Testimony 

Before the Subcommittee on Health, 

Committee on Energy and Commerce, 

House of Representatives 

United States General Accounting Office 

GAO

For Release on Delivery 

Expected at 9:30 a.m. EST 

Thursday, March 18, 2004 MEDICAID

Intergovernmental 

Transfers Have Facilitated 

State Financing Schemes 

Statement of Kathryn G. Allen 

Director, Health Care—Medicaid 

 and Private Health Insurance Issues 

GAO-04-574T 
www.gao.gov/cgi-bin/getrpt?GAO-04-574T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Kathryn G. 

Allen at (202) 512-7118. 

Highlights of GAO-04-574T, a testimony 

before the Subcommittee on Health, 

Committee on Energy and Commerce, 

House of Representatives 

March 18, 2004

MEDICAID 

Intergovernmental Transfers Have 

Facilitated State Financing Schemes 

For many years states have used varied financing schemes, sometimes 

involving IGTs, to inappropriately increase federal Medicaid matching 

payments. Some states, for example, receive federal matching funds on the 

basis of large Medicaid payments to certain providers, such as nursing 

homes operated by local governments, which greatly exceed established 

Medicaid rates. In reality, the large payments are often temporary, since 

states can require the local-government providers to return all or most of the 

money to the states. States can use these funds—which essentially make a 

round-trip from the states to providers and back to the states—at their own 

discretion. 

States’ financing schemes undermine the federal-state Medicaid partnership, 

as well as the program’s fiscal integrity, in at least three ways. 

• The schemes effectively increase the federal matching rate established 

under federal law by increasing federal expenditures while state 

contributions remain unchanged or even decrease. GAO estimated that 

one state effectively increased the federal matching share of its total 

Medicaid expenditures from 59 percent to 68 percent in state fiscal year 

2001, by obtaining excessive federal funds and using these as the state’s 

share of other Medicaid expenditures. 

• There is no assurance that these increased federal matching payments 

are used for Medicaid services, since states use funds returned to them 

via these schemes at their own discretion. In examining how six states 

with large schemes used the federal funds they generated, GAO found 

that one state used the funds to help finance its education programs, and 

others deposited the funds into state general funds or other special state 

accounts that could be used for non-Medicaid purposes or to supplant 

the states’ share of other Medicaid expenditures. 

• The schemes enable states to pay a few public providers amounts that 

well exceed the costs of services provided, which is inconsistent with 

the statutory requirement that states ensure economical and efficient 

Medicaid payments. In one state, GAO found that the state’s proposed 

scheme increased the daily federal payment per Medicaid resident from 

$53 to $670 in six local-government-operated nursing homes. 

Although Congress and the Centers for Medicare & Medicaid Services have 

acted to curtail financing schemes when detected, problems persist. States 

can still claim excessive federal matching funds for payments exceeding 

public facilities’ actual costs. GAO suggests that Congress consider a 

recommendation open from prior work, that is, to prohibit Medicaid 

payments that exceed actual costs for any government-owned facility. 

Medicaid, the federal-state health 

financing program for many of the 

nation’s most vulnerable 

populations, finances health care 

for an estimated 53 million lowincome Americans, at a cost of 

$244 billion in 2002. Congress 

structured Medicaid as a shared 

fiduciary responsibility of the 

federal government and the states, 

with the federal share of each 

state’s Medicaid payments 

determined by a formula specified 

by law. In 2002, the federal share of 

each state’s expenditures ranged 

from 50 to 76 percent under this 

formula; in the aggregate, the 

federal share of total Medicaid 

expenditures was 57 percent. 

Some states have used a number of 

creative financing schemes that 

take advantage of statutory and 

regulatory loopholes to claim 

excessive federal matching 

payments. GAO was asked to 

summarize prior work on how 

some of these schemes operated, 

including the role of 

intergovernmental transfers (IGT), 

which enable government 

entities—such as the state and 

local-government facilities like 

county nursing homes—to transfer 

funds among themselves. GAO was 

also asked to discuss these 

schemes’ effects on the federalstate Medicaid partnership and to 

discuss what can be done to curtail 

them. 
Page 1 GAO-04-574T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today as you explore the issue of states’ use of 

intergovernmental transfers in the federal-state Medicaid program. 

Medicaid finances health care for an estimated 53 million low-income 

Americans at a cost of $244 billion.1

 Medicaid is the third-largest 

mandatory spending program in the federal budget and one of the largest 

components of state budgets, second only to education. The program 

fulfills a crucial national role by providing health coverage for a variety of 

vulnerable populations, including low-income families with children and 

certain people who are elderly, blind, or disabled. Congress has structured 

Medicaid as a shared responsibility of the federal government and the 

states, with the federal share of each state’s Medicaid payments 

determined by a formula specified by law. The Centers for Medicare & 

Medicaid Services (CMS), within the Department of Health and Human 

Services (HHS), is the federal agency responsible for the program, and the 

states design and administer their programs with considerable discretion 

and flexibility. 

For more than a decade, states have used a number of creative financing 

schemes to inappropriately increase the federal share of Medicaid 

expenditures. Intergovernmental transfers, or IGTs, are one of the tools 

that have enabled them to do so. State and local governments use IGTs to 

carry out their shared governmental functions, such as collecting and 

redistributing revenues to provide essential government services. But by 

using IGTs, states can also transfer funds to or from local-government 

entities, such as government-owned nursing homes, as part of complex 

financing schemes that inappropriately boost the federal share of Medicaid 

costs. In my testimony today, I will (1) describe how some state financing 

schemes have operated, including the role of IGTs in these schemes; 

(2) discuss how such financing schemes compromise the federal-state 

partnership that is the foundation of the Medicaid program; and 

(3) discuss what can be done to further curtail state financing schemes. 

My testimony today is based on our prior work assessing state financing 

schemes and federal oversight of them. We conducted this body of work 

 1

Estimated federal-state cost is for fiscal year 2002, the latest year for which data are 

available. 
Page 2 GAO-04-574T 

from June 1993 through January 2004 in accordance with generally 

accepted government auditing standards.2

In summary, for many years states have used varied financing schemes, 

sometimes involving IGTs, to inappropriately increase federal matching 

payments. Taking advantage of statutory and regulatory loopholes, some 

states, for example, have made large Medicaid payments to certain 

providers, such as nursing homes operated by local governments, which 

have greatly exceeded the established Medicaid payment rate. These state 

expenditures would enable states to claim large federal matching 

payments. Such transactions create the illusion of valid expenditures for 

services delivered by local-government providers to Medicaid-eligible 

individuals. In reality, the spending is often only temporary because states 

require the local governments to return all or most of the money to the 

states through IGTs. Once states receive the returned funds, they can use 

them to supplant the states’ own share of future Medicaid spending or 

even use them for non-Medicaid purposes. Because such arrangements 

effectively increase the federal Medicaid share above what is set under 

law, they violate the fiscal integrity of Medicaid’s federal-state partnership. 

As new schemes have come to light, Congress and CMS have taken 

legislative and regulatory actions to curtail them; nonetheless, problems 

remain. We believe Congress and CMS should continue their efforts to 

preclude states’ ability to claim excessive federal Medicaid payments, and 

we suggest that Congress consider a recommendation that remains open 

from our prior work, that is, to prohibit Medicaid payments that exceed 

actual costs for any government-owned facility. 

Title XIX of the Social Security Act authorizes federal funding to states for 

Medicaid, which finances health care services including acute and longterm care for certain low-income, aged, or disabled individuals. States 

have considerable flexibility in designing and operating their Medicaid 

programs. Within broad federal requirements, each state determines which 

services to cover and to what extent, establishes its own eligibility 

requirements, sets provider payment rates, and develops its own 

administrative structure. In addition to groups for which federal law 

requires coverage—such as children and pregnant women at specified 

income levels and certain persons with disabilities—states may choose to 

expand eligibility or add benefits that the statute defines as optional. 

 2

See related GAO products at the end of this statement. 

Background 
Page 3 GAO-04-574T 

Medicaid is an open-ended entitlement: states are generally obligated to 

pay for covered services provided to eligible individuals, and the federal 

government is obligated to pay its share of a state’s expenditures under a 

CMS-approved state Medicaid plan. The federal share of each state’s 

Medicaid expenditures is based on a statutory formula linked to a state’s 

per capita income in relation to national per capita income. In 2002, the 

specified federal share of each state’s expenditures ranged from 50 

percent to 76 percent; in the aggregate, the federal share of total Medicaid 

expenditures was 57 percent.3

 The Social Security Act provides that up to 

60 percent of the state share of Medicaid spending can come from localgovernment revenues and sources.4

 Some states design their Medicaid 

programs to require local governments to contribute to the programs’ 

costs. 

For more than a decade, some states have used various financing schemes, 

some involving IGTs, to create the illusion of a valid state Medicaid 

expenditure to a health care provider. This payment has enabled states to 

claim federal matching funds regardless of whether the program services 

paid for had actually been provided. As various schemes have come to 

light, Congress and CMS5

 have taken actions to curtail them (see table 1). 

Many of these schemes involve payment arrangements between the state 

and government-owned or government-operated providers, such as localgovernment-operated nursing homes. 

 3

In May 2003, Congress passed the Jobs and Growth Tax Relief Reconciliation Act, which 

appropriated $10 billion for a temporary increase in the federal matching rate for states. 

This across-the-board increase of 2.95 percent was effective from April 1, 2003, through 

June 30, 2004. 

4

See 42 U.S.C. § 1396a(a)(2) (2000). 

5

In June 2001, the Health Care Financing Administration (HCFA) was renamed the Centers 

for Medicare & Medicaid Services (CMS). We continue to refer to HCFA throughout this 

testimony where agency actions were taken under its former name. 

Some State Financing 

Schemes Have Used 

IGTs to Create the 

Illusion of Valid 

Medicaid 

Expenditures 
Page 4 GAO-04-574T 

Table 1: Medicaid Financing Schemes Used to Inappropriately Generate Federal Payments and Federal Actions to Address 

Them 

Financing arrangement Description Action taken 

Excessive payments to state 

health facilities 

States made excessive Medicaid payments to stateowned health facilities, which subsequently returned 

these funds to the state treasuries. 

In 1987, the Health Care Financing 

Administration (HCFA) issued 

regulations that established payment 

limits specifically for inpatient and 

institutional facilities operated by states. 

Provider taxes and donations Revenues from provider-specific taxes on hospitals and 

other providers and from provider “donations” were 

matched with federal funds and paid to the providers. 

These providers could then return most of the federal 

payment to the states. 

The Medicaid Voluntary Contribution 

and Provider-Specific Tax Amendments 

of 1991 essentially barred certain 

provider donations, placed a series of 

restrictions on provider taxes, and set 

other restrictions for state contributions. 

Excessive disproportionate 

share hospital (DSH) payments 

DSH payments are meant to compensate those hospitals 

that care for a disproportionate number of low-income 

patients. Unusually large DSH payments were made to 

certain hospitals, which then returned the bulk of the 

state and federal funds to the state. 

The Omnibus Budget Reconciliation Act 

of 1993 placed limits on which hospitals 

could receive DSH payments and 

capped both the amount of DSH 

payments states could make and the 

amount individual hospitals could 

receive. 

Excessive DSH payments to 

state mental hospitals 

A large share of DSH payments were paid to stateoperated psychiatric hospitals, where they were used to 

pay for services not covered by Medicaid or were 

returned to the state treasuries. 

The Balanced Budget Act of 1997 

limited the proportion of a state’s DSH 

payments that can be paid to state 

psychiatric hospitals. 

Upper payment limit (UPL) for 

local government health facilities 

In an effort to ensure that Medicaid payments are 

reasonable, federal regulations prohibit Medicaid from 

paying more than a reasonable estimate of the amount 

that would be paid under Medicare payment principles for 

comparable services. This UPL applies to payments 

aggregated across a class of facilities and not for 

individual facilities. As a result of the aggregate upper 

limit, states were able to make large supplemental 

payments to a few local public health facilities, such as 

hospitals and nursing homes. The local government 

health facilities then returned the bulk of the state and 

federal payments to the states. 

The Medicare, Medicaid, and SCHIP 

Benefits Improvement and Protection 

Act of 2000 required HCFA to issue a 

final regulation that established a 

separate payment limit for each of 

several classes of local government 

health facilities. In 2002, CMS issued a 

regulation that further lowered the 

payment limit for local public hospitals. 

Source: GAO. 
Page 5 GAO-04-574T 

A variant of these creative financing arrangements involves states’ 

exploitation of Medicaid’s upper payment limit (UPL) provisions.6

 These 

schemes share certain characteristics, including IGTs, with other financing 

schemes from prior years (see table 1). In particular, these arrangements 

create the illusion that a state has made a large Medicaid payment—

separate from and in addition to Medicaid expenditures that providers 

have already received for covered services—which enables the state to 

obtain a federal matching payment. In reality, the large payment is 

temporary, since the funds essentially make a round-trip from the state to 

the Medicaid providers and back to the state. As a result of such round-trip 

arrangements, states obtain excessive federal Medicaid matching funds 

while their own state expenditures remain unchanged or even decrease. 

Figure 1, which is based on our earlier work, illustrates how this 

mechanism operated in one state (Michigan).7

Figure 1: One State’s Arrangement to Increase Federal Medicaid Payments 

Inappropriately 

 6

The UPL sets the ceiling on what the federal government will pay as its share of the 

Medicaid costs for different classes of covered services and often exceeds what states 

actually pay providers for Medicaid-covered services. States were able to exploit the UPL 

loophole by paying nursing homes and hospitals owned by local governments much more 

than the established Medicaid payment rate and requiring the providers to return, through 

IGTs, the excess payments to the state. 

7

See U.S. General Accounting Office, Medicaid: States Use Illusory Approaches to Shift 

Program Costs to Federal Government, GAO/HEHS-94-133 (Washington, D.C.: Aug. 1, 

1994), and Major Management Challenges and Program Risks: Department of Health and 

Human Services,, GAO-03-101 (Washington, D.C.: January 2003). 

3 County health facilities transfer 

$271 million back to state

2 County health facilities 

retain $6 million

1 State combines state payment and federal match to 

make a Medicaid payment to county health facilities 

$155 million $122 million

State

$271 million

County health facilities

$277 million

Federal

government

Source: GAO analysis.
Page 6 GAO-04-574T 

As shown in figure 1, the state made Medicaid payments totaling 

$277 million to certain county health facilities; the total included 

$155 million in federal funds and $122 million in state funds (step 1). On 

the same day that the county health facilities received the funds, they 

transferred all but $6 million back to the state, which retained 

$271 million (steps 2 and 3). From this transaction, the state realized a net 

gain of $149 million over the state’s original outlay of $122 million. In cases 

like this, local-government facilities can use IGTs to easily return the 

excessive Medicaid payments to the state via electronic wire transfers. We 

have found that these round-trip transfers can be accomplished in less 

than 1 hour. The IGT is critical, because if the payment does not go back 

to the state, the state gains no financial benefit and actually loses from the 

arrangement because it has simply paid the provider more than its 

standard Medicaid payment rate for the services. In a variant of this 

practice, some states require a few counties to initiate the transaction, by 

taking out bank loans for the total amount the states determined they can 

pay under the UPL. The counties wire the funds to the states, which then 

send most or all of the funds back to the counties as Medicaid payments. 

The counties use these “Medicaid payments” to repay the bank loans. 

Meanwhile, the states claim federal matching funds on the total amount. 

Consistent with past actions, Congress and CMS have taken steps to 

curtail UPL financing schemes when they have come to light. At the 

direction of Congress,8

 the agency—then called the Health Care Financing 

Administration (HCFA)—finalized a regulation in 2001 that significantly 

narrowed the UPL loophole by limiting the amount of excessive funds 

states could claim.9

 HCFA estimated that its 2001 regulation would reduce 

the federal government’s financial liability due to inappropriate UPL 

arrangements by $55 billion over 10 years;10 a related 2002 regulation was 

 8

The Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 

directed HCFA to issue a final regulation to limit states’ ability to claim excessive federal 

matching funds through UPL arrangements. See Pub. L. No. 106-554, App. F, § 705(a), 114 

Stat. 2763A-463, 575–576 (2000). 

9

Specifically, HCFA eliminated states’ ability to combine, or aggregate, UPLs across private 

and local-government providers. Before this regulation, a state could claim excessive 

payments on the basis of the combined amount potentially payable to all private and localgovernment providers in the state. The regulation established separate UPLs for separate 

classes of non-state-government facilities (those owned by local governments), including 

inpatient hospitals, nursing homes, and intermediate care facilities for the mentally 

retarded.

 See 66 Fed. Reg. 3148 (2001) (codified at 42 C.F.R. part 447 (2002)).

10HCFA’s estimate covered UPL arrangements for nursing homes, inpatient hospital 

services, and outpatient hospital services.
Page 7 GAO-04-574T 

estimated to yield an additional $9 billion over 5 years.11 CMS recognized 

that some states had developed a long-standing reliance on these 

excessive UPL funds, and the law and regulation authorized transition 

periods of up to 8 years for states to come into compliance with the new 

requirements.12 As we recently reported,13 however, even under the new 

regulations, states can still aggregate payments to all local-government 

nursing homes under one UPL to generate excessive federal matching 

payments beyond their standard Medicaid claims. For example, CMS 

information about states complying with the new regulation indicates that, 

through UPL arrangements with public nursing homes and other public 

facilities, states can still claim about $2.2 billion annually in federal 

matching funds exceeding their standard Medicaid claims. 

States’ use of these creative financing mechanisms undermines the 

federal-state Medicaid partnership as well as the program’s fiscal integrity 

in at least three ways. 

First, state financing schemes effectively increase the federal matching 

rate established under federal law by increasing federal expenditures 

while state contributions remain unchanged or even decrease. For 

example, for one state we analyzed (Wisconsin), we estimated that by 

obtaining excessive federal matching payments and using these funds as 

the state share of other Medicaid expenditures, the state effectively 

increased the federal matching share of its total Medicaid expenditures 

from 59 percent to 68 percent in state fiscal year 2001.14 The state did so by 

generating nearly $400 million in excessive federal matching funds via 

round-trip arrangements with three counties. Similarly, the HHS Office of 

the Inspector General found that a comparably structured arrangement in 

 11The 2002 regulation reduced the upper limit for local-government hospitals from 150 

percent to 100 percent. 

12The length of a state’s transition period was to be based in part on how long the state had 

had in place a UPL arrangement meeting certain specified criteria. During the assigned 

transition period—established in 1-, 2-, 5-, or 8-year intervals—excessive UPL payments 

were to be phased out. 

13See U.S. General Accounting Office, Medicaid: Improved Federal Oversight of State 

Financing Schemes Is Needed, GAO-04-228 (Washington D.C.: Feb. 13, 2004). 

14U.S. General Accounting Office, Medicaid: HCFA Reversed Its Position and Approved 

Additional State Financing Schemes, GAO-02-147 (Washington D.C.: Oct. 30, 2001), and 

GAO-04-228. 

Financing Schemes 

Undermine Medicaid’s 

Federal-State 

Partnership 
Page 8 GAO-04-574T 

Pennsylvania effectively increased that state’s statutorily determined 

matching rate from 54 percent to about 65 percent.15

Second, CMS has no assurance that these increased federal matching 

payments are used for Medicaid services. Federal Medicaid matching 

funds are intended for Medicaid-covered services for the Medicaid-eligible 

individuals on whose behalf payments are made.16 Under state financing 

schemes, however, states can use funds returned to them at their own 

discretion. We recently examined how six states with large UPL financing 

schemes involving nursing homes used the federal funds they generated.17

As in the past, some states in our review deposited excessive funds from 

UPL arrangements into their general funds, which the states may or may 

not use for Medicaid purposes. For example, one state (Oregon) has used 

funds generated by its UPL arrangement to help finance education 

programs. Table 2 provides further information on how states used their 

UPL funds in recent years, as reported by the six states we reviewed. 

 15U.S. Department of Health and Human Services, Office of the Inspector General, Review 

of the Commonwealth of Pennsylvania’s Use of Intergovernmental Transfers to Finance 

Medicaid Supplementation Payments to County Nursing Facilities, A-03-00-00203 

(Washington, D.C.: 2001).

16See 42 U.S.C. § 1396 and § 1396d(a). 

17GAO-04-228. 
Page 9 GAO-04-574T 

Table 2: Selected States’ Use of Funds Generated through UPL Arrangements 

State Use 

Michigan Funds generated by the state’s UPL arrangement are deposited in the 

state’s general fund but are tracked separately as a local fund source. 

These local funds are earmarked for future Medicaid expenses and used 

as the state match, effectively recycling federal UPL matching funds to 

generate additional federal Medicaid matching funds. 

New York Funds generated by the state’s UPL arrangement are deposited into its 

Medical Assistance Account. Proceeds from this account are used to pay 

for the state share of the cost of Medicaid payments, effectively recycling 

federal funds to generate additional federal Medicaid matching funds. 

Oregon Funds generated by the state’s UPL arrangement are being used to help 

finance education programs and other non-Medicaid health programs. 

UPL matching funds recouped from providers are deposited into a special 

UPL fund. Facing a large budget deficit, a February 2002 special session 

of the Oregon legislature allocated the fund balance, about $131 million, 

to finance kindergarten to 12th grade education programs. According to 

state budget documents, the UPL funds are being used to replace 

financing from the state’s general fund. 

Pennsylvania Funds generated by the state’s UPL arrangement are used for a number 

of Medicaid and non-Medicaid purposes, including long-term care and 

behavioral health services. In state fiscal years 2001–2003, the state 

generated $2.4 billion in excessive federal matching funds, of which 43 

percent was used for the state share of Medicaid expenses (recycled to 

generate additional federal matching funds), 6 percent was used for nonMedicaid purposes, and 52 percent was unspent and available for nonMedicaid uses. (Percentages do not total 100 percent because of 

rounding.) 

Washington Funds generated by the state’s UPL arrangement are commingled with a 

number of other revenue sources in a state fund. The fund is used for 

various state health programs, including a state-funded basic health plan, 

public health programs, and health benefits for home care workers. A 

portion of the fund is also transferred to the state’s general fund. The 

fund is also used for selected Medicaid services and the State Children’s 

Health Insurance Program, which effectively recycles the federal funds to 

generate additional federal Medicaid matching funds. 

Wisconsin Funds generated by the state’s UPL arrangement are deposited in a 

state fund, which is used to pay for Medicaid-covered services in both 

public and private nursing homes. Because the state uses these 

payments as the state share, the federal funds are effectively recycled to 

generate additional federal Medicaid matching funds. 

Source: GAO. 
Page 10 GAO-04-574T 

Third, these state financing schemes undermine the fiscal integrity of the 

Medicaid program because they enable states to make to providers 

payments that significantly exceed their costs. In our view, this practice is 

inconsistent with the statutory requirement that states ensure that 

Medicaid payments are economical and efficient.18 Under UPL financing 

arrangements, some states pay a few public providers excessive amounts, 

well beyond the cost of services provided. We found, for example, that 

Virginia’s proposed arrangement would allow the state to pay six localgovernment nursing homes, on average, $670 in federal funds per Medicaid 

nursing home resident per day—more than 12 times the $53 daily federal 

payment these nursing homes normally received, on average, per Medicaid 

resident.19

Although CMS and the Congress have often acted to curtail states’ 

financing schemes, problems persist. Improved CMS oversight and 

additional congressional action could help address continuing concerns 

with UPL financing schemes and other inappropriate arrangements. 

We recently reported that CMS has taken several actions to improve its 

oversight of state UPL arrangements, including forming a team to 

coordinate its review of states’ proposed and continuing arrangements, 

drafting internal guidelines for reviewing state methods for calculating 

UPL amounts, and conducting financial reviews that have identified 

hundreds of millions of dollars in improper claims.20 Starting in August 

2003, when considering states’ proposals to change how they would pay 

nursing homes or other institutions, CMS also began to ask states to 

provide previously unrequested information. The information includes 

sources of state matching funds for supplemental payments to Medicaid 

providers, the extent to which total payments would exceed providers’ 

costs, how a state would use the additional funds, and whether a state 

required providers to return payments (and, if so, how the state planned to 

spend such funds). As of October 2003, CMS indicated that it had asked 30 

states with proposed state Medicaid plan amendments to provide 

additional information, and the agency was in the process of receiving and 

reviewing states’ initial responses. 

 18See 42 U.S.C. § 1396a(a)(30)(A). 

19GAO-02-147. 

20GAO-04-228. 

Further Federal 

Action Would Help 

Address Continuing 

Concerns with State 

Financing Schemes 
Page 11 GAO-04-574T 

We also reported, however, that CMS’s efforts do not go far enough to 

ensure that states’ UPL claims are for Medicaid-covered services provided 

to eligible beneficiaries. Moreover, we remain concerned that in carrying 

out its oversight responsibilities, CMS at times takes actions inconsistent 

with its stated goals for limiting states’ use of these arrangements. For 

example, we previously reported that while the agency was attempting to 

narrow the glaring UPL loophole in 2001, it was allowing additional states 

to engage in the very schemes it was trying to shut down, at a substantial 

cost to the federal government.21 More recently, we reported that CMS’s 

granting two states the longest available transition period of 8 years, for 

phasing out excessive claims under their UPL arrangements, was not 

consistent with the agency’s stated goals. We estimated that, as a result of 

these decisions, these two states can claim about $633 million more in 

federal matching funds under their 8-year transition periods than they 

could have claimed under shorter transition periods consistent with CMS’s 

stated policies and goals.22

In our view, additional congressional action also could help address 

continuing concerns about Medicaid financing schemes. Although 

Congress and CMS have taken significant steps to help curb inappropriate 

UPL arrangements and other financing schemes, states can still claim 

federal matching funds for more than a public provider’s actual costs of 

providing Medicaid-covered services. As long as states are allowed to 

make payments exceeding a facility’s actual costs, the loophole remains. A 

recommendation open from one of our earlier reports would, if 

implemented, close the existing loophole and thus mitigate these 

continuing concerns. We previously recommended that Congress consider 

prohibiting Medicaid payments that exceed actual costs for any 

government-owned facility.23 If this recommendation were implemented, a 

facility’s payment would be limited to the reasonable costs of covered 

services it actually provides to eligible beneficiaries, thus eliminating the 

possibility of the exorbitant payments that are now passed through 

individual facilities to states. The Administration appears to support such 

legislative action; the President’s budget for fiscal year 2005 sets forth a 

legislative proposal to cap Medicaid payments to government providers 

 21GAO-02-147.

22GAO-04-228. 

23U.S. General Accounting Office, Medicaid: States Use Illusory Approaches to Shift 

Program Costs to Federal Government, GAO/HEHS-94-133 (Washington D.C.: Aug. 1, 

1994). 
Page 12 GAO-04-574T 

(such as public hospitals or county-owned nursing homes) to the actual 

cost of providing services to Medicaid beneficiaries.24

The term “IGTs” has come to be closely associated—if not synonymous—

with the abusive financing schemes undertaken by some states in 

connection with illusory payments for Medicaid services to claim 

excessive federal matching funds. IGTs are a legitimate state budget tool 

and not problematic in themselves. But when they are used to carry out 

questionable financial transactions that inappropriately shift state 

Medicaid costs to the federal government, they become problematic. 

We believe the problem goes beyond IGTs. An observation we made in our 

first report on this issue in 1994 is as valid today as it was then: in our 

view, the Medicaid program should not allow states to benefit from 

arrangements where federal funds purported to benefit providers are given 

to providers with one hand, only to be taken back with the other.25 State 

financing schemes, variants of which have been applied for a decade or 

longer, circumvent the federal and state funding balance set under law. 

They have also resulted in the diversion of federal funds intended to pay 

for covered services for Medicaid-eligible individuals to whatever purpose 

a state chooses. 

Although Congress and CMS have often acted to address Medicaid 

financing schemes once they become apparent, new variations continue to 

emerge. Experience shows that some states are likely to continue looking 

for creative means to supplant state financing, making a compelling case 

for the Congress and CMS to sustain vigilance over federal Medicaid 

payments. Understandably, states that have relied on federal funding as a 

staple for their own share of Medicaid spending are feeling the budgetary 

pressure from the actual or potential loss of these funds. The continuing 

challenge remains to find the proper balance between states’ flexibility to 

administer their Medicaid programs and the shared federal-state fiduciary 

responsibility to manage program finances efficiently and economically in 

a way that ensures the program’s fiscal integrity. 

 24U.S. Department of Health and Human Services, Budget in Brief FY 2005 (Washington, 

D.C.: Mar. 1, 2004), http://www.hhs.gov/budget/docbudget.htm (downloaded Mar. 15, 2004). 

25GAO/HEHS-94-133. 

Conclusions 
Page 13 GAO-04-574T 

Mr. Chairman, this concludes my prepared statement. I will be happy to 

answer any questions that you or Members of the Subcommittee may have. 

For future contacts regarding this testimony, please call Kathryn G. Allen 

at (202) 512-7118. Katherine Iritani, Tim Bushfield, Ellen W. Chu, Helen 

Desaulniers, Behn Miller Kelly, and Terry Saiki also made key 

contributions to this testimony. 

Contact and 

Acknowledgments 
Page 14 GAO-04-574T 

Medicaid: Improved Federal Oversight of State Financing Schemes Is 

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Major Management Challenges and Program Risks: Department of 

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Medicaid: HCFA Reversed Its Position and Approved Additional State 

Financing Schemes. GAO-02-147. Washington, D.C.: October 30, 2001. 

Medicaid: State Financing Schemes Again Drive Up Federal Payments. 

GAO/T-HEHS-00-193. Washington, D.C.: September 6, 2000. 

State Medicaid Financing Practices. GAO/HEHS-96-76R. Washington, 

D.C.: January 23, 1996. 

Michigan Financing Arrangements. GAO/HEHS-95-146R. Washington, 

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Medicaid: States Use Illusory Approaches to Shift Program Costs to 

Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 

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