Within broad federal requirements, each state administers and operates its Medicaid program in accordance with a Medicaid state plan, which must be approved by CMS. A state plan describes the groups of individuals to be covered; the methods for calculating payments to providers, including which types of providers are eligible to receive payments; and the categories of services covered. Federal law identifies broad categories of services that states must cover, such as inpatient hospital services, nursing facility services, and physician services, and also many categories of services that states can cover at their own option, such as home- and community-based long-term care services, physical therapy, or optometry. Any changes a state wishes to make in its Medicaid plan, such as establishing new Medicaid payments (including supplemental payments) to providers or changing methodologies for payment rates for services, must be submitted to CMS for review and approval as a state plan amendment. In reviewing state plan amendments to ensure that state provisions are consistent with federal Medicaid requirements, CMS reviews and approves payment methodologies and does not review actual payments for individual providers. CMS communicates Medicaid program requirements to states through federal regulations, a published State Medicaid Manual, standard letters issued to all state Medicaid directors, and technical guidance on particular topics. Under federal Medicaid requirements, federal Medicaid matching funds are available for state payments made for Medicaid-covered services provided to Medicaid beneficiaries. While payments are not limited to the costs of providing services, payments made to a provider under a state plan must be economical and efficient and within the Medicaid UPL, which is the ceiling on the amount of federal matching funds a state can claim for certain services. The UPL is based on an estimate of what Medicare would have paid for comparable services. Because states’ regular Medicaid payments are often lower than what Medicare would pay for similar services, states are able to make UPL supplemental payments, and the federal government shares in the payments to the maximum amount allowed under the UPL (see figure 1). The UPL is not a provider-specific limit but instead is applied on an aggregate basis for certain provider ownership types and categories of services. Each state must calculate a separate UPL for each combination of provider ownership type and category of service to determine the maximum amount of UPL payments that it can make for each ownership-service type combination. States may establish multiple UPL supplemental payment programs and hospitals may receive UPL supplemental payments from more than one of these programs. Approval to make new payments and apply other eligibility criteria is obtained through the state plan amendment process, which requires CMS review and approval. CMS’s review and approval role does not extend to reviewing the specific manner in which states distribute payments, including which individual providers receive payments, the amount of the payments, or how providers spend the payments they receive. Under the flexibility of the Medicaid UPL, some states have targeted UPL supplemental payments to a small number of hospitals within a particular category. For example, in 2012, we reported that a large share of UPL supplemental payments were concentrated on a small number of hospitals and in many cases resulted in Medicaid surpluses. We concluded that payments that greatly exceeded Medicaid costs raised questions about the purpose of the payments, including how they related to Medicaid services and if they are economical and efficient. In 2015, we reported that CMS lacked a policy and process to determine if payments to individual providers are economical and efficient, and we recommended that CMS develop criteria to assess payments to individual providers and develop a process to identify and review them. HHS agreed and reported that the agency is taking action to respond to our recommendation. States may also administer parts of their Medicaid programs under the authority of section 1115 of the Social Security Act, which authorizes the Secretary to waive certain federal Medicaid requirements and allow costs that would not otherwise be eligible for federal matching funds for experimental, pilot, or demonstration projects that, in the Secretary’s judgment, are likely to assist in promoting Medicaid objectives. In recent years an increasing number of states have received permission from HHS to make supplemental payments under Medicaid demonstrations. Supplemental payments under a Medicaid demonstration are made according to the terms and conditions approved by HHS for the demonstration and may include reporting or other requirements that do not apply to UPL supplemental payments authorized under the Medicaid state plan. States and the federal government share in the financing of Medicaid payments according to a formula established in law. States finance the nonfederal share of their Medicaid programs primarily with state funds, particularly state general funds appropriated to the state Medicaid agency. Within certain limits, however, states may also use other sources of funds—including funds from local government providers, such as county-owned or county-operated hospitals, or from local governments on behalf of government providers. For example, local government providers and local governments can provide Medicaid funding to the state via fund transfers, known as intergovernmental transfers. Federal law allows states to finance up to 60 percent of the nonfederal share from local government funds. This limit is applied in the aggregate—that is, across each state’s entire Medicaid program—and not for individual payments or categories of service. Under federal law, states cannot lower the amount, duration, scope, or quality of Medicaid services provided due to a lack of funds from local sources. We recently reported that states have increasingly relied on local governments to fund the nonfederal share of state Medicaid payments, particularly for supplemental payments. Selected hospitals that received large UPL supplemental payments under state plans in three of four selected states did not account specifically for the use of revenue from these payments in their financial systems, as they were not required to do so. But hospital officials described various uses of the revenue, such as defraying the costs of treating the uninsured and the costs of capital purchases. Selected hospitals that received large Medicaid payments in two of four selected states were required to track spending and allowed to use payments for purposes such as uninsured costs. Officials from all nine of our selected hospitals that received large UPL supplemental payments under state plans in three of the four states in our review reported that they did not track how they used the excess revenue from the UPL payments they received, nor were they required to do so. These surpluses reflect the amount that total Medicaid payments, which include regular Medicaid and supplemental payments, exceeded Medicaid costs and were significant for the selected hospitals. For example, in 2009, the Medicaid surpluses for the nine hospitals ranged from $400,000 to more than $77 million, with average Medicaid surpluses of about $39 million. Although supplemental payments to these hospitals amounted to tens or hundreds of millions annually and are generally paid on a lump sum, quarterly, or annual basis, officials told us that their financial systems do not separately identify the supplemental payment revenues or track the costs to which supplemental payments are applied. Rather, these officials said the UPL supplemental payments are treated as revenue along with other payments the hospital receives, and revenues are not segregated for specific purposes. Although hospitals did not track the UPL supplemental payment revenues, hospital officials were able to describe some of the general purposes for which the revenues, including the Medicaid surpluses resulting from the large payments, were used. Hospital officials described purposes such as defraying the costs of treating uninsured patients, contributing to specific capital purchases, and making general improvements to community access to care and services. Officials from several hospitals described more than one purpose for which the UPL supplemental payments and resulting Medicaid surpluses were used. (See table 1.) Hospital officials from seven of nine selected hospitals in these three states said they used the revenues from the large UPL supplemental payments they received in part to cover the costs of providing services to uninsured patients. Federal Medicaid law explicitly authorizes one type of Medicaid supplemental payment—Medicaid DSH supplemental payments—for which states can claim federal matching funds for the costs of treating uninsured patients. The amount of federal funding each state may claim for DSH supplemental payments is limited by federal law, as each state is subject to a federal DSH allotment that establishes the maximum federal funding available for DSH payments. These limits, however, do not restrict hospitals from using available revenues to cover the costs of providing services to uninsured patients. While officials with the seven hospitals were unable to specify how much of their UPL supplemental payments, including their Medicaid surpluses, were used to cover the costs of uninsured patients, the amount of federal funds above the states’ federal DSH allotments that were available to the hospitals for spending on the uninsured could be significant. For example, for New Mexico, Oklahoma, and Texas, statewide Medicaid surpluses due to UPL supplemental payments exceeded $400 million in federal funds in 2009, which is significant compared to these states’ DSH allotments of just over $1 billion in the same year. In New Mexico and Oklahoma, the federal share of Medicaid surpluses due to UPL payments actually exceeded the states’ federal DSH allotments. (See table 2.) Several hospital officials described other uses of revenues from UPL supplemental payments, including funding general hospital operations and maintenance; capital projects, such as new facilities; and equipment purchases, such as new imaging equipment. Although hospital officials were able to describe multiple purposes for which they used revenues from Medicaid surpluses resulting from large UPL supplemental payments, they were unable to specify how much was used for each purpose they described. Examples of specific expenses cited by hospital officials include the following: A New Mexico hospital official described a variety of capital expenses for which revenues from UPL payments, in part, were used. Examples included constructing new medical office buildings, constructing a new cancer treatment center, opening a new health clinic, purchasing a new CT scanner, purchasing a new X-ray imaging system, and purchasing a new helicopter to transport patients. Although hospital officials could not estimate how much of the Medicaid surplus was devoted to capital investment, the surplus was significant compared to the amount of its capital investments. For example, in 2009 this hospital had a Medicaid surplus of about $16 million. The budget for its capital investments totaled $24.6 million that year.