CMS Rule Would Close Medicaid Loophole
The Center for Medicare & Medicaid Services (CMS) recently proposed a rule to limit some of the most egregious provider taxes used by states to inflate their federal Medicaid match. On July 11th, the Committee for a Responsible Federal Budget filed comments voicing support for the proposed rule while calling for additional actions to prevent future financing schemes and improve transparency. In combination with restrictions imposed under the One Big Beautiful Bill Act (OBBBA), this rule will better ensure federal Medicaid dollars are spent based on actual health care costs and intended matching rates – not based on the cleverness of states and providers in developing financing schemes.
The proposed rule would close a loophole that has allowed several states to get around the requirement that provider taxes redistribute Medicaid funds to a range of providers, not just the ones that paid the tax. Importantly, OBBBA includes a provision that would generally accomplish the same things, along with other financing scheme limits. Nevertheless, we encourage CMS to take a “both/and” approach to strengthen the requirements and provide clarity to states. Both actions by Congress and the Administration improve the financial integrity of the Medicaid program.
You can read our comment letter here.
As our letter explains, Medicaid is funded through a combination of state and federal funding. And while the federal match is intended to be formula-based, states have several tools at their disposal to increase their effective match. In particular, states often use provider taxes to increase the federal share of Medicaid spending by using the revenue from provider taxes to increase payments to the very same providers they tax and then collect federal matching funds on those payments.
States have leveraged this scheme to increase provider taxes rapidly over the years and shift costs to the federal government. In 2008, provider taxes generated $10 billion (7 percent of the state share); by 2018, they generated $37 billion (17 percent). Studies found that states’ use of provider taxes and local government funds decreased states’ share of Medicaid and shifted responsibility toward the federal government by about 5 percentage points. That rate is likely higher today, though it is likely to decline in the coming years assuming OBBBA implementation.
Current federal rules try to prevent these cost shifting schemes by requiring provider taxes be:
- Broad-based (apply to all providers in a class),
- Uniform (apply the same rate to all), and
- Not hold providers harmless (i.e., providers should not receive back the same amount they pay in taxes).
The “hold harmless” provision has a 6 percent of provider revenue “safe harbor threshold,” which OBBBA reduced for most states. While most attention on provider taxes (including our own), has focused on this “hold harmless,” there are other ways that states circumvent the spirit of provider tax rules.
CMS may waive the broad-based and uniformity requirements if a state can demonstrate that the tax is “generally redistributive.” To qualify for the waiver, the state’s tax arrangement must pass the “B1/B2 test,” a statistical test that compares whether Medicaid providers are taxed disproportionately compared to a uniform tax.
States have learned to exploit a loophole in the B1/B2 test by crafting taxes that impose much higher taxes on targeted Medicaid-intensive providers and lower taxes on non-Medicaid providers. For example, California levies a tax on Medicaid managed care organizations at rates 100 times higher than on commercial plans. These taxes pass the current B1/B2 test even if the tax violates the intent of the law.
CMS’s proposed rule is designed to curb this type of abuse. Specifically, CMS’s proposed rule would tighten the standards for determining whether a provider tax is “generally redistributive.” For example, the rule prohibits states from designing taxes that “accomplish the same effect” as such disparate tax rates as California’s even if the state’s tax does not “explicitly mention…Medicaid.” CMS estimates that taxes such as these generated $23.6 billion annually in funds for the state share, but if the taxes had been applied proportionately, only $11.4 billion (48 percent) would have been raised.
Our comment letter supported this reform, while pointing out that the agency could take additional steps to limit future provider tax abuses. In addition to the B1/B2 test, CMS could apply other statistical tests as they considered in a proposed rule in 2019. CMS should also require states to report details on how they raise the state share of funding, which states are not currently required to do. Linking provider-level tax data with provider-level Medicaid payment data would allow CMS to see both sides of the equation. CMS could assess whether provider taxes are, in practice, generally redistributive, or if providers are simply held harmless for the taxes they pay.
The letter also discussed how the new rule might interact with similar changes in OBBBA. The recently enacted legislation complements but complicates finalizing CMS’s proposed rule. OBBBA contains a provision similar to CMS’ proposed rule and would close the same financing loophole. However, OBBBA has a different implementation timeline than the proposed rule and uses slightly different wording. CMS will determine how the two interact in the coming months as they interpret the new statute. Given the overlap, CMS should use the proposed rule to further articulate the new law and improve accountability. Using a “both/and” approach, CMS can ensure that clever states do not find additional loopholes.
Regardless of the differences, CMS and Congress have taken important steps toward cracking down on provider tax loopholes. We support these actions to improve the overall integrity of the Medicaid program.
