The old TV program Hee Haw sang a ditty which went, “If it weren’t for bad news, there would be no news at all?”

It seems that is our current situation—we have an unending barrage of world and national news that seems to be negative almost 100 percent of the time. One of the bad news issues that affects the health care industry is legislative efforts to curtail health care spending. Current budgetary discussion seems to be centered on reducing Medicaid spending which in FY2023 totaled $894 billion, with the federal government paying $614 billion, or about 69% of the total while the states paid the remaining $280 billion, or 31%, of Medicaid expenditures.

One area receiving great attention is Medicaid provider taxes. Critics of the provider tax, including Trump’s Medicaid chief, Mehmet Oz, have called provider taxes a circular money-laundering scheme because they ultimately attract more federal matching funds—money that is generally directed back to the hospitals paying the tax.

States commonly use Medicaid provider tax revenue to fund Medicaid base rates, Medicaid DSH payments, non-DSH supplemental payments.  Some states have also used revenue from provider taxes to finance the ACA Medicaid expansion. States first began using provider taxes in the 1980s to finance their share of Medicaid.  Medicaid providers would donate funds or agree to be taxed and the revenues from those donations and taxes would be used to finance a portion of the state’s share of Medicaid.  This use of Medicaid provider taxes grew to such an extent that federal regulations and limitations were enacted in the 1990s. Current federal regulation requires the following specific provisions for Medicaid provider tax plans:

• Broad-based, which means the tax is imposed on all providers within a specified class of providers ( e.g. hospitals, nursing homes, etc.). This means that all providers within the class must be taxed, not just those with high Medicaid exposure.
• Uniform, which means the tax must apply equally to all providers within the specified class. For example, tax rates cannot be higher on Medicaid revenue. Most states currently tax hospitals on a net patient revenue basis.
• Not hold taxpayers (providers) “harmless,” which means states are prohibited from directly or indirectly guaranteeing that providers will receive their tax revenues back (i.e., be “held harmless”).

In assessing whether provider taxes comply with federal laws, current regulations specify that the hold harmless requirement does not apply when the tax revenues comprise 6% or less of net patient revenues from treating patients (see 42 CFR Section 433.68), a level sometimes referred to as a “safe harbor” limit.  If a provider tax exceeds the 6% safe harbor, it would be subject to greater scrutiny under the hold harmless provisions. If the tax program is found to violate the hold harmless provisions (e.g., if 75% or more of taxpayers in the class receive 75% or more of their total tax costs back in enhanced Medicaid payments), the amount of tax revenue exceeding the safe harbor would be offset from the state’s Medicaid expenditures before the federal government calculates its matching funds. In essence, exceeding the 6% safe harbor does not automatically disallow the tax, but it eliminates the automatic exception to the harmless rule, and the state must demonstrate that the tax program does not violate the hold harmless provisions.  To date, no state has imposed a provider tax at a rate above the allowed 6% safe harbor rate.  Current provisions of the Big Beautiful Bill recently passed by Congress will gradually reduce the safe harbor rate from 6% to 3.5% over the next few years. 

Changes in the safe harbor are also impacted by the Federal Medical Assistance Percentage (FMAP). The FMAP determines the federal government’s share of Medicaid costs, and it’s calculated using a formula based on state per capita income relative to the national average. States with lower per capita incomes receive a higher federal match rate. The FMAP cannot be less than 50% or more than 83%. FMAP is calculated by dividing a state’s average per capita income by the national average per capita income, then squaring the result, and subtracting it from one. This result is then multiplied by 45%. The resulting percentage is the federal government’s share of Medicaid costs. For example, a state with a low per capita income might have an FMAP of 70%, meaning the federal government pays 70% of the state’s Medicaid costs, and the state pays the remaining 30%.

With this background, a key question is which states would be most impacted by the reduction in the 6% safe harbor limit? States with both high FMAPs and high current Medicaid tax rates would fare the worst while states with lower FMAPs and low Medicaid tax rates would suffer less. The table below shows state values for the following:

• FMAPs
• Medicaid Hospital Tax Rates
• Hospitals with Reported Values for Net Patient Revenue
• Total State Net Patient Revenue for Reporting Hospitals
• Total State Net Income for Reporting Hospitals

There are six states that do not have Medicaid taxes on hospitals (Alaska, Delaware, Nebraska, North Dakota, South Dakota, and New Mexico). Hospitals in these six states should not be affected by changes in safe harbor rates, but other proposed Medicaid changes could still affect Medicaid funding.

The potential impact of reductions or elimination of the safe harbor provision at the state level could be estimated as follows:

Possible State Funding Loss = Net Patient Revenue X (Current Medicaid Tax Rate – Allowed Safe Harbor Rate) X FMAP %

Let’s use Alabama as an example.  Alabama’s hospital provider tax rate is 6.0% of net patient revenue, according to the Alabama Department of Revenue.  The state’s current FMAP is 72.84%. In 2023 we found 86 Alabama hospitals with combined net patient revenue of $13,824,168,780.  When the safe harbor rule is reduced to 3.5% Alabama would stand to lose $251,738,111.   Note that this value is 41 percent of the total reported net income by hospitals in Alabama ($ 611,442,745). 

$251,738,111 =$13,824,168,680 x(6%-3.5%) x 72.84%

For the 86 Alabama hospitals that could be a potential loss of $2.93 million in revenue per hospital.  Most likely the actual number would be less, but it is clear the loss could be very sizable.

The table below can provide a quantitative assessment of the possible Medicaid funding loss if sizable changes are made in Medicaid Provider Tax Safe Harbor limits. Sister Mary Haddad, president and CEO of the Catholic Health Association of the United States, called the current Senate proposal “unconscionable” in its scope, pointing to proposed limits on provider taxes, state payments, and retroactive coverage, along with expanded work requirements and reduced support for immigrant populations.  Whatever the final legislative outcome is, the potential reduction in hospital Medicaid financing could create major changes in both the availability of health care as well as the quality of medical services.