State and federal governments limit the amount that Medicaid will pay for certain generic drugs under federal price ceilings known as the "Federal upper limit."

According to the United States Department of Health and Human Services, the "Federal upper limit program was put in place to ensure that the Federal Government acts as a prudent payer by taking advantage of current market prices" for generic drugs. Under this program, the federal government limits states' payments to 150 percent of the published price of any drug that has three or more competing suppliers.

Each state determines its own method of determining reimbursement payments under its Medicaid program. States can set limitations beyond the Federal upper limit. These state price ceilings are known as "Maximum Allowable Costs" or "State upper limits."

In Illinois, for example, the "maximum price" the state will pay for generic drugs is calculated as the lowest of the five possible prices:

the Federal upper limit;
the State upper limit;
the pharmacy's prevailing charge to the general public;
the manufacturer’s average wholesale price minus 25 percent; or
the average wholesale price for drugs where that price is based upon the actual market wholesale price.

The state also pays a dispensing fee of $4.60.

Typically, federal and state governments pay much less for a generic drug when an upper limit has been set.