Why It Matters: HR1’s Change to Medicaid Waiver Budget Neutrality Rules

The 2025 budget reconciliation bill (“HR1” or “One Big Beautiful Bill Act”) significantly amended Medicaid, the federal public health insurance program for low-income people. HR1 has garnered significant attention surrounding new rules like work reporting requirements that limit the ACA’s Medicaid eligibility expansion. 

Less noticed has been another important amendment modifying Medicaid’s governance and financing: HR1 calcified a policy requiring that states’ demonstration project waivers, which facilitate policy experimentation not strictly allowed by federal law, to be “budget neutral.” This shift from a Carter-era executive branch policy to a statutory requirement will reverberate in federal/state relations, and the Medicaid program as a whole, for years to come. 

To illuminate the potential impacts of this change, we will explain demonstration project waivers; contextualize HR1’s new statutory requirement, Section 71118, which is a shift from an “executive condition” (which we explore here) to a statutory condition; and reveal why the branch of government that imposes a rule is structurally and substantively consequential. We then briefly consider the impact of budget neutrality as a statutory requirement on health and Medicaid policy.

Since 1962, Social Security Act Section 1115 has authorized state proposals for a “demonstration project waiver” if it “furthers the purpose” of Medicaid, which federal law declared in 1965 to be providing money to states to “furnish medical assistance” to low-income people. Under Section 1115, the HHS Secretary can waive provisions in Medicaid Act section 1902, which lists programmatic rules like the elements a state plan must include for participating in Medicaid such as eligibility and covered benefits. Also, Section 1115 permits the HHS Secretary to authorize federal payment for state expenditures that would not qualify under Section 1903 of the Medicaid Act, which describes the federal match and related rules. In other words, Section 1115 established broad power for HHS with little specificity, other than which requirements the Secretary has power to waive and when waivers allow financial matching not otherwise statutorily permissible.

Section 1115 thus necessitated implementation policies, which sometimes have been statutory, like the ACA creating processes for waiver applications and renewals. Some rules have been agency-created, including a longstanding requirement that waiver proposals be “budget neutral.” During the Carter administration, HCFA (CMS’s predecessor) articulated the budget neutrality principle to aid in determining whether to exercise agency discretion to approve a state’s application. ‘Budget neutral to the federal government’ means a state’s proposal would not result in costs to the federal government greater than what Medicaid costs would be without it. OMB reinforced this condition during the Reagan administration, but it became more significant when the Clinton administration’s failed health reform effort led HHS to invite states to submit more waiver applications, leading to more common use of waivers in the Medicaid program. 

Some major health policy reforms have relied on Section 1115 waivers. For example, Massachusetts’ universal health insurance plan depended on a waiver, and later became a model for the ACA. On the other hand, the first Trump administration invited state waiver applications to implement work requirements as a limitation on eligibility, which federal courts invalidated. Across policies, budget neutrality has been a consistent requirement, becoming part of the negotiation between a state and HHS. 

Budget neutrality is calculated on a longer time horizon, usually balanced out over the life of a waiver, whereas states perform Medicaid accounting annually. Critics argued the way budget neutrality was interpreted by different administrations was increasing Medicaid’s cost for the federal government. The U.S. Government Accountability Office (GAO) reports reinforced the critique that budget neutrality was elusive.

Section 71118 of HR1 formalized budget neutrality as a statutory requirement, shifting it from a more flexible executive condition to a more rigid statutory condition. Conditions on federal spending are a familiar tool that Congress uses to define and implement spending programs. Such conditions enable the federal government to operate programs in partnership with states, usually combining federal fiscal capacity with state administration. This cooperative federalism structure is common across social programs. The Supreme Court’s 1987 South Dakota v. Dole analysis remains the test for whether conditions on spending are unconstitutional and foregrounds federalism concerns.

Executive and statutory conditions are markedly different. As we wrote here, recent litigation raises questions about the extent to which Spending Clause and separation of powers doctrines demand checks on executive conditions, which may encroach on congressional control over spending and appropriations. We argue conditions imposed by executive branch actors pursuant to statutory authority are functionally similar to explicit statutory conditions and can be analyzed under Dole. On the other hand, executive conditions that do not exercise statutory authority can evade the checks of political processes and judicial scrutiny. Such checks improve accountability, transparency, and other values like liberty through public debate. Before the ACA, lack of transparency was a common critique of Section 1115 waiver negotiations because executive branch officials often negotiated behind closed doors and off the record – this same concern exists for all executive conditions. 

The budget neutrality policy showed how executive conditions are not the same as statutory conditions. The statutory language of SSA Section 1115 did not require budget neutrality. Indeed, the executive condition of budget neutrality could have been understood to contradict the reason the SSA authorized demonstration project waivers — to allow states to pursue the federalism value of policy experimentation while furthering the purpose of Medicaid. From this perspective, waivers would need to “demonstrate” policy goals like increased eligibility or better benefits or otherwise improve “furnishing medical assistance.” But because Medicaid does not cap federal contributions to states’ spending so long as states comply with federal law, the executive condition that was the budget neutrality policy arguably constrained waivers in a way Congress did not intend. Yet, waivers also enabled HHS to engage with states, facilitating flexibility to, for example, negotiate toward Medicaid expansion after NFIB v. Sebelius effectively rendered it optional. 

Section 71118 will constrain the Secretary’s power in favor of a statutory budget neutrality rule, and may also limit achieving new health policy goals. Federal Medicaid spending may become more predictable. But Section 71118 may have the effect of limiting the use of waivers to expand Medicaid eligibility and benefits by shifting the risk of financial burdens to states. States have less fiscal capacity than the federal government to experiment with new policies, and such experiments are likely to become less common and less creative after HR1. Shifting a longstanding executive condition to a less flexible statutory condition may add transparency to Section 1115 applications. However, this statutory condition may also push Medicaid policymaking out or down – out of HHS, down to states, and therefore policies improving health care access for low-income Americans may become less achievable.