CMS Proposes Significant Changes to Provider Tax Programs
The Centers for Medicare & Medicaid Services (CMS) has submitted a potentially groundbreaking regulation to the Office of Management and Budget (OMB) that could fundamentally alter how states finance their Medicaid programs. The regulation, titled “Preserving Medicaid Funding for Vulnerable Populations—Closing a Health Care-Related Tax Loophole,” signals a significant shift in federal oversight of state Medicaid financing mechanisms.
Understanding Provider Tax Programs
Provider taxes have become an increasingly vital funding tool for state Medicaid programs. These taxes allow states to generate revenue from healthcare providers or managed care organizations, which then helps states draw down additional federal matching funds. The federal government currently covers more than two-thirds of total Medicaid costs nationwide, with states responsible for the remainder.
According to a Government Accountability Office report, states’ reliance on provider taxes increased to 17% in 2018, representing a 10% increase from 2008 levels. This growing dependence on provider taxes has raised concerns among some federal officials who view certain implementations as potentially exploitative of federal matching arrangements.
The Proposed Regulation’s Intent
The new regulation aims to “update existing regulations that govern the process for states to obtain a waiver of the statutory requirements that health care-related taxes are broad based and uniform to ensure that taxes passing the statistical test are generally redistributive,” according to the official description.
While the full text remains unreleased, analysts from TD Cowen suggest the rule may seek to reform provider tax programs. However, they note, “It is unclear if these would result in ‘cuts’ to Medicaid funding or would primarily be a redistribution of provider-tax funded Medicaid supplemental payments.”
Potential Impact on State Medicaid Programs
Eric Levine, an associate health principal at Avalere, warns about the potential consequences: “Changes that reduce or restrict the provider tax will directly impact a state’s ability to access Medicaid funding. If these changes are implemented, states will need to reassess their Medicaid financing strategies.”
The Kaiser Family Foundation (KFF) emphasizes that restricting provider taxes could lead to reduced enrollment and fewer benefits for Medicaid beneficiaries across affected states. This poses a significant challenge as Medicaid serves as a critical safety net for vulnerable populations.
The “Hold Harmless” Requirement and Safe Harbor Threshold
One key requirement of provider tax programs is that they cannot “hold harmless” providers—meaning states cannot guarantee providers will recoup their tax payments. Currently, a safe harbor provision exempts programs from this requirement when tax revenues total 6% or less of net patient revenues.
If future rulemaking reduces this safe harbor threshold—possibly to 3% by 2028 as some proposals suggest—many states would face significant disruption to their Medicaid financing structures. The Congressional Budget Office estimates that lowering the threshold to 2.5% would reduce the federal deficit by $71 billion.
Political Context and Project 2025 Influence
Released on April 19, TD Cowen analysts believe this regulation contributed to a decrease in hospital stocks. They also suggest the rule may indicate that OMB Director Russell Vought—a major contributor to Project 2025, a Heritage Foundation initiative being implemented across the Trump administration—could play “a more active role” in CMS rulemaking than his predecessors.
Project 2025’s 922-page plan explicitly criticizes what it calls “gimmicks” in Medicaid and urges CMS to end “state financing loopholes.” Similar language appears in a recent report from the Trump-aligned Paragon Health Institute, which argues states are incentivized to inflate Medicaid budgets through provider taxes.
Congressional Budget Considerations
As Congress debates potential Medicaid spending reductions of up to $880 billion over ten years, provider taxes have come under increasing scrutiny. Eliminating these taxes entirely could save an estimated $612 billion over the next decade.
One spending cut option before Congress suggests “Reversing Executive Expansion of State-Directed Payments in Medicaid,” with informal savings estimates of $25 billion over ten years. Another proposal to “Limit Medicaid Provider Taxes” by decreasing the safe harbor threshold to 3% by 2028 carries a $175 billion price tag over the same period.
Industry Impact and Provider Concerns
TD Cowen analysts suggest that depending on how future hold harmless policies are implemented, state-directed payments could be redistributed from for-profit providers to nonprofit providers. They specifically note that lowering the safe harbor threshold would disproportionately and negatively impact major healthcare systems like Tenet Healthcare, Universal Health Services, and HCA Healthcare.
Hospital organizations maintain these taxes are necessary to counterbalance underfunding in other areas of the Medicaid program. The revenues from provider taxes currently fund crucial services including disproportionate share hospital payments and managed care state-directed payments.
Recent Precedent in California
The CMS warned California in December that future rulemaking could jeopardize a managed care tax arrangement the agency had approved. The arrangement, proposed by California to strengthen its Medi-Cal program, was approved only because it complied with a mandatory statistical test, though CMS indicated it otherwise believed the program failed to meet requirements.
The Road Ahead
Analysis from the Medicaid and CHIP Payment and Access Commission (MACPAC) reveals that directed payments total approximately $110 billion annually, substantially higher than previous estimates. As the administration moves forward with implementing this regulation, states, providers, and Medicaid beneficiaries alike face uncertainty about the future stability of this critical healthcare safety net program.
The final form of the proposed rule remains to be seen, but it could include new requirements on state waivers around hold harmless enforcement, increased data collection on provider tax usage, limits on state-directed payments exceeding Medicaid service costs, or new restrictions on the proportion of state-directed funding from provider taxes.
CMS has already announced it will begin enforcing new guidance on hold harmless agreements starting in 2028, giving states several years to prepare for potential changes to their Medicaid financing strategies.
