The Costly Legal Loophole Harming Medicaid Billions

Medicaid is a widely recognized program that offers medical coverage to low-income individuals in the United States, funded through both state and federal resources. Research from health policy think tank FFF indicates that over 60 percent of Americans either have benefited from Medicaid or know someone who has. Consequently, discussions about modifications to the program often encounter significant pushback.

An illustration of this complexity is a little-known loophole that enables states to artificially boost their Medicaid expenses in order to receive additional federal funds. This setup permits certain states to retain a portion of the money allocated for treating Medicaid beneficiaries.

Here’s how it operates.

As an example, if a state has a 60 percent reimbursement rate and allocates $10 billion towards Medicaid services, the federal government would return $6 billion to that state.

This is the fundamental premise of the system, as it was established in 1965.

By the mid-1980s, some states had devised methods to escalate provider payments alongside their own Medicaid costs, effectively shifting the financial burden to the federal government.

In these arrangements, healthcare providers would voluntarily contribute funds to a state or agree to pay a tax. The states would subsequently return the amount contributed or even exceed it through enhanced reimbursements. Finally, states would invoice the federal government for the rise in costs.

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For instance, a hospital may consent to pay the state $10 million in taxes. In return, the state might elevate Medicaid reimbursements to that hospital by $20 million. With a reimbursement rate of 60 percent, the state would then obtain $12 million in federal Medicaid funding.

Combining the tax revenue, the state would ultimately secure $22 million while disbursing $20 million, thus netting an additional $2 million for extra Medicaid expenses or other needs.

This arrangement not only provided added benefits to providers through enhanced reimbursements but also enabled states to alleviate their spending, while the federal government faced the resultant cost increases.

In 1991, Congress engaged in discussions about this topic.

Lawmakers advocating for the continuation of the system contended that it had become crucial for state Medicaid financing.

Rep. Raymond McGrath (R-N.Y.) warned that dismantling the system could cost his state $500 million in federal matching funds, foreseeing “chaos” in the Medicaid framework if provider taxes were eliminated.

Conversely, the administration of President George H.W. Bush expressed strong opposition towards the taxes, asserting that “State donation and provider-specific tax programs, if unchecked, will undermine a basic premise of the Medicaid program—that States have a stake in the costs of the program.”

Ultimately, Congress decided to impose restrictions on provider taxes and donations.

First, contributions from providers to the state are tightly regulated to curb misuse. Second, state taxes must fulfill specific conditions or risk the loss of federal funds.

Taxes should be applicable to all providers within a defined category, such as nursing homes, rather than exclusively targeting those serving Medicaid clients. Moreover, states cannot furnish any direct or implied assurance of reimbursement to providers concerning the tax amounts. The cap on provider taxes stands at 6 percent.

Here’s how the provider tax presently functions.

Increasing Tax, Dependence

In 2004, 35 states imposed taxes on medical care providers. Today, every state except Alaska, along with the District of Columbia, levies some form of tax on providers.

Additionally, states are increasingly reliant on tax revenue to finance Medicaid and other services, according to the Government Accountability Office (GAO).

From 2008 to 2018, the proportion of Medicaid spending funded by provider taxes jumped from 7 percent to 17 percent, as reported by the GAO.

In 2018, states accrued $63 billion from provider taxes and local government sources, with $16 billion (25 percent) not allocated for provider payments, according to GAO estimates.

This shift transferred 5 percent of Medicaid expenses from the states to the federal government, according to GAO assessments. Moreover, the practice led to diminished overall reimbursements for some providers when factoring in their tax payments.

In relation to GDP, a recognized measure of a country’s total wealth, state Medicaid expenditure burdens have remained stable from 2008 to 2023. While overall spending escalated, similar economic growth meant that state Medicaid spending effectively remained unchanged, as described by the think tank Paragon Health Institute.

However, the program’s overall expenses rose dramatically during this time, with the federal government absorbing the entire cost increase over 15 years, as stated by Paragon.

Over the same span, the federal government’s contribution to total Medicaid expenses increased from 60 to 72 percent.

With Medicaid accounting for 92 percent of the committee’s budgetary concerns, discussions surrounding potential program changes have gained momentum.

Some lawmakers have proposed restricting the federal government’s reimbursement rates to states or cutting the percentage of reimbursement.

House Speaker Mike Johnson (R-La.) clarified that he is opposed to either of those measures. “We’re focused on finding efficiencies in every program, not on stripping benefits for individuals who rightfully deserve them,” Johnson stated in a February 26 interview on CNN.

This position has led some lawmakers to scrutinize provider taxes.

They determined that abolishing the tax could yield a reduction of $612 billion in the federal deficit over a decade. Lowering the tax rate to 2.5 percent would bring about a $241 billion deficit reduction, while adjusting it to 5 percent would result in a decrease of $48 billion.

“Republicans are aiming to implement the largest reduction to Medicaid in American history, and we must maintain pressure on them legislatively and in communities across the nation,” asserted House Minority Leader Hakeem Jeffries (D-N.Y.) in a video call with Democratic innovators on March 5.

Unknown Impact

The use of state taxes to amplify Medicaid reimbursements has drawn scrutiny from both sides of the political aisle. Former President Joe Biden labeled state taxes on healthcare providers a “scam,” according to Bob Woodward’s “The Price of Politics.”

Conversely, others advocate for the mechanism as a means for financially strained states to sustain Medicaid. The CRS points out that the provider tax enables states to enhance reimbursements to specific provider categories, like hospitals and nursing homes.

Utilization of this tax tends to rise during or following economic recessions. “Medicaid provider tax revenues may provide a means for states to sustain Medicaid funding amid budget constraints,” noted the CRS.

Nonetheless, the extent to which restricting state taxes on healthcare providers would affect Medicaid remains uncertain.

Eliminating all taxes on healthcare providers could potentially reduce federal Medicaid disbursements by approximately 8 percent over the next decade, based on CBO estimates. A tax rate reduction would lead to decreases ranging from 0.6 to 3 percent.

“It seems unlikely that enough finances are at stake for states to consider decreasing their [Medicaid] expansion population,” suggested Niklas Kleinworth of Paragon Health Institute to The Epoch Times.

Kleinworth speculated that states might prioritize funding cuts for what are termed social determinants of health, including home modifications, non-medical transportation, and education.

“States are likely to strive for more efficiency within their Medicaid programs,” Kleinworth remarked.

Accurately determining the overall effects is challenging since there is not a comprehensive understanding of the total amount of provider tax revenues utilized by states for Medicaid expenditures, according to CRS.

Considering this gap in knowledge, the GAO proposed five years ago that the Centers for Medicare and Medicaid Services should gather thorough and consistent data on all funding sources employed by states to finance Medicaid, which encompasses provider taxes.

As of February, this recommendation has yet to be implemented.