Using Medicaid to Support Working Age Adults with Serious Mental Illnesses in the Community: A Handbook. Medicaid and Community Services: Opportunities and Boundaries


The federal-state Medicaid program is an especially important source of funding for community mental health services. The program offers states the opportunity to secure federal dollars to strengthen and expand community services. The Medicaid rehabilitative services option is particularly important in underwriting services that contribute to the recovery and independence of working-age adults with serious mental illnesses. At the same time, there are boundaries that circumscribe the use of Medicaid to underwrite some types of services.


Medicaid’s role in paying for mental health services has grown considerably over the years. In 1997, it accounted for about 20 percent of all behavioral health spending23 and 35 percent of all public mental health expenditures.24 Medicaid is the single largest payer of public mental health services and is expected to play an even larger role in underwriting these services in the future.25

Medicaid plays a critical role in supporting working-age adults with serious mental illnesses. About 1.2 million working-age adults with mental disorders (excluding mental retardation) receive SSI benefits.26 These individuals are nearly universally eligible for Medicaid and include those who rely heavily on mental health services.

Federal Medicaid law does not spell out a defined set of mental health services or benefits. However, the Medicaid program includes certain basic coverage options (e.g., targeted case management, clinic and rehabilitative services) through which a state may elect to offer community mental health services as part of its Medicaid program. Medicaid permits states to provide a wide-range of critical community mental health services, including evidence-based practices such as ACT, and important recovery-oriented services such as peer support. While some Medicaid benefits include psychiatric services (e.g., short-term hospitalization), none are specifically defined as mental health services.

All available evidence shows that Medicaid has made enormous contributions to expanding access to mental health care for low-income populations. It also has expanded consumer choice for low-income people with mental disorders and has promoted community-based treatment for people with mental and addictive illnesses. Mental health care in the United States is unquestionably better because of the Medicaid program than it was thirty-five or even fifteen years ago.27

As will be described in greater detail in Chapter 4 and Chapter 5, many states have successfully incorporated a wide variety of community mental health services into their Medicaid programs. As states have concentrated more and more on supporting individuals with serious mental illnesses in the community and have adopted the CSS framework in their public systems, they have shifted away from employing the more circumscribed, outpatient treatment-oriented “clinic option” coverage in favor of using the more robust and flexible rehabilitative services option. Moreover, the scope of services that states are furnishing under the rehabilitative services option has broadened, thereby improving system capabilities to better respond to individual needs.

For example, from 1971 through 1993, California relied on the clinic option to underwrite public mental health services. But, under the clinic option, services had to be directed by a physician, provided mainly in a clinic, and focused primarily on the treatment of the mental disorder. In 1993, the state adopted the “rehab option” because services can be directed by licensed mental health practitioners (not just physicians) and “may be provided almost anywhere in the community, and may be focused both on the treatment of the mental disorder and the associated functional limitations that may jeopardize community living.”28

Federal law gives states the flexibility to align their Medicaid mental health coverages to their broader system goals and objectives. Medicaid is very much a state-shaped program. In the case of community mental health services, this is especially the case because federal policy gives states considerable latitude within broad guidelines in selecting the services that they offer. For example, states have extensively shaped the rehabilitation option, broadening its scope and securing coverage of important services such as peer supports and ACT. In addition, as will be discussed in Chapter 6, states also have the flexibility to adopt alternative service delivery models under Medicaid, including managed care models.

In many respects, the Medicaid program is best understood as a financing tool that enables states to obtain federal financial participation in the costs of services they elect to furnish and which comport with federal statutory and regulatory parameters. Federal Medicaid policy does not dictate a state’s service system goals and objectives. It sets parameters that determine whether the costs of services will qualify for federal funding. Medicaid’s contribution to underwriting community services for individuals is heightened when a state’s Medicaid coverages and core services are in close alignment.


Even though Medicaid helps fund mental health services -- especially on behalf of low-income individuals who have the most intensive need for services -- the Medicaid program cannot provide all the services and supports that beneficiaries with serious mental illnesses require in order to live successfully in the community. Medicaid is principally a purchaser of mental health and other primary health services, and with respect to mental health services, there are fundamental boundaries concerning the types of services that Medicaid may purchase. These boundaries have their roots in basic provisions of federal Medicaid law. While these boundaries often are less constraining than sometimes believed, it is nonetheless the case that not every service or support can -- or should -- be covered under Medicaid. Employing Medicaid to underwrite mental health services involves “finding the fit” between the services and supports that a state has identified as critical to meeting the needs of individuals with serious mental illnesses and Medicaid program requirements (as discussed in Chapter 5).

Medicaid-funded community mental health services have evolved along different lines than home and community services for individuals with other disabilities.29 Because federal Medicaid law prohibits the coverage of services in “Institutions for Mental Disease” (IMDs) that have more than 16 beds (the “IMD exclusion” is discussed in detail in Chapter 4), most states have not used the Medicaid home and community-based services waiver program to support working-age adults with serious mental illnesses. Instead, states employ Medicaid state plan services and other federal waiver authorities to support individuals in the community.

The principal boundaries that circumscribe the extent to which Medicaid can be employed to underwrite community mental health services include:

  • Eligibility. Medicaid services can be provided only to individuals who meet a state’s Medicaid eligibility criteria. States have latitude in establishing these criteria (as discussed in Chapter 3). Medicaid is a means tested program; in addition to meeting financial eligibility criteria, individuals with disabilities must also meet service eligibility criteria, which typically are based on functional limitations. The proportion of working-age adults with serious mental illnesses who qualify for Medicaid in a state depends on each state’s eligibility policies for adults with disabilities of all types. Medicaid eligibility rules can mean that some individuals with relatively low incomes may not qualify for Medicaid even though they have a serious illness. Individuals who do not qualify for Medicaid must be supported through other state and local resources.
  • Housing. Medicaid does not pay for housing. Except for certain institutional settings, Medicaid dollars generally cannot be used to pay for room and board or the routine living expenses of individuals. Medicaid, however, can finance services that are furnished in community residences or in a person’s own living arrangement, including the family home.
  • Vocational Services. Medicaid law does not permit states to obtain federal financial participation in the costs of job-specific vocational training, except under a waiver program (see Chapter 6), since the costs of such training may be underwritten with federal-state vocational rehabilitation dollars and/or state and other dollars. Medicaid dollars can be used to underwrite the costs of job-related rehabilitative, pre-vocational and personal assistance services (see Chapter 5). In addition, states may craft eligibility policies that enable people with disabilities to maintain Medicaid coverage when they obtain employment (see Chapter 3).
  • Capacity Building. Medicaid is designed to pay for services provided to eligible individuals. Medicaid funding is not available to underwrite the costs of starting up services. For example, in Michigan there is an especially robust network of ACT teams in place around the state. Michigan officials regarded the creation of this network as vital in order to minimize costly hospitalizations. The state used community mental health services block grant dollars to start up these teams. Once the teams were operational, they qualified for and began receiving Medicaid funding to sustain their ongoing operation.30 Capacity building frequently requires the investment of state, local and private resources. The Community Mental Health Block Grant also has been an important resource for states to launch services that later could qualify for Medicaid funding.

Just as the provision of treatment services alone are not sufficient to promote community living for individuals with serious mental illnesses, Medicaid funding by itself is insufficient to meet many fundamental and diverse needs. Medicaid is a powerful, important contributor to the provision of mental health services and other primary health care for individuals. But, Medicaid funding must be employed in tandem with other federal, state, and local funding sources in order to comprehensively address the full range of supports that working-age adults with serious mental illnesses require to live successfully in the community. As recommended by the President’s New Freedom Commission on Mental Health, it is important that states develop comprehensive mental health plans that take a broad view of how Medicaid along with other federal and state programs can work together to support individuals with mental illnesses.

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