Many state lawmakers are concerned that if their states accept Obamacare grant funding, they will be implementing policies counter to the states’ best interests.

In any battle, it is wise to pick targets strategically. Obamacare is a many-headed monster—its funding is not one block grant. Conservatives should focus on refusing federal funding for elements of Obamacare that are integral to the legislation’s design and have significant policy consequences—while giving lower priority to funding that doesn’t meet both of those tests.

The Obamacare grant programs now attracting the most attention are the three related to creating health insurance exchanges:

Exchange planning. The first program offered “exchange planning” grants of $1 million per state. Every state except Alaska applied for a planning grant, though Florida, Louisiana, and New Hampshire subsequently returned theirs. However, the only obligation for states that accepted planning grants is to submit a report to the Department of Health and Human Services (HHS). Some of those reports (which will be public documents) could further highlight the problems and disruptions Obamacare will cause.

Early innovator. The second program offered “early innovator” grants, which HHS awarded to seven states (Kansas, Maryland, Massachusetts, New York, Oklahoma, Oregon, and Wisconsin). Those were grants of $6 million to $54 million to develop prototypes of the information technology infrastructure needed to implement Obamacare. New governors in Kansas and Oklahoma have, wisely, returned those grants. The remaining five states should do the same, though that is unlikely given the political makeup of most of them.

Exchange establishment. The third and most significant program offers “exchange establishment” grants. HHS is offering these grants in two levels, with opportunities for states to apply each calendar quarter through June 2012. Unlike the exchange planning grants, these require action. States accepting exchange establishment grants must commit to achieving specified milestones in implementing Obamacare’s exchange design and related provisions—most notably the Medicaid expansion, new subsidy program, and insurance market regulations.

Obamacare’s exchanges present state lawmakers with a dilemma. The legislation designed them to control access to state Medicaid programs and to implement federal health insurance regulations, but then gave states the option of creating the exchanges themselves or letting federal officials do so. Naturally, state lawmakers, even ones opposed to Obamacare, are looking for ways states can control the exchanges (thus retaining at least some control over their Medicaid programs and insurance markets) and limit Obamacare’s cost and damage.

Initially, while HHS was still deciding how to implement the legislation, a narrow window of opportunity existed for states to pursue a “pushback” strategy of creating a restricted exchange and requiring it to contract with the state’s Medicaid program and insurance department to perform the eligibility, enrollment, and insurance regulation functions that state lawmakers seek to retain control of. HHS effectively closed that window in its proposed exchange regulations issued in July. In particular, section 155.110, dealing with exchange contracting, specifies in subsection (b) that, “To the extent that an Exchange establishes such arrangements, the Exchange remains responsible for ensuring that all Federal requirements related to contracted functions are met.”

In its exchange establishment grant application, HHS requires a state to submit not only a letter of intent and support from its governor, but also “(a) a letter of support from the State Medicaid Director agreeing not to duplicate efforts between the Exchange and State Medicaid office and to work with the Exchange on developing shared functionalities, and (b) a letter of support from the State Insurance Commissioner agreeing to work with the Exchange on implementation and to coordinate efforts as appropriate.”

The combined effect of these regulations and grant requirements are that a state would have to agree to surrender any last vestiges of meaningful control over how Obamacare is implemented. Thus, a state would now have no more real control over an exchange it set up than over one HHS established.

While just 24 months remain until exchanges must open for business, HHS has made little discernable progress toward creating federal fallback exchanges.

Consequently, at this point the best course of action for states is to neither apply for nor accept exchange establishment grant funding.

Instead, state lawmakers should pursue their own patient-centered, market-based reforms separate from and independent of Obamacare, using only private-sector or state resources. In particular, state lawmakers interested in creating a defined-contribution option for employment-based coverage should ensure that any “exchange” or “clearinghouse” to handle the administrative functions does not receive federal funding.

Conservatives should similarly review their approach to other grant programs in Obamacare.

For example, states should refuse HHS’s health insurance “premium review” grants. Obamacare’s premium review provisions are bad policy and a political tool for blaming insurers when Obamacare drives up coverage costs. Obamacare gave HHS authority to require insurers to report premium data and to “name and shame” rate increases, but did not empower HHS to block premium increases. Only state insurance regulators—implementing state laws—can do that. Thus, these grants are intended to make HHS’s job easier (by requiring states to give HHS state insurance data), and to co-opt state insurance departments into denying rate increases HHS deems “unreasonable.”

To protect the integrity and independence of their insurance departments, state lawmakers should decline premium review grants. Five states (Alaska, Georgia, Iowa, Minnesota, and Wyoming) have not applied for those grants, and two others (Florida and Oklahoma) have since returned them. The remaining states should also return their grants.

In the end, avoiding grants with significant policy strings attached, while important, is only part of the task for state lawmakers opposed to Obamacare. They should also be pursuing their own agenda of patient-centered, market-based reforms that will constitute the “replace” part of “repeal and replace.” Given that the political, judicial, and logistical impediments to implementing Obamacare are actually increasing over time, those alternatives might be needed sooner than anyone expected.