funding that is “saved” by the waivers’ reforms to coverage or services not normally allowed by Medicaid — so-called “Costs Not Otherwise Matchable,” or CNOM. This flexibility is why many states apply for waivers and waiver extensions to implement reforms (such as managed care initiatives) that do not require waivers. It is only through section 1115 that savings from these changes can be applied to expanding Medicaid enrollment to populations that fall outside the statute’s optional categories, or to services that are beyond the statute’s specified range of coverage.

Although CNOM flexibility motivates many states to jump into the 1115 process, the share of Medicaid devoted to CNOM is small — just 3 percent of total program spending in 2019.


The federal government’s budget neutrality expectations are clearer and more transparent than they were four decades ago, but it would be an overstatement to describe the process as airtight. It remains idiosyncratic, and largely outside of public view. Every state believes it deserves special consideration, and federal officials sometimes (but not always) seem to agree.

 James C. Capretta is a columnist for State of Reform and a senior fellow at the American Enterprise Institute.