United States Court of Appeals 

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 8, 2010 Decided January 14, 2011 

No. 09-5447 

CAPE COD HOSPITAL, ET AL., 

APPELLANTS

v. 

KATHLEEN SEBELIUS, SECRETARY, UNITED STATES 

DEPARTMENT OF HEALTH AND HUMAN SERVICES, 

APPELLEE

Appeal from the United States District Court 

for the District of Columbia 

(No. 1:08-cv-01751) 

Paul D. Clement argued the cause for appellants. With 

him on the briefs were Christopher L. Keough, Stephanie A. 

Webster, Erin E. Murphy, John M. Faust, and John P. 

Elwood. 

Jeffrey Clair, Attorney, U.S. Department of Justice, 

argued the cause for appellee. With him on the brief were 

Ronald Machen, U.S. Attorney, and Michael S. Raab, 

Attorney. R. Craig Lawrence, Assistant U.S. Attorney, 

entered an appearance. 
2 

Before: TATEL, Circuit Judge, and WILLIAMS and 

RANDOLPH, Senior Circuit Judges. 

Opinion for the Court filed by Circuit Judge TATEL. 

TATEL, Circuit Judge: Five hospitals contend that the 

Secretary of Health and Human Services improperly 

implemented a statutory provision in a way that over the years 

has progressively reduced Medicare payments for inpatient 

services. In particular, they challenge rules governing 

reimbursements for the 2007 and 2008 fiscal years. Because 

the Secretary failed to provide a reasoned response to the 

hospitals’ comments regarding those rules, we vacate the 

district court’s grant of summary judgment in the Secretary’s 

favor and remand for further proceedings in light of the 

guidance set forth in this opinion. 

I.

Established in 1965, Medicare “provides federally funded 

health insurance for the elderly and disabled.” Methodist 

Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1226–27 (D.C. 

Cir. 1994). The Secretary administers the program through 

the Centers for Medicare and Medicaid Services (CMS). 

Originally, Medicare reimbursed hospitals based on the 

“ ‘reasonable costs’ ” they incurred in providing services to 

Medicare patients. Id. at 1227 (quoting 42 U.S.C. § 1395f(b) 

(1988)). Concerned that this system created inadequate 

incentives for hospitals to control costs, Congress in 1983 

required the Secretary to implement a prospective payment 

system under which hospitals would receive a fixed payment 

for inpatient services. Id. Since hospitals receive the same 

payment under this system regardless of their actual costs, 

Congress believed that it would encourage efficiency “by 

rewarding cost[-]effective hospital practices.” Id. (quoting H. 
3 

Rep. No. 98-25, at 132 (1983), reprinted in 1983 

U.S.C.C.A.N. 219, 351). 

 In calculating prospective payment rates, CMS begins 

with a figure called the “standardized amount,” which roughly 

reflects the average cost incurred by hospitals nationwide for 

each patient they treat and then discharge. See 42 U.S.C. 

§ 1395ww(d)(2); Changes to the Hospital Inpatient 

Prospective Payment Systems and Fiscal Year 2007 Rates, 71 

Fed. Reg. 47,870, 48,146 (Aug. 18, 2006) [hereinafter Final 

2007 Rule]. Central to the issue before us, CMS does not 

calculate the standardized amount from scratch each year. 

Instead, following Congress’s directive, it calculated the 

standardized amount for a base year and has since carried that 

figure forward, updating it annually for inflation. See 42 

U.S.C. § 1395ww(b)(3)(B)(i), (d)(2), (d)(3)(A)(iv)(II); 42 

C.F.R. § 412.64(c)–(d); Final 2007 Rule, 71 Fed. Reg. at 

48,146; see also Prospective Payments for Medicare Inpatient 

Hospital Services, 48 Fed. Reg. 39,752, 39,763–64 (Sept. 1, 

1983) (explaining how the Health Care Financing 

Administration, CMS’s predecessor, developed base-year cost 

data at the inception of the inpatient prospective payment 

system). 

 To account for the fact that labor costs vary across the 

country, CMS determines the proportion of the standardized 

amount attributable to wages and wage-related costs and then 

multiplies that labor-related proportion by a “wage index” that 

reflects “the relation between the local average of hospital 

wages and the national average of hospital wages.” 

Appellee’s Br. 5; see also 42 U.S.C. § 1395ww(d)(2)(H), 

(d)(3)(E); Se. Ala. Med. Ctr. v. Sebelius, 572 F.3d 912, 914–

15 (D.C. Cir. 2009). Unlike the standardized amount, wage 

indexes are calculated anew each year instead of being carried 

forward from one year to the next. 
4 

 The standardized amount is also modified to account for 

the fact that the costs of treating patients vary based on the 

patients’ diagnoses. Medicare patients are classified into 

different groups based on their diagnoses, and each of these 

“diagnosis-related groups” is assigned a particular “weight” 

representing the relationship between the cost of treating 

patients within that group and the average cost of treating all 

Medicare patients. See 42 U.S.C. § 1395ww(d)(4). 

 Putting all these components together, CMS determines 

how much a hospital should be paid for treating a Medicare 

patient by performing the following calculation (where SA = 

standardized amount; labor% = the proportion of the 

standardized amount attributable to wages and wage-related 

costs; non-labor% = the proportion of the standardized 

amount not attributable to labor-related costs; WI = wage 

index; and DRG Weight = the weight assigned to a particular 

diagnosis-related group): 

[SA*(non-labor%) + (SA*(labor%)*WI)]*(DRG Weight) = 

Payment 

 In 1997, Congress determined that “[a]n anomaly that 

exists with the way area wage indexes are applied has resulted 

in some urban hospitals being paid less than the average rural 

hospital in their states.” H.R. Rep. No. 105-149, at 1305 

(1997). To correct this problem, Congress provided in the 

Balanced Budget Act of 1997 (“BBA”) that the wage index 

assigned to a hospital in an urban area must be at least as 

great as the wage index assigned to rural hospitals within the 

same state. Pub. L. No. 105-33, § 4410(a), 111 Stat. 251, 402 

(reprinted at 42 U.S.C. § 1395ww note) (“[T]he area wage 

index applicable under [42 U.S.C. § 1395ww(d)(3)(E)] to any 

hospital which is not located in a rural area . . . may not be 
5 

less than the area wage index applicable under such section to 

hospitals located in rural areas in the State in which the 

hospital is located.”). This provision is commonly referred to 

as the “rural floor.” 

 

Potentially, the rural floor could affect the total amount 

of money Medicare pays hospitals each year. For example, if 

CMS increased the wage indexes of urban hospitals to bring 

them in line with the wage indexes of rural hospitals in the 

same state, payments to those urban hospitals would increase. 

All other things being equal, the aggregate amount of 

Medicare payments would increase as well. But Congress 

required the Secretary to take steps to ensure that all other 

things would not be equal. It mandated that the rural floor be 

“budget neutral.” In other words, it required the Secretary to 

implement the rural floor in a manner that would have no 

effect on the annual total of Medicare payments made to all 

hospitals throughout the country for inpatient services. Cape 

Cod Hosp. v. Sebelius, 677 F. Supp. 2d 18, 22 (D.D.C. 2009). 

Congress accomplished this through BBA section 4410(b), 

which provides: “The Secretary . . . shall adjust the area wage 

index . . . in a manner which assures that . . . aggregate 

payments . . . in a fiscal year for the operating costs of 

inpatient hospital services are not greater or less than those 

which would have been made in the year if [the rural floor] 

did not apply.” 

 

 The five hospitals that are appellants herein challenge 

how the Secretary has implemented this budget-neutrality 

provision. Rather than adjusting area wage indexes to achieve 

budget neutrality, as the hospitals argue the statute requires, 

the Secretary adjusted the standardized amount. Thus, if the 

rural floor threatened to increase aggregate payments in a 

particular year, she applied a downward adjustment to the 

standardized amount to offset the effect of the rural floor. See
6 

Final 2007 Rule, 71 Fed. Reg. at 48,147. The Secretary then 

carried forward the adjusted standardized amount from year to 

year, purportedly making further adjustments only as 

necessary to account for incremental changes in each new 

year. See id. (explaining that CMS would apply the “budget 

neutrality adjustment factor[] . . . to the standardized amount[] 

without removing the effect[] of the [prior year’s] budget 

neutrality adjustment[]”). The parties contrast this 

“cumulative” approach of carrying forward prior adjustments 

and making incremental annual changes with a 

“noncumulative” approach under which the Secretary would 

calculate the full amount of the requisite adjustment anew 

each year. Since the cumulative and noncumulative 

approaches are simply different methods of making the same 

arithmetic computation, they should produce identical results 

if performed correctly. The problem, the hospitals contend, is 

that the Secretary botched the math, mixing the cumulative 

and noncumulative methods in a way that gradually decreased 

Medicare payments for inpatient services over time. 

To understand the error the hospitals accuse the Secretary 

of making, consider the following hypothetical taken from the 

hospitals’ briefs. Imagine an employee normally earns $10 

per hour. His employer decides to give him a company car, 

the value of which equates to compensation of $1 per hour. 

To avoid an increase in the employee’s overall 

compensation—i.e., to achieve “budget neutrality”—the 

employer reduces the employee’s wage to $9 per hour. Now 

imagine that next year, the employee receives a nicer car 

worth $2 per hour. To calculate what the employee’s wage 

should then be to keep his overall compensation at $10 per 

hour, the employer could use either a cumulative or 

noncumulative approach. Under the cumulative method, the 

employer would subtract the $1 incremental increase in the 

value of the car from the employee’s current wage of $9 to 
7 

arrive at a new, budget-neutral wage of $8. Under the 

noncumulative approach, the employer would simply subtract 

the full value of the car ($2) from the desired total 

compensation ($10) to arrive at the same figure—a wage of 

$8 per hour. But it would make no sense for the employer to 

subtract the full $2 value of the new car from the employee’s 

current $9 wage and thus pay him only $7 per hour. Doing so 

would not be “budget neutral”—it would reduce the 

employee’s total compensation by $1 per hour. Yet this is 

essentially what the hospitals accuse CMS of doing in 

calculating the annual budget-neutrality adjustment to account 

for the rural floor. Specifically, the hospitals argue that CMS 

has duplicated prior adjustments by each year calculating the 

full amount of the adjustment necessary to counteract the 

effect of the rural floor and then applying that adjustment to a 

figure that includes adjustments carried over from previous 

years. 

 According to the hospitals, this error first came to light in 

a May 2006 email exchange in which a CMS employee 

informed a consultant working with the hospitals that CMS 

calculated the budget-neutrality factor necessary to account 

for the rural floor by comparing projected aggregate payments 

for the coming fiscal year with the rural floor applied with the 

aggregate payments that would have been made in the current 

fiscal year without the rural floor. CMS then reduced the 

standardized amount to account for the full difference 

between these two figures, “even though the standardized 

amount being carried over already included reductions from 

prior years’ rural floor budget-neutrality adjustments.” 

Appellants’ Opening Br. 12. This email exchange, the 

hospitals argue, indicates that CMS illogically combined the 

cumulative and noncumulative methods for calculating 

budget-neutrality adjustments. Each year, CMS calculated 

“the entire payment effect of the rural floor” but applied the 
8 

corresponding adjustment “to a carried-over figure that 

already incorporated previous years’ rural floor budgetneutrality adjustments,” thereby duplicating prior adjustments 

in a manner that progressively reduced aggregate payments 

over time. Id. at 12–13. 

 When CMS failed to respond to an email pointing out 

this apparent error, the hospital consultant again attempted to 

bring the error to CMS’s attention in a comment letter 

regarding the agency’s proposed 2007 rules for the inpatient 

prospective payment system. CMS’s notice of proposed 

rulemaking (NPRM) required comments to be submitted by 

June 12, 2006. Proposed Changes to the Hospital Inpatient 

Prospective Payment Systems and Fiscal Year 2007 Rates, 71 

Fed. Reg. 23,996, 23,996 (Apr. 25, 2006) [hereinafter 

Proposed 2007 Rule]. Although the notice indicated that 

comments could be hand delivered to CMS’s Baltimore 

office, it also stated, “If you intend to deliver your comments 

to the Baltimore address, please call telephone number (410) 

786-7195 in advance to schedule your arrival with one of our 

staff members.” Id. The consultant hand delivered his 

comment to the Baltimore office without first calling this 

number. In a sworn declaration, the consultant stated that he 

called an individual he knew who worked in CMS’s Division 

of Acute Care, “the part of the agency responsible for 

[inpatient prospective] payment issues.” Giovanis Decl. ¶¶ 3–

4. The CMS employee met the consultant in the lobby of the 

Baltimore office, accepted the comment letter, and signed a 

delivery receipt confirming that the comment was submitted 

on June 9, 2006, three days before the end of the comment 

period. See id. ¶¶ 2–6. The record contains no evidence of 

what the employee did with the letter after receiving it. But 

what is clear is that CMS failed to respond to the consultant’s 

comment in its final 2007 rule. See Final 2007 Rule, 71 Fed. 

Reg. 47,870. 
9 

Following the 2007 rulemaking, CMS “reevaluated [its] 

rural floor adjustment methodology.” Cape Cod Hosp., 677 

F. Supp. 2d at 24. Specifically, in May 2007, it published a 

proposed rule for fiscal year 2008 that would offset the rural 

floor by adjusting area wage indexes rather than by adjusting 

the standardized amount as CMS had done in the past. Id.; 

see also Proposed Changes to the Hospital Inpatient 

Prospective Payment Systems and Fiscal Year 2008 Rates, 72 

Fed Reg. 24,680, 24,792 (May 3, 2007) [hereinafter Proposed 

2008 Rule]. CMS also proposed a special “rural floor 

adjustment” that would slightly increase the standardized 

amount. Proposed 2008 Rule, 72 Fed. Reg. at 24,839. 

Nowhere in the NPRM, however, did it explain the purpose of 

this adjustment. 

After requesting and being denied additional information 

regarding CMS’s proposed rule, the hospitals submitted 

comments that noted, among other things, that the agency’s 

proposals appeared inadequate to reverse the cumulative 

reduction in aggregate payments caused by CMS’s apparent 

errors in calculating rural-floor budget-neutrality adjustments 

for prior years. Many other hospitals and trade associations 

submitted similar comments. 

 In its 2008 final rule, CMS adopted its proposal and 

applied the rural-floor budget-neutrality adjustment to area 

wage indexes rather than to the standardized amount. See

Changes to the Hospital Inpatient Prospective Payment 

Systems and Fiscal Year 2008 Rates, 72 Fed. Reg. 47,130, 

47,329 (Aug. 22, 2007) [hereinafter Final 2008 Rule]. CMS 

pointed out that although its previous adjustments to the 

standardized amount had been cumulative, its adjustment of 

wage indexes would be noncumulative. Id. at 47,330. 

Responding to commenters’ requests for more information 
10 

regarding the special “rural floor adjustment” to the 

standardized amount, CMS explained that it was a one-off 

adjustment “meant to address” the “transition from a 

cumulative budget neutrality adjustment . . . to a 

noncumulative adjustment.” Id. at 47,421. The agency made 

clear that the adjustment removed only the effect of the 2007 

rural-floor budget-neutrality adjustment to the standardized 

amount, thus leaving in place all rural-floor budget-neutrality 

adjustments made before 2007. Id. (“The rural floor 

adjustment removes the effect of the budget neutrality 

adjustment applied in [fiscal year] 2007 to the standardized 

amount for application of the rural floor.”). In response to 

commenters’ concerns that the changes CMS proposed were 

insufficient to remedy the effects of previous miscalculations, 

the agency stated that the “calculation of budget neutrality in 

past fiscal years [was] not within the scope of [its] 

rulemaking.” Id. at 47,330. Without admitting that it made 

computational errors in prior years, CMS declared that even if 

such errors were made, it “would not make an adjustment to 

make up for those errors when setting rates for [fiscal year] 

2008.” Id. “[F]inality,” CMS explained, “is critical to a 

prospective payment system.” Id. As a result, it concluded 

that “the need to establish final prospective rates outweighs 

the greater accuracy [it] might gain if [it] retroactively 

recomputed rates whenever an error is discovered.” Id. 

 All five hospitals that are parties to this appeal filed 

timely petitions challenging the 2007 final rule with the 

Department of Health and Human Services’ Provider 

Reimbursement Review Board. See 42 U.S.C. § 1395oo. 

Two hospitals also challenged the 2008 final rule. After the 

Review Board determined it lacked authority to resolve the 

legal questions presented by the hospitals, they filed a 

complaint against the Secretary in the U.S. District Court for 

the District of Columbia. See id. § 1395oo(f)(1) (permitting 
11 

medical providers to file suit in federal district court 

following a Review Board determination that it lacks 

authority to decide the legal question presented). The parties 

submitted cross-motions for summary judgment. The 

Secretary also filed a motion to strike, arguing that the 

consultant’s 2006 email exchange and comment letter, which 

the hospitals had submitted to the district court, were not 

properly part of the 2007 rulemaking record. Without those 

documents, the Secretary asserted, the hospitals were unable 

to overcome her contention that they had waived their 

objection to the 2007 rule by failing to raise it during the 

rulemaking process. 

 

 Although the district court granted the Secretary’s motion 

to strike with respect to the email exchange, it ruled that the 

Secretary had improperly excluded the consultant’s comment 

letter from the 2007 rulemaking record. Cape Cod Hosp., 677 

F. Supp. 2d at 25–29. In particular, the district court 

determined that the CMS employee’s acceptance of the letter 

“indicated that [the consultant’s] submission was acceptable” 

despite the consultant’s failure to call the telephone number 

listed in the NPRM. Id. at 28. On the merits, the district 

court largely rejected the hospitals’ challenges to the 2007 

and 2008 rules and entered summary judgment in the 

Secretary’s favor. According to the court, the Secretary 

reasonably interpreted BBA section 4410(b) as imposing 

upon her no obligation to reconsider rural-floor budgetneutrality adjustments calculated in prior years. Id. at 29–32. 

The court also concluded that the Secretary sufficiently 

responded to comments regarding the 2008 proposed rule. Id.

at 34–35. Although acknowledging that the Secretary failed 

to respond to the hospital consultant’s comment letter 

regarding the 2007 rule, id. at 34, the court determined that by 

making an upward adjustment to the standardized amount in 

2008 to reverse the effect of the 2007 rural-floor budget-
12 

neutrality adjustment, CMS “moot[ed]” the hospitals’ 

challenge to the 2007 rule, id. at 35–36. The Secretary does 

not defend this ruling on appeal, and we agree with the 

hospitals that since the 2008 rule in no way compensated for 

any underpayments that might have been made in 2007, a live 

controversy remains regarding the hospitals’ objection to the 

2007 rule. 

II.

 The hospitals argue that CMS’s 2007 and 2008 rules 

were arbitrary and capricious and violated BBA section 

4410(b), the rural-floor budget-neutrality provision. See 5 

U.S.C. § 706(2)(A) (requiring a court to “hold unlawful and 

set aside” a final agency action “found to be . . . arbitrary, 

capricious, an abuse of discretion, or otherwise not in 

accordance with law”). In response, the Secretary contends 

that she acted within the scope of the discretion Congress 

afforded her in achieving budget neutrality. Furthermore, she 

argues, the district court erred in supplementing the 2007 

rulemaking record with the consultant’s June 2006 comment 

letter and should instead have ruled that the hospitals waived 

their objection to the 2007 rule by failing to follow the proper 

procedures in submitting the letter. We review the district 

court’s decision to supplement the 2007 rulemaking record for 

abuse of discretion. See James Madison Ltd., by Hecht v. 

Ludwig, 82 F.3d 1085, 1095 (D.C. Cir. 1996). Our review of 

the hospitals’ contention that CMS’s 2007 and 2008 rules 

were arbitrary and capricious and violated BBA section 

4410(b) is plenary. See Methodist Hosp., 38 F.3d at 1229. 

The 2007 Rulemaking 

The hospitals contend that in 2007, as in previous years, 

the Secretary improperly calculated a budget-neutrality 

adjustment that compensated for the full effect of the rural 
13 

floor, rather than the incremental annual change, and then 

applied this adjustment to the carried-over adjusted 

standardized amount, which already included similar 

adjustments from prior years. According to the hospitals, this 

“incoherent admixture” of cumulative and noncumulative 

methodologies produced aggregate payments that were less 

than the amount that would have been paid in 2007 if the rural 

floor had not been applied, thus violating section 4410(b)’s 

budget-neutrality requirement. Appellants’ Opening Br. 34. 

 

For her part, the Secretary argues that the hospitals 

waived their objection to the 2007 rule by failing to “follow 

the Secretary’s clear and express procedures for commenting 

on the proposed rule.” Appellee’s Br. 57–58. In particular, 

the Secretary emphasizes that the consultant failed to abide by 

the NPRM’s request that individuals planning to hand deliver 

their comments to CMS’s Baltimore office first call a 

particular telephone number to schedule the delivery. See 

Proposed 2007 Rule, 71 Fed. Reg. at 23,996. According to 

the Secretary, the consultant’s failure to call this number 

hampered the agency’s ability to ensure that staff members 

responsible for the 2007 rulemaking received the comment in 

a timely manner and had the ability to consider it before 

issuing the final rule. As a result, the Secretary contends, the 

consultant’s letter was properly excluded from the 2007 

rulemaking record, thus depriving the hospitals of a basis for 

pursuing their challenge to the rule. 

Where, as here, an agency has issued a rule under the 

Administrative Procedure Act’s notice-and-comment 

provisions, see 5 U.S.C. § 553, courts ordinarily refuse to 

consider objections not submitted in accordance with agency 

procedures during the rulemaking process. See Appalachian 

Power Co. v. EPA, 251 F.3d 1026, 1036 (D.C. Cir. 2001). 

“[S]imple fairness to those who are engaged in the tasks of 
14 

administration . . . requires as a general rule that courts should 

not topple over administrative decisions unless the 

administrative body not only has erred but has erred against 

objection made at the time appropriate under its practice.” 

United States v. L.A. Tucker Truck Lines, Inc., 344 U.S. 33, 

37 (1952). Under the unique circumstances of this case, 

however, barring the hospitals’ challenge to the 2007 rule 

would be patently unfair. Through their consultant, the 

hospitals submitted a comment letter outlining their objection 

to the rule to a CMS employee who worked in the very 

division “responsible for [inpatient prospective] payment 

issues.” Giovanis Decl. ¶ 3; see also Cerne Decl. ¶ 1. True, 

the consultant failed to call the telephone number listed in the 

NPRM before delivering the letter. But the CMS employee 

nonetheless accepted the letter without even hinting that the 

consultant’s submission was in any way improper. Although 

the employee now asserts that she was unaware that the 

document was a comment regarding a proposed rule, see 

Cerne Decl. ¶ 9, she signed a delivery-confirmation receipt 

expressly stating that the document was a “Comment Letter to 

[the] Centers for Medicare and Medicaid Services on the 

Proposed [Fiscal Year] 2007 [Inpatient Prospective Payment 

System] Changes.” Furthermore, since the employee admits 

that she has “some familiarity with the annual . . . rulemaking 

process,” she has no basis for plausibly claiming either that 

she failed to understand what the document she accepted was 

or that she failed to appreciate the importance of ensuring that 

it was forwarded to the staff members responsible for the 

2007 rulemaking. Id. ¶ 4. Given these facts, we agree with 

the district court that the consultant was entitled to presume 

that his “submission was acceptable.” Cape Cod Hosp., 677 

F. Supp. 2d at 28. 

 

In reaching this conclusion, we in no way suggest that 

agencies lack authority to impose and enforce submission 
15 

requirements of the kind at issue here. To the contrary, we 

have little doubt that the CMS employee to whom the hospital 

consultant tendered his comment letter could have refused to 

accept it based on the consultant’s failure to call the 

prescribed telephone number. But since the CMS employee 

accepted the letter without objection, the agency may not now 

complain about the consultant’s failure to call the number 

listed in the NPRM. The district court thus did not abuse its 

discretion in supplementing the 2007 rulemaking record with 

the consultant’s letter. See James Madison, 82 F.3d at 1095 

(noting that courts may supplement the official administrative 

record compiled by an agency when the agency has 

“deliberately or negligently excluded documents that may 

have been adverse to its decision”); see also Kent Cnty., Del. 

Levy Court v. EPA, 963 F.2d 391, 395–96 (D.C. Cir. 1992) 

(supplementing the administrative record with internal EPA 

documents that the agency negligently failed to consider 

during the rulemaking process). And because CMS failed to 

address the consultant’s letter when issuing its 2007 final rule, 

we shall remand for CMS to provide a reasoned response to 

this “relevant and significant public comment[].” Pub. 

Citizen, Inc. v. FAA, 988 F.2d 186, 197 (D.C. Cir. 1993) 

(“The requirement that agency action not be arbitrary or 

capricious includes a requirement that the agency adequately 

explain its result and respond to relevant and significant 

public comments.”) (internal citation and quotation marks 

omitted); see also Fox Television Stations, Inc. v. FCC, 280 

F.3d 1027, 1050–51 (D.C. Cir.), modified on reh’g, 293 F.3d 

537 (D.C. Cir. 2002). 

In so doing, we have no need to decide whether, as the 

hospitals argue, BBA section 4410(b)’s express reference to 

“area wage index[es]” required CMS to offset the effect of the 

rural floor by adjusting area wage indexes rather than the 

standardized amount. Perhaps, as the hospitals contend, 
16 

adjusting wage indexes would have averted the computational 

errors alleged in this litigation. But even assuming that 

section 4410(b) requires CMS to achieve budget neutrality 

only through adjustments to wage indexes—an issue, we 

reiterate, we are not deciding—the hospitals concede that 

CMS’s departure from the statutory language “would have 

had no practical effect” had the agency correctly implemented 

its chosen methodology of cumulatively adjusting the 

standardized amount. Appellants’ Opening Br. 32. Because 

courts must overlook “harmless” agency errors, PDK Labs. 

Inc. v. DEA, 362 F.3d 786, 799 (D.C. Cir. 2004); see also 5 

U.S.C. § 706 (requiring courts reviewing agency action to 

take “due account . . . of the rule of prejudicial error”), we 

understand the primary issue with respect to the 2007 rule to 

be whether CMS overly deflated aggregate payments by 

incorrectly calculating rural-floor budget-neutrality 

adjustments to the standardized amount, not whether the 

agency has committed some free floating statutory error that 

may have “no practical effect.” 

The 2008 Rulemaking 

As explained above, in 2008 the Secretary switched from 

making cumulative rural-floor budget-neutrality adjustments 

to the standardized amount to making noncumulative 

adjustments to the wage index. In connection with this 

change, the Secretary made a small, one-off adjustment that 

reversed the effect of the 2007 rural-floor budget-neutrality 

adjustment. See Final 2008 Rule, 72 Fed. Reg. at 47,330, 

47,421. The hospitals argue that in transitioning from a 

cumulative to a noncumulative methodology, the Secretary 

should have increased the standardized amount sufficiently to 

reverse the effects of all prior rural-floor budget-neutrality 

adjustments, not just the one made in 2007. The Secretary’s 

failure to do so, the hospitals contend, resulted in aggregate 

payments in 2008 that were “less than those which would 
17 

have been made” had the rural floor never been enacted, thus 

violating BBA section 4410(b). 

 

The Secretary does not contend that the hospitals failed to 

present this argument to CMS during the 2008 rulemaking, 

and for good reason: the rulemaking record is replete with 

requests that the agency increase its one-off upward 

adjustment to the standardized amount to offset the effect of 

rural-floor budget-neutrality adjustments made in years 

preceding 2007. Yet in issuing its 2008 final rule, CMS 

provided little justification for failing to reverse those prior 

adjustments. Observing that it had a “longstanding policy that 

finality is critical to a prospective payment system,” CMS 

merely asserted that the “calculation of budget neutrality in 

past fiscal years [was] not within the scope of th[e] [2008] 

rulemaking.” Id. at 47,330. 

This response to the commenters’ concerns is insufficient 

for two reasons. First, CMS’s interest in the finality of 

prospective payment rates cannot justify failing to correct past 

errors in calculating rural-floor budget-neutrality adjustments 

that affect the aggregate amount of current Medicare 

payments. Second, the agency’s interest in finality fails to 

address the hospitals’ contention that in transitioning from a 

cumulative to a noncumulative system, CMS needed to 

reverse all prior rural-floor budget-neutrality adjustments to 

the standardized amount even if those adjustments had been 

calculated correctly. 

As to the first point, in both her response to comments 

regarding the 2008 rule and her brief on appeal, the Secretary 

has invoked what might be called the “Mark McGwire 

defense,” seeking to avoid the potential consequences of the 

mistakes the hospitals allege CMS has made by repeatedly 

asserting that she is “not here to talk about the past.” See 
18 

Anne E. Kornblut, Two Parties in Congress Are at Odds Only 

Against Witnesses, N.Y. Times, Mar. 18, 2005, at D6 (noting 

that in a March 17, 2005, congressional hearing on steroid use 

in baseball, homerun slugger Mark McGwire responded to 

committee members’ questions about his use of performanceenhancing substances by repeatedly stating that he was “not 

here to talk about the past”); cf. Final 2008 Rule, 72 Fed. Reg. 

at 47,330 (“With regard to alleged errors in [fiscal years] 

1999 through 2007, our calculation of budget neutrality in 

past fiscal years is not within the scope of th[e] [2008] 

rulemaking.”). This will not do. Having built the past into 

the cumulative methodology it chose for counteracting the 

budgetary impact of the rural floor, CMS may not now ignore 

past errors that have the effect of overly deflating current 

aggregate payments in violation of BBA section 4410(b)’s 

budget-neutrality mandate. 

 

To the extent the Secretary argues that the Medicare 

statutes authorize or require CMS to carry over from year to 

year erroneously calculated rural-floor budget-neutrality 

adjustments to the standardized amount, her interpretation of 

the statutes is not a “permissible construction” entitled to 

Chevron deference. Chevron, U.S.A., Inc. v. Natural Res. 

Def. Council, Inc., 467 U.S. 837, 843 (1984). Congress has 

required only that the standardized amount be carried over 

annually (with appropriate adjustments for inflation). See 42 

U.S.C. § 1395ww(d)(3)(A)(iv)(II). The Secretary points to no 

statutory provision requiring rural-floor budget-neutrality 

adjustments to the standardized amount to be carried over in 

this manner. Indeed, in promulgating the 2008 final rule, 

which itself reversed the 2007 rural-floor budget-neutrality 

adjustment, CMS seems to have recognized the absence of 

any statutory bar to reversing the effect of prior rural-floor 

budget-neutrality adjustments. If, as the Secretary seems to 

suggest, prior adjustments to the standardized amount are 
19 

sacrosanct, it is difficult to understand how CMS could have 

made this small corrective adjustment in 2008. 

Far from requiring CMS to carry over past adjustments 

that improperly deflate aggregate Medicare payments, BBA 

section 4410(b) seems to mandate precisely the opposite. 

That provision compels the Secretary to make appropriate 

adjustments to ensure that aggregate payments “in a fiscal 

year for the operating costs of inpatient hospital services 

[covered by the prospective payment system] are not greater 

or less than those which would have been made in the year if 

[the rural floor] did not apply.” BBA § 4410(b). Under a 

cumulative methodology, past budget-neutrality adjustments 

are incorporated into the current year’s adjustment. Thus, if 

those past adjustments were incorrectly calculated, the 

budget-neutrality adjustment for the current fiscal year will 

almost certainly be erroneous as well, meaning that aggregate 

payments will differ from the amount that would have been 

paid absent the rural floor. As a result, we fail to see how the 

Secretary can plausibly argue that past cumulative 

adjustments to the standardized amount are outside “the 

scope” of a rulemaking focused in part on the question of 

whether the rural floor has been implemented in a budgetneutral manner. Final 2008 Rule, 72 Fed. Reg. at 47,330. 

On appeal, the Secretary insists that Congress has ratified 

her position that section 4410(b) permits her to ignore 

mistakes made in calculating rural-floor budget-neutrality 

adjustments for prior years. Although the Supreme Court has 

stated that “Congress is presumed to be aware of an 

administrative or judicial interpretation of a statute and to 

adopt that interpretation when it re-enacts a statute without 

change,” Merrill Lynch, Pierce, Fenner & Smith, Inc. v. 

Curran, 456 U.S. 353, 382 n.66 (1982) (internal quotation 

marks omitted), this canon of statutory interpretation has little 
20 

relevance here given that Congress has never reenacted 

section 4410, see Pub. Citizen, Inc. v. Dep’t of Health & 

Human Servs., 332 F.3d 654, 668 (D.C. Cir. 2003). Nor is 

this a case where Congress can be said to have “implicitly 

ratified” a longstanding administrative interpretation of a 

statute by failing to enact legislation to overturn that 

interpretation. Id. at 669–70. Presuming ratification based on 

congressional inaction is inappropriate “absent some evidence 

of (or reason to assume) congressional familiarity with the 

administrative interpretation at issue.” Id. at 669. Since 

CMS’s alleged errors in calculating the rural-floor budgetneutrality adjustment came to light only recently, the agency’s 

position that section 4410(b) imposes no obligation on CMS 

to correct those errors even if they affect the aggregate 

amount of current Medicare payments is simply of too recent 

vintage to presume that Congress has tacitly ratified CMS’s 

interpretation by failing to overturn it. 

In rejecting the Secretary’s argument that section 4410(b) 

permits CMS to ignore prior errors in calculating rural-floor 

budget-neutrality adjustments that affect current payments, 

we also necessarily reject the Secretary’s related contention 

that the hospitals are improperly seeking a form of 

“retroactive relief” inconsistent with the prospective nature of 

the payment system used to compensate hospitals for 

providing inpatient Medicare services. Appellee’s Br. 23; see 

also Final 2008 Rule, 72 Fed. Reg. at 47,330 (“Although 

errors in ratesetting are inevitable, we believe the need to 

establish final prospective rates outweighs the greater 

accuracy we might gain if we retroactively recomputed rates 

whenever an error is discovered.”). True, the hospitals did 

seek reimbursement of underpayments for years preceding 

2007 in their comments regarding the 2008 final rule, but they 

have abandoned those claims here and instead focus on their 

challenges to the 2007 and 2008 rules, which were issued 
21 

after CMS’s alleged computational errors came to light. 

There was nothing “retroactive” about the hospitals’ requests 

during the 2007 and 2008 rulemakings that Medicare 

payments for those years be calculated in accordance with 

section 4410(b)’s budget-neutrality mandate. 

Since the hospitals are only seeking recalculation of 

payments made in 2007 and 2008, the Secretary’s reliance on 

Methodist Hospital of Sacramento v. Shalala is misplaced. 

There, the Secretary published an area wage index calculated 

based on erroneous data. Methodist Hosp., 38 F.3d at 1228. 

After learning of the error, the Secretary promptly issued a 

corrected wage index but refused to give the correction 

retroactive effect. Id. Although we upheld the Secretary’s 

decision not to apply the correction retroactively, id. at 1229–

35, we never suggested that even after the error in the data on 

which the Secretary had relied was brought to her attention, 

she could have chosen to continue using the inaccurate wage 

index in calculating future payments. To the contrary, we 

indicated that any such refusal to correct the wage index 

going forward would be impermissible. See id. at 1230 

(“Administrative proceedings and judicial review could still 

provide a meaningful corrective remedy if, for example, the 

Secretary refused to make any revision to an erroneous wage 

index.”). 

 

Indeed, the Secretary herself has taken the position that 

correcting prior computational errors that affect current 

payments is perfectly permissible when making such changes 

has benefited Medicare. In Regions Hospital v. Shalala, 522 

U.S. 448 (1998), the Supreme Court upheld a regulation 

permitting the Secretary to conduct supplementary audits of 

cost reports that hospitals submitted for the 1984 fiscal year. 

The Secretary issued this regulation because she believed that 

“some ‘questionable’ [graduate medical education] costs had 
22 

been ‘erroneously reimbursed’ to providers for their 1984 

fiscal year.” Id. at 454 (quoting Changes in Payment Policy 

for Direct Graduate Medical Education Costs, 53 Fed. Reg. 

36,589, 36,591 (proposed Sept. 21, 1988)). Unless corrected, 

the inflated 1984 reimbursements would have been 

perpetuated under a new reimbursement methodology 

Congress enacted in 1986 that established the costs 

“ ‘recognized as reasonable’ ” for fiscal year 1984 as the 

baseline for calculating payments to hospitals for graduate 

medical education costs. Id. at 453 (quoting 42 U.S.C. 

§ 1395ww(h)(2)(A)). A hospital subjected to a 

supplementary audit argued that the Secretary’s “reaudit” 

regulation constituted an “impermissible retroactive rule.” Id.

at 456. Rejecting this contention, the Court emphasized that 

“a prescription is not made retroactive merely because it 

draws upon antecedent facts for its operation.” Id. (internal 

quotation marks omitted). The Court thus agreed with the 

Secretary that the regulation was not “retroactive” because it 

merely “sought to prevent future overpayments and to permit 

recoupment of prior excess reimbursement only for years in 

which the reimbursement determination had not yet become 

final.” Id. at 454. If, as the Secretary argued in Regions 

Hospital, her recalculation of prior reimbursement figures 

used in determining current payments was not retroactive, we 

find it difficult to see how the Secretary can fairly 

characterize the hospitals’ request here—that CMS correct 

prior computational errors so that they no longer affect 

current payments—as a claim for retroactive relief. 

As mentioned above, CMS’s invocation of its interest in 

finality suffers from a second defect: it fails to address the 

hospitals’ contention that CMS needed to reverse all prior 

rural-floor budget-neutrality adjustments—even those that 

were correctly calculated—in transitioning from a cumulative 

to a noncumulative methodology for offsetting the effect of 
23 

the rural floor. To understand the hospitals’ argument, 

consider again the hypothetical employer that splits its 

employee’s total compensation of $10 per hour between a 

wage and the value of a company car. Assume that in year 

one, the employee received a wage of $9 per hour and a 

company car worth $1 per hour. Then, in year two, the 

employer upgraded the employee’s car to one worth $2 per 

hour. If the employer was correctly using a cumulative 

approach to calculate the employee’s year-two wage, it would 

subtract the marginal $1 increase in the value of the car from 

the employee’s year-one wage of $9 per hour to calculate the 

employee’s new wage of $8. Now assume that the employer 

decides to switch to a noncumulative approach for calculating 

the employee’s wage in year three and that the car’s value 

remains unchanged at $2 per hour. It would make no sense 

for the employer to use the $8 wage as a baseline, subtract $2 

for the car’s value, and determine the employee’s year-three 

wage should be $6. Instead, the employer should reverse the 

prior adjustments to the employee’s wage, subtract $2 from 

$10, and calculate the correct, unchanged wage of $8 per 

hour. Critical to the issue before us, in switching from the 

cumulative to the noncumulative methodology, the employer 

would need to reverse the adjustments made to the 

employee’s wage in years one and two even if it had 

calculated those adjustments correctly. Thus, no purported 

interest in the “finality” of prior calculations could save the 

employer from the responsibility of reversing previous 

adjustments to the employee’s wage. So too here. CMS’s 

interest in the finality of prospective payment rates cannot 

justify failing to reverse the effects of prior cumulative 

adjustments to the standardized amount that threaten to 

duplicate the agency’s noncumulative wage-index adjustment. 

We of course recognize not only that the Medicare 

program is far more complicated than this simple 
24 

hypothetical, but also our obligation to afford great deference 

to the Secretary’s expertise in implementing the “complex and 

highly technical” statutes governing Medicare. Methodist 

Hosp., 38 F.3d at 1229 (internal quotation marks omitted). 

Our deference, however, is not unlimited. We must engage in 

a “searching and careful” review of the record to ensure that 

the Secretary has applied her expertise in a reasoned manner 

and has not acted arbitrarily or capriciously or otherwise 

violated legislative mandates. Citizens to Preserve Overton 

Park, Inc. v. Volpe, 401 U.S. 402, 416 (1971); see also 5 

U.S.C. § 706(2)(A). Here, the hospitals have made a 

compelling argument that regardless of whether CMS made 

computational errors in calculating the rural-floor budgetneutrality adjustments for years preceding 2008, it should 

have reversed all of those prior adjustments in transitioning to 

its new system of making noncumulative adjustments to the 

wage index. CMS failed adequately to address this concern in 

issuing its 2008 final rule. Furthermore, the rationale that 

CMS did provide—that its interest in finality justifies its 

refusal to revisit previously calculated rural-floor budgetneutrality adjustments—fails on its own terms because BBA 

section 4410(b) does not permit the agency to ignore prior 

errors in calculating rural-floor budget-neutrality adjustments 

when those errors are built into the formula used to calculate 

current Medicare payments. We shall thus remand for CMS 

either to explain why reversing all prior rural-floor budgetneutrality adjustments was unnecessary to achieve budget 

neutrality in 2008 or, if it can provide no explanation beyond 

the finality concern we have rejected here, to recalculate the 

payments due the hospitals under a formula that removes the 

effects of the prior rural-floor budget-neutrality adjustments. 

See Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm 

Mut. Auto. Ins. Co., 463 U.S. 29, 52 (1983) (concluding that 

the National Highway Traffic Safety Administration’s 

explanation for rescinding passive-restraint requirements was 
25 

“not sufficient to enable [the Court] to conclude that the 

rescission was the product of reasoned decisionmaking” and 

thus remanding for the agency to further consider the matter). 

III. 

For the foregoing reasons, we vacate the judgment of the 

district court and remand with instructions to (1) vacate those 

portions of the 2007 and 2008 rules challenged in this suit, 

and (2) remand to the Secretary for further proceedings 

consistent with this opinion.

So ordered.