Medicaid Provider Taxes
Released: 2016-08-05T00:00:00

Introduction

Medicaid is a means-tested entitlement program that finances the delivery of primary and acute medical services as well as long-term services and supports. Participation in Medicaid is voluntary for states, though all states, the District of Columbia, and five territories choose to participate. Each state designs and administers its own version of Medicaid under broad federal rules, and Medicaid is jointly financed by the federal government and the states.

States incur Medicaid costs by making payments to service providers (e.g., for beneficiaries' doctor visits) and performing administrative activities (e.g., making eligibility determinations), and the federal government reimburses states for a share of these costs. The federal government's share of a state's expenditures for most Medicaid services is called the federal medical assistance percentage (FMAP). The FMAP varies by state according to each state's per capita income. For FY2016, FMAPs range from 50% to 74%.

The state share of Medicaid expenditures is funded through a variety of sources. At least 40% of each state's share of Medicaid expenditures must be financed by the state, and up to 60% of the state's share may come from local governments. In state fiscal year (SFY) 2014, states reported that about 74% of the state share of Medicaid costs was financed by state general funds (most of which are raised from personal income, sales, and corporate income taxes). The remaining 26% was financed by other funds (including local government funds, provider taxes, fees, donations, assessments, and tobacco settlement funds).

Currently, many states use provider taxes to finance a portion of their state share of Medicaid expenditures. Federal statute and regulations define a provider tax as a health care-related fee, assessment, or other mandatory payment for which at least 85% of the burden of the tax revenue falls on health care providers. In order for states to be able to draw down federal Medicaid matching funds, the provider tax must be both broad-based (i.e., imposed on all providers within a specified class of providers) and uniform (i.e., the same tax for all providers within a specified class of providers). States are not allowed to hold the providers harmless for the cost of the provider tax (i.e., they cannot guarantee that providers receive their money back).

In SFY2016, 49 states and the District of Columbia are using at least one provider tax to finance Medicaid. Many of these states use the provider tax revenue to increase Medicaid payment rates for the class of providers, such as hospitals, responsible for paying the provider tax. This financing strategy allows states to fund increases to Medicaid payment rates without the use of state funds because the increased Medicaid payment rates are funded with provider tax revenue and federal Medicaid matching funds. States also use provider tax revenue to fund other Medicaid or non-Medicaid purposes.

This report provides background regarding states' use of provider taxes in the 1980s and describes the relevant federal statutes and regulations, which were mostly established in the early 1990s. The report explains how states use provider taxes to help finance Medicaid and provides information regarding the extent to which states currently use such taxes. The report ends with a discussion of the provider tax provisions in past and present proposals that would impact Medicaid provider taxes.

States' Initial Use of Provider Taxes in the 1980s

In the mid-1980s, states began using provider taxes along with provider donations to help finance Medicaid. Essentially, Medicaid providers would donate funds or agree to be taxed, and the revenue from these taxes and donations would be used to finance a portion of the state's share of Medicaid expenditures. In some cases, Medicaid providers initiated these provider tax and donation arrangements because states would often use the provider tax and donation revenue to raise Medicaid payment rates. Plus, these arrangements were often designed in such a way as to hold the Medicaid providers harmless for the cost of their taxes or donations.

Here is an example of how the provider tax arrangements operated in the 1980s. In a state, hospitals with high Medicaid utilization could agree to pay $10 million in provider taxes, and the state would increase Medicaid reimbursement rates for hospitals with high Medicaid utilization by $20 million. Assuming the state had a 60% FMAP, the state would then receive $12 million in federal Medicaid matching funds (60% of $20 million). In the end, hospitals with high Medicaid utilization would have gained $10 million ($20 million in increased Medicaid rates minus $10 million in tax payments), the state would have gained $2 million ($22 million from the hospitals and the federal government minus the $20 million paid to the hospitals), and the federal government would have paid $12 million.

Essentially, states were borrowing funds from Medicaid providers in order to draw down federal funds and increase Medicaid payment rates to the providers that had paid taxes or donated funds. The providers were often fully reimbursed for the cost of their tax payment or donation. For this reason, provider tax mechanisms were politically viable for states.

These financing arrangements became a point of contention between the federal government and the states. While not all states were using these Medicaid financing strategies, some states were particularly aggressive in their use of provider taxes and donations in financing Medicaid. This aggressive use of these Medicaid financing strategies motivated congressional action to curb states' use of the provider tax and donation arrangements.

Federal Statutes and Regulations

In 1991, Congress passed the Medicaid Voluntary Contribution and Provider-Specific Tax Amendments ( P.L. 102-234 ) to restrict the use of provider donations in financing Medicaid to extremely limited situations and to limit states' ability to draw down federal Medicaid matching funds with provider tax revenue.

The 1991 law defines a provider tax as any licensing fee, assessment, or other mandatory payment in which 85% or more of the burden falls upon health care providers. In order for states to claim federal matching payments for provider tax revenues, the 1991 law

requires provider taxes to be broad-based (i.e., imposed on all providers within a specified class of providers) and uniform (i.e., the same tax for all providers within a specified class of providers)—in other words, states cannot limit the provider taxes to only Medicaid providers; and prohibits states from a direct or indirect guarantee that providers receive their money back (or be "held harmless").

The Secretary of Health and Human Services (HHS) is authorized to waive the broad-based and uniform requirements of provider taxes. In order to waive either the broad-based or uniform requirement, a state needs to prove that the net impact of the tax is "generally redistributive" and the amount of the tax is not directly correlated to Medicaid payments.

"Generally redistributive" is defined as the tendency of a state's provider tax to derive revenues from non-Medicaid services in a class and to use these revenues as the state's share of Medicaid expenditures. According to the quantitative tests set forth in regulation, a provider tax is perfectly redistributive if the tax burden for Medicaid providers is the same under a tax without the waiver as under the tax with the waiver. The redistributive nature of a provider tax increases as the tax burden falls more heavily on providers with relatively fewer Medicaid patients.

Classes of Providers

The specified 19 classes of providers used to ensure that tax programs are "broad-based" are those that provide the following:

inpatient hospital services, outpatient hospital services, nursing facility services, services of intermediate care facilities for individuals with intellectual disabilities, physicians' services, home health care services, outpatient prescription drugs, services of Medicaid managed care organizations (including health maintenance organizations, preferred provider organizations, and such other similar organizations as the Secretary may specify by regulation), ambulatory surgical centers, dental services, podiatric services, chiropractic services, optometric/optician services, psychological services, therapist services, nursing services, laboratory and X-ray services, emergency ambulance services, and other health care items or services for which the state has enacted a licensing or certification fee.

Requiring that all providers within a class be taxed, as opposed to only Medicaid providers, dampened the appeal of provider taxes. Prior to the 1991 law, provider taxes were often imposed only on Medicaid providers. These provider tax arrangements were agreed to (and sometimes initiated) by the Medicaid providers because the Medicaid providers could be held harmless from the cost of the tax through increased Medicaid payment rates. However, because non-Medicaid providers cannot be as easily held harmless from the cost of the tax, the broad-based requirement restricted the use of provider taxes because the non-Medicaid providers are more likely to oppose the imposition of provider taxes.

Hold Harmless

Regulations describe three tests that are applied to provider taxes in order to determine whether taxpayers (i.e., the providers paying the provider tax) are held harmless. Taxes that fail any of these tests are determined to have a hold harmless provision in violation of the law. The three tests are as follows:

A positive correlation test is used to determine whether a state or other unit of government imposing the tax provides directly or indirectly for a non-Medicaid payment to the taxpayers in an amount that is positively correlated to either the tax amount or the difference between their Medicaid payment and the tax amount. The Medicaid payment test is violated if all or any portion of the Medicaid payment to the taxpayer varies based only on the amount of the total tax payments. The guarantee test is violated if the state or other unit of government imposing the tax provides directly or indirectly for any payment, offset, or waiver that guarantees to hold taxpayers harmless for all or a portion of the tax.

Under the guarantee test, the existence of an indirect guarantee is determined through a two-prong test. The first prong of the guarantee test relates to the rate at which taxpayers are taxed. That is, if the provider tax is applied at a rate less than 6% of the net patient service revenues received by the taxpayer, the tax is permissible under the guarantee test.

The second prong of the guarantee test is the "75/75 rule," which is applied to provider taxes imposed at a rate greater than the threshold amount specified in the first prong of the guarantee test (currently 6%). When the provider tax produces revenue in excess of the threshold amount, the tax is considered to hold the taxpayers harmless (i.e., violate the hold harmless test) if more than 75% of the taxpayers in the provider class receive 75% or more of the cost of the tax back through enhanced Medicaid payments or other state payments.

In other words, a state can impose a provider tax above the threshold amount (currently 6%) and draw down federal matching funds on the tax revenue, as long as the state can prove that the "75/75 rule" has not been violated (i.e., more than 75% of the taxpaying providers do not receive more than 75% of the cost of the tax back through enhanced Medicaid rates).

If a state imposes a provider tax above the threshold amount and violates the "75/75 rule" (i.e., more than 75% of the taxpaying providers receive more than 75% of the cost of the tax back through enhanced Medicaid rates), then the full amount of the tax revenue would be offset from the state's Medicaid expenditures. This means the provider tax revenue could still be used to fund Medicaid, but the state would not be able to draw down federal Medicaid matching funds on the provider tax revenue. Specifically, the revenue from provider taxes that do not meet federal requirements would be deducted from the state's Medicaid expenditures prior to the calculation of the federal financial participation.

To date, no state has imposed a provider tax at a rate above the threshold amount specified in the first prong of the guarantee test.

States' Current Use of Provider Taxes

States' use of provider tax revenue varies from state to state, but states often use provider tax revenue to draw down federal Medicaid matching funds in order to increase Medicaid payment rates for the same providers that are responsible for paying the tax. A simple example of this is illustrated in Figure 1 . In this example, a state with a 60% FMAP imposes a provider tax on all nursing homes in the state, and the state collects $10 million in tax revenue through this provider tax. The state then increases Medicaid reimbursement rates to nursing homes, which means nursing homes with Medicaid enrollees receive an additional $8 million. With these Medicaid expenditures, the state draws down $4.8 million (60% of $8 million) in federal Medicaid matching funds. In this example, the state was able to increase Medicaid payment rates to nursing homes without the use of any state general funds, and the state is left with $6.8 million to use for other Medicaid or non-Medicaid purposes.

In SFY2016, 49 states and the District of Columbia are using at least one provider tax to help finance Medicaid. While federal requirements allow states to impose taxes on 19 classes of providers, the classes of providers that are most often taxed include nursing facilities, hospitals, and intermediate care facilities for individuals with intellectual disabilities (ICF/ID). Detail regarding the types of provider taxes used by each state is provided in Table A-1 of the Appendix .

Provider Tax Revenue

The full amount of provider tax revenues used by states to help finance the state share of Medicaid expenditures is unknown. The Center for Medicare & Medicaid Services (CMS) collects some information from states regarding the amount of provider tax revenue through data included on the CMS-64 form, but this information is underreported. The National Association of State Budget Officers (NASBO) augments the information collected by CMS, but the NASBO information is also incomplete.

A portion of the CMS-64 form collects information regarding the provider donations, taxes, fees, and assessments collected by states. While states are required to provide this information to CMS for informational purposes, states report this information inconsistently, and the provider tax information is likely underreported. For example, in FY2012, 6 states did not report any provider tax revenue on the CMS-64 form, even though 47 states reported having at least one provider tax during that period of time.

NASBO publishes an annual State Expenditure Report that provides information regarding the state and federal shares of Medicaid expenditures. The report specifies the sources of the states' share of Medicaid expenditures as either state general funds or "other state funds," which are revenues collected by the state that are restricted by law for particular governmental functions or activities. Provider taxes comprise a significant portion of "other state funds," while tobacco tax revenue, donations, and local funds are also common sources of "other state funds."

The primary source for NASBO's "other state funds" information is the CMS-64 expenditure data, but NASBO augments this data. Specifically, NASBO collects detailed information from some states regarding the amount of provider taxes, fees, donations, assessments, and local funds used to finance the state share of Medicaid expenditures. However, NASBO acknowledges that its State Expenditure Report does not capture 100% of the provider taxes, fees, assessments, and local funds used to finance the state share of Medicaid expenditures.

The available data (shown in Figure 2 ), while limited, indicate a trend showing that states' use of "other state funds" has increased significantly as a percentage of the state share of Medicaid expenditures since SFY1990. For SFY2013 through SFY2015 (estimate), "other state funds" have comprised about 26% of the state share of Medicaid expenditures.

While NASBO data does not provide detail about the "other state funds," a Government Accountability Office (GAO) analysis of data reported by states in response to a GAO questionnaire focusing on the nonfederal share of Medicaid payments found that provider taxes comprised 34% of "other state funds" in SFY2012.

Number of Provider Taxes

States' use of Medicaid provider taxes has increased in recent years. Figure 3 shows that the number of states with different types of Medicaid provider taxes has increased. The number of states with any Medicaid provider tax has increased from 35 states in SFY2004 to 50 states in SFY2013, and the number of states with at least one provider tax has remained at 50 through SFY2016. Thirty-two states had three or more provider taxes in place in SFY2015.

In response to a GAO questionnaire about the new Medicaid provider taxes established from 2008 through 2012, states mentioned multiple uses of the revenue from the new Medicaid provider taxes. For instance, states cited funding Medicaid provider payment rates (34 times), non-DSH supplemental payments (31 times), DSH payments (13 times), avoiding Medicaid benefit cuts (27 times), and expanding Medicaid benefits (11 times). In addition, seven states reported planning to use provider tax revenue to fund all or part of the ACA Medicaid expansion starting in SFY2017.

Oversight of Provider Taxes

CMS is responsible for determining whether states abide by the statutory and regulatory requirements pertaining to provider taxes. States are not required to receive CMS approval for provider taxes that adhere to the federal requirements. However, states seeking waivers from the broad-based and uniform requirements do need CMS approval. From 2008 through 2012, CMS reviewed and approved Medicaid provider tax waivers in 29 states.

Current Issues

Limiting or eliminating states' use of provider taxes in financing Medicaid has been identified as a way to reduce federal Medicaid spending. A few years ago, there were a few proposals to limit or eliminate states' use of provider taxes, but provider tax proposals had not been discussed in the past couple years. However, recently, the House Energy and Commerce Committee marked up a bill ( H.R. 4725 ) that includes a Medicaid provider tax provision.

Proposals to limit states' ability to use provider taxes in financing the state share of Medicaid expenditures usually focus on lowering the threshold for provider taxes, which would decrease federal Medicaid payments to states. This would effectively shift more of the Medicaid program's growing costs to the states. As a result, states would have to weigh the impact of maintaining current Medicaid reimbursement and/or service levels against other state priorities for spending. They could choose to constrain Medicaid expenditures by reducing provider payment rates, limiting benefit packages, or restricting eligibility. These types of programmatic changes could also affect access to and the quality of medical care for Medicaid enrollees. For example, if states reduced the Medicaid reimbursement rates to providers, such as hospitals, physician, and nursing homes, these providers may be less willing to accept Medicaid patients.

Below are short descriptions of the past proposals impacting Medicaid provider taxes and the most recent proposal to limits states' use of provider taxes.

Past Proposals Impacting Medicaid Provider Taxes

The President's FY2013 budget proposal included a provision to phase down the Medicaid provider tax threshold from the current level of 6% to 3.5% from FY2015 to FY2017. The President's budget estimated that this proposal would reduce federal Medicaid expenditures by $21.8 billion from FY2015 through FY2022. According to a survey of states, in SFY2013, 41 states and the District of Columbia reported that this provision would reduce the provider tax rates for at least one provider tax in their state.

The National Commission on Fiscal Responsibility and Reform recommended restricting and eventually eliminating states' use of provider taxes. The commission estimated this provision would reduce federal Medicaid expenditures by $44 billion from FY2012 through FY2020.

Bill Marked Up by the House Energy and Commerce Committee

On March 15, 2016, the House Energy and Commerce Committee marked up the Common Sense Savings Act of 2016 ( H.R. 4725 ) and reported the bill to the House floor. Section 4 of this bill would reduce the Medicaid provider tax threshold from 6% to 5.5%. The Congressional Budget Office estimates this provision would reduce federal Medicaid expenditures by $4.6 billion from FY2016 through FY2026.

Appendix. Types of Provider Taxes Used by States

A vast majority of states use provider taxes to finance Medicaid. As shown in Table A-1 , 50 states (including the District of Columbia) used at least one provider tax in SFY2016.

Nursing home taxes were the most popular type of provider tax, with 44 states using a nursing home tax. Hospital and ICF/ID provider taxes were used by a majority of states, with hospital taxes in 40 states and ICF/ID taxes in 37 states. In addition, 22 states had other types of provider taxes.