American Journal of Law & Medicine

No room at the Inn: how the federal Medicaid program created inequities in psychiatric hospital access for the indigent mentally ill.


   Get off [public transportation] at San Francisco's Powell Street 
   station and you enter an open-air asylum. A woman crouches on the 
   sidewalk, screaming obscenities. A man stumbles in circles, haunted 
   by demonic voices. Hands reach out and rattle cups for spare change; 
   voices curse those who pass by. For more than three decades, 
   California has turned its back on those who suffer from severe 
   mental illness, treating them as unfortunate fixtures in our urban 
   landscape rather than as human beings who desperately need 
   medication, treatment and housing in order to cope with their 
   illnesses. (1) 

California is not alone in turning its back on the severely mentally ill. Because of financial incentives from the federal government, every state continues to close state-run psychiatric hospitals, (2) leaving those who are poor and severely mentally ill with no treatment or care. Many cities have areas similar to San Francisco where the mentally ill suffer in public (3) because it is cheaper to abandon the mentally ill to an open-air asylum than it is to build and fund psychiatric hospitals.

In the decades following World War II, media reports of the horrifying conditions of psychiatric hospitals shocked and embarrassed most of the United States. (4) As a result, various groups advocated reform of the overall system of treatment for the mentally ill and particularly attacked the practice of placing the mentally ill in over-crowded, filthy, warehouse-like institutions. (5) Popular culture depicted psychiatric hospitals as places in which the government and sadistic doctors and nurses tortured society's non-conformists and free thinkers. (6) Theories such as psychiatric hospitalization producing mental illness or resulting in psychosis were appropriate reactions to an insane world that gained widespread acceptance. (7)

Almost simultaneously, medical research discovered that certain medications could effectively reduce or eliminate the most debilitating symptoms of serious mental illness. These antipsychotic medications "controlled the symptoms of certain psychoses sufficiently to allow many patients to function outside a hospital." (8) Belief that such medications would enable previously severely disabled individuals to function independently in the community encouraged the widespread release of the mentally ill from state hospitals. (9)

Thus, deinstitutionalization has mainly been described as the result of one or more of the combination of the following: disgust with the condition of psychiatric hospitals; (10) theorizing that mental illness didn't exist, so that if removed from the hospitals, patients would recover; (11) belief that many institutionalized individuals could function well outside the hospital if community care options were provided; (12) and the development of effective medications that could alleviate the most devastating symptoms of mental illness. (13) Yet, almost completely absent from the scholarly literature is an examination of the federal government's Medicaid policies in accelerating the abandonment of the mentally ill. (14)

While debates continue in Congress over "parity" in healthcare coverage of mental illness by private insurance companies, (15) there is no audible debate about the federal government's responsibility for the plight of the indigent mentally ill. (16) By excluding from Medicaid reimbursement the majority of mentally ill individuals who need long-term psychiatric care in a hospital, yet permitting payment for "treatment" received elsewhere, the federal government has contributed to the provision of substandard care, as well as to the failure to provide the mentally ill with any care at all. Since many of the most severely mentally ill are also extremely poor, (17) forcing private insurance to cover psychiatric illnesses (18) does nothing to assist those who cannot afford insurance in the first place.

This Article will first describe the history of Medicaid, the federal program designed to assist the extremely poor by reimbursing states for medical costs. Next, this Article will demonstrate that the institutions for mental disease (IMD) exclusion (19) results in the denial of psychiatric hospitalization for the indigent mentally ill, the closing of existing psychiatric hospitals and the implementation of other measures taken to shift the cost of treating the mentally ill from the state governments to the federal level, which routinely means no treatment at all. Finally, the Article will suggest that the medical profession's better understanding of the physical basis for psychiatric illnesses shouldcause Congress to repeal the IMD exclusion.



In 1965, the federal government enacted the Grants to States for Medical Assistance Program, known as Medicaid. (20) Medicaid is designed to improve healthcare for the poor by providing matching funds for state expenditures. Appropriations are allocated:

   [f]or the purpose of enabling each State, as far as practicable ..., 
   to furnish (1) medical assistance on behalf of families with 
   dependent children and of aged, blind or disabled individuals, whose 
   income and resources are insufficient to meet the costs of necessary 
   medical services, and (2) rehabilitation and other services to help 
   such families and individuals attain or retain capability for 
   independence or self-care ... (29) 

Medicaid was intended as a "state-administered, federally funded medical care reimbursement program" (22) designed to cover federal welfare recipients, restricted to "indigent people who were either disabled, blind, over 65 years old, or members of families with dependent children." (23)

By "enabling" each state, Medicaid does not provide healthcare directly to patients, but instead provides matching (and even exceeding) funds to encourage the states to make healthcare available for the very poor. "The federal government shares the cost of each state's program, based on a formula determined by the state's relative wealth. The federal share ranges from 50% to 78%...." (24) Thus, states already providing identical services to those covered by Medicaid stood to gain significant amounts of money by applying for the federal funding.

From the beginning, Medicaid has not covered psychiatric care provided in a state-funded psychiatric hospital. The term "medical assistance" is defined as "payment of part or all of the cost of the following care and services," (25) except "any such payments with respect to care or services for any individual who has not attained 65 years of age and who is a patient in an institution for mental diseases." (26) The Code was amended in 1973 to reimburse providers for psychiatric hospitalization of patients under the age of twenty-one. (27) Medicaid s definitions of "institution for mental disease" and "psychiatric hospital" are the same and apply the identical standard:

   (f) The term 'psychiatric hospital' means an institution which-- 
   (1) is primarily engaged in providing, by or under the supervision 
   of a physician, psychiatric services for the diagnosis and treatment 
   of mentally ill persons; 
   (3) maintains clinical records on all patients and maintains such 
   records as the Secretary finds to be necessary to determine the 
   degree and intensity of the treatment provided to individuals ...; 
   (4) meets such staffing requirements as the Secretary finds 
   necessary for the institution to carry out an active program of 
   treatment for individuals who are furnished services in the 
   institution; and 
   (5) is accredited by the Joint Commission on Accreditation of 
   Hospitals. (28) 

Excluding psychiatric hospitals from coverage is not unique to Medicaid. Two years before passing Medicaid, Congress mandated creation of Community Mental Health Centers (CMHCs), which were designed to foster outpatient psychiatric treatment instead of hospitalization. CMHCs were to "include an emergency psychiatric unit, inpatient services, outpatient services, day and night care, foster home care, rehabilitation programs, and general diagnostic and evaluation services." (29) Underlying both CMHCs and the IMD exclusion is the misguided belief that the need for long-term hospitalization would be eliminated and that CMHCs would fulfill all the needs of former psychiatric patients by providing care in the community. (30) In fact, the failure of communities to provide effective and humane care was the original impetus for the establishment of state psychiatric hospitals. (31)


To understand the rationale behind the IMD exclusion, it is necessary to review the development of psychiatric care in the United States. Historically, care for mentally ill individuals was considered a family, locality or state responsibility. In the early colonial United States, mentally ill individuals were treated in various ways depending upon the individual's economic status, the type of mental disability suffered and the economic and social options available to the colony. Many mentally ill individuals were cared for at home, or confined in individual, cell-like buildings. (32) Such buildings were usually designed to contain the violent mentally ill and were erected because many colonial settlements lacked a jail. (33)

Another common response to the mentally ill concerned individuals who wandered from town to town but did not reside in any particular settlement. The response to the wandering mentally ill was the same as the treatment received by any unwanted newcomer: expulsion from the community. "[T]he most repressive measures were adopted to keep out poor strangers, including the dependent insane, through the medium of harsh settlement laws." (34) Such laws included penalties for returning uninvited and unwelcome. "In some colonies, public whippings faced all destitute persons who dared to return to a locality after once having been driven out .... In others, still harsher laws provided for the whipping of poor strangers ... even before expulsion." (35)

As the colonial period progressed, and populations grew, new solutions were devised to address the problem of the indigent mentally ill. When a family could not provide for or control a mentally ill member, the individual became the concern of the community. At times, the town officials provided funds directly to families to assist them in caring for their mentally ill member. Another option involved having the stricken individual "boarded out," with funds paid by the officials for a private citizen to take over his care. (36)

Similar to "boarding out," but with more disturbing implications, was the solution common to more rural areas of having private citizens bid for the opportunity to care for the mentally ill in exchange for the person's free labor. (37) The citizen who bid the lowest won the auction and was responsible for boarding the patient in exchange for a small sum of public funds, as well as the right to have the patient work:

   The custom most shocking to modern thought, undoubtedly, was that 
   of placing the poor on the auction block like so many chattel slaves 
   --the only difference being that they were sold to the lowest, 
   instead of the highest, bidder. However barbaric it may appear in 
   our eyes, the system was at that time generally accepted with quite 
   the same complacency that the average Southerner then showed toward 
   the institution of slavery. As a matter of record, the custom of 
   bidding off the poor persisted over a wide area throughout the 19th 
   century.... The guiding principle underlying this practice was to 
   get rid of public charges at the lowest possible cost and the least 
   amount of trouble to the community. The custom seems to have 
   originated in the northeastern states, since it was popularly known 
   as the 'New England System.' (38) 

This system, with the agreement that the indigent individual provides free labor to the winning bidder, resulted in the mentally ill being particularly desirable. "The insane and the feebleminded are often most eagerly sought after [at auction], for 'strong backs and weak minds' make good farm laborers--and the bidders are invariably farmers." (39)

Eventually, the mentally ill were placed in the only institutions of early American history, structures that did not differentiate among the causes of poverty: the workhouse and the almshouse. While the workhouse was designed to keep outsiders away from settlements by subjecting them to harsh labor, the almshouse was to "lodge, feed, and perhaps employ the town needy." (40) Sometimes both were combined in one institution. "The workhouse became a motley receptacle of the destitute and deviant of all kinds, trying to serve simultaneously as house of correction, a hospital and an almshouse." (41) Such institutions pre-dated the building of any type of hospital, including psychiatric hospitals.

When the first hospital, Pennsylvania Hospital, opened in the colonies in 1756, mentally ill patients were housed in basement cells. The hospital's treatment of the mentally ill differed little from that of the prison system and in some aspects may have been worse. One particularly unpleasant custom was that of "exhibiting the insane patients to the gaze of curious sightseers for a set admission fee. …

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