Regulatory policy

Recent developments in the budget neutrality policy relating to the exception to Article 1115

Section 1115 of the Social Security Act allows the Secretary of the Department of Health and Human Services to waive certain rules of the Medicaid program and provide federal funding to states to test innovative coverage system reforms and benefits that would further the goals of the Medicaid program. Although not required by law or regulation, it has long been a policy of the Centers for Medicare & Medicaid Services (CMS) to require Section 1115 demonstrations to be “budget neutral” to the federal government, in in other words, the cost to the federal government of the demonstration must not exceed the cost that would have been in the absence of the demonstration. At the start of each demonstration period, states negotiate with CMS what Medicaid spending would have been without the demonstration. This is known as the “no waiver” benchmark and serves as a budget neutrality ceiling for the state. In general, States must keep actual waiver expenditure below the baseline without waiver or they may be required to make reimbursements to CMS.


Although conceptually simple, budget neutrality has evolved into a complicated set of calculations that do not always reflect true growth in Medicaid costs or states’ need for flexibility to respond to dynamic real-world circumstances (e.g., pandemic or a crisis of substance use disorders). Cindy Mann and Anne Karl of Manatt, along with Heather Howard of Princeton University, described some of the challenges of budget neutrality in a recent Health Affairs leading item. They point out that the current approach to budget neutrality:


  • Does not recognize that spending increases may be necessary to achieve key objectives. Budget neutrality focuses entirely on program spending and does not consider how investments can lead to significant improvements in quality, access, equity or other priorities (even if they do not generate financial savings).
  • Encourages innovation. States are at full risk when initiatives cost more than expected, discouraging states from pursuing bold new programs.
  • Hinders efforts to address historical inequalities. Addressing historical underinvestment in communities and providers serving historically marginalized populations may require states to make compensatory spending cuts in other program areas, discouraging these types of investments.
  • Promotes short-term thinking. States only get budget neutrality “credit” for savings achieved during the five-year demonstration period. This discourages investments that can generate long-term savings (for example, investments in children’s health).
  • Is unfair. Some states with long-standing waivers can access vast hypothetical “savings,” allowing them to finance substantial investments. At the same time, states with newer waivers and those without a track record of cost-saving policies find themselves unable to innovate without offsetting the cuts.
  • Is inflexible. The CMS generally did not allow states to make mid-show budget neutrality adjustments to account for routine programmatic changes (e.g., state plan rate increases).
  • Does not take into account inter-program savings. Section 1115 waiver demonstrations may result in savings to other federal programs (eg, Medicare). States do not currently receive budget neutrality credit for these savings.


The CMS has recently attempted to mitigate some of these shortcomings through its “rebasing” policy announced in 2018. This policy levels the playing field for budget neutrality in some respects by limiting the ability of states with waivers of a long-standing practice of ‘holding’ the economies of budget neutrality. for life. However, this new policy does nothing to address many of the other challenges outlined above and may create other unforeseen challenges for States and CMS.


In recent months, CMS has declared its interest in solving fundamental problems with its policy of budget neutrality. As noted above, the inability of states to adjust budget neutral caps to allow for increases in payment rates that would otherwise have been allowed under the state Medicaid plan or other authorities. (e.g. directed payments). Two recent waiver approvals — a modification in Kansas and an extension in Vermont — indicate that the administration has begun to take steps to address this particular issue. Below we outline the key features of each of these waiver approvals:


  • Kansas. On June 17, CMS approved an amendment to the state’s KanCare demonstration for the sole purpose of adjusting the demonstration’s budget neutral caps to account for changes to the Health Care Access Improvement Program. health (HCAIP) of the state. HCAIP includes state-directed payments to hospitals that are permitted outside of the demonstration; the Kansas Legislature recently passed legislation allowing the state to increase these payments. This waiver amendment adjusts the state budget neutrality caps for current and future demonstration years to reflect these changes. In the recent past, CMS generally did not allow states to modify protests solely for the purpose of making changes to budget neutrality, even if the policy requiring the change would otherwise have been authorized by federal Medicaid law. This amendment suggests that CMS could take a more flexible approach to allowing these types of changes in the future.
  • Vermont. On June 28, CMS approved an extension of Vermont’s longstanding demonstration of global health commitment. Along with many other changes, the approval gives the state ongoing authority to make adjustments to budget neutrality to account for increases in supplier rates. Notably, CMS will allow Vermont to make such changes without submitting a formal amendment. Instead, Vermont would simply need to separately request a budget neutrality adjustment from CMS; if approved by CMS, any changes would apply from the effective date of the rate increase. This approach—allowing budget neutral adjustments without amendment—further streamlines the budget neutral adjustment process compared to the approach used in Kansas. While it is unclear what approach CMS will take for other states in the future, it is nonetheless encouraging that CMS recognizes this key gap in the existing budget neutrality policy and is taking steps to address it.


With a number of states in negotiations with CMS over significant changes to existing waivers and new demonstrations, CMS may be on the verge of releasing further changes to its budget neutral policy that go beyond authorization. adjustments to take into account regular rate increases. CMS could continue to make policy changes by approving waiver changes, extensions, and new demonstrations (like in Kansas and Vermont). It could also choose to issue guidance that would take a more holistic approach to changing the budget neutrality policy. In any case, States and other stakeholders should be encouraged that CMS has begun to take concrete steps to alleviate some of the greatest challenges associated with the current policy of budget neutrality. The authority of Section 1115 has long been used by states to make significant investments in advancing key federal and state health care priorities, such as health equity, expanding coverage, improving quality and access, and driving delivery system and payments reform. Streamlining the budget neutrality policy will ensure that the authority of Section 1115 will continue to serve as a valuable tool in advancing these priorities.