In his book, The Price of Politics, renowned journalist Bob Woodward chronicled the 2011 negotiations between the Obama administration and Congress as the sides attempted to reach a deal to trim future budget deficits. One area of common ground between the administration and congressional Republicans centered on Medicaid provider taxes, which happens to be the subject of my most recent study, “Medicaid Provider Taxes: The Gimmick That Exposes Flaws with Medicaid’s Financing,” published today by the Mercatus Center at George Mason University.

Provider taxes are assessments levied on health care providers, often accompanied with the guarantee of increased Medicaid payments to those same providers, largely financed from federal Medicaid matching funds. According to Woodward, the Republican negotiators raised the issue of provider taxes and Vice President Joe Biden made his view clear:

It’s a scam, Biden agreed. The states were gaming the system, taxing doctors and hospitals so they could get federal reimbursements and then returning the money to the providers. Let’s call it like it is, and let’s just do this. … It could save $40 billion. “If we can’t do this—” the vice president said, “come on!”

Although the vice president was absolutely right, the parties were unable to come to agreement. And provider taxes have grown significantly since. Provider taxes demonstrate the worst aspect of our nation’s health care entitlement programs (Medicare, Medicaid, and the Affordable Care Act)—complicated rules and subsidies that profit special interest groups and empower government bureaucracies with too little benefit for patients most in need and taxpayers.

Tax Delivers for States and Providers

Oregon state representative Mitch Greenlick calls provider taxes a “dream tax” for states. According to Greenlick, “[w]e collect the tax from the hospitals, we put it up as a match for federal money, and then we give it back to the hospitals.”

As an illustration, assume a state assesses a hospital tax equal to $100 million and then returns the funds back to the hospitals through higher Medicaid payments. A state with a 60% reimbursement rate—the average rate—receives $60 million from the federal government to cover what is essentially an artificial Medicaid expenditure. The state can then spend that extra $60 million on hospitals, other Medicaid providers, or other government programs.

A 2014 report from the Government Accountability Office (GAO) detailed how Illinois recently used provider taxes to benefit the provider and state at the expense of federal taxpayers. According to GAO, “in Illinois, a $220 million payment increase for nursing homes funded by a tax on nursing facilities resulted in an estimated $110 million increase in federal matching funds and no increase in state general funds, and a net payment increase to the facilities, after paying the taxes, of $105 million.” 

Medicaid Gimmicks Raise Overall Medicaid Spending

Provider taxes and other “scams” employed by states result from the problematic way Medicaid is financed—an uncapped federal government reimbursement of at least half of every state’s Medicaid spending. Provider taxes shift costs from states to the federal government, but they also raise overall spending by lowering the relative price of Medicaid expenditures to states. Provider taxes make state Medicaid programs cheaper because the revenue raised can be used as the state share of spending.

Over the past several years, both provider tax revenue and federal Medicaid spending has increased sharply. The table below shows that provider tax revenue—adjusted for inflation—more than doubled from 2008 through 2015.

The table also shows that both federal Medicaid spending and the federal share of overall program spending has increased substantially as provider taxes have expanded. Although the enhanced federal Medicaid reimbursement for the ACA expansion is partly responsible for these increases, the growing use of provider taxes and similar techniques is certainly responsible for a large part as well.

Politics of Provider Taxes

Every state except Alaska (and Alaska recently awarded a contract to a firm “to study and develop” a tax proposal) uses Medicaid provider taxes. Since provider taxes are essentially a kick-back, the providers who benefit the most are generally those serving a larger number of Medicaid enrollees. They receive higher Medicaid payments than they would have received in the absence of the tax.

The kick-back often involves extra payments, dubbed supplemental payments, to providers. These extra payments raise serious questions of political influence and cronyism. For example, in 2014 GAO identified two New York City hospitals—Coler Memorial and Coler Goldwater— that received $416 million in extra Medicaid payments in 2011 in addition to $70 million in regular Medicaid payments. These Medicaid payments were nearly five times what Medicare would have paid these hospitals for these services, which is supposed to be the legal limit on what Medicaid can pay.

Widespread Recognition of Provider Tax Problem

In 1991, President George H. W. Bush signed legislation to limit states’ ability to use provider taxes, principally by reducing the explicit nature of the kick-back. It appeared to work temporarily. However, states eventually figured out how to—more or less—get around those restrictions while undertaking new schemes like intergovernmental transfers (IGTs). These involve states making large supplemental Medicaid payments to government health care providers after the providers make an artificial transfer of funds to the state for the state to leverage federal Medicaid funds.

Both the George W. Bush and the Obama administrations recognized the problem of provider taxes and proposed limiting the amount that states could raise through them. The major Medicaid recommendation made by National Commission on Fiscal Responsibility and Reform, better known as the Bowles-Simpson Commission, was to “[e]liminate state gaming of [the] Medicaid tax gimmick.”

Health policy experts from across the political spectrum acknowledge that provider taxes reduce the transparency and integrity of the Medicaid program and undermine the federal-state Medicaid partnership. Most recently, at a December 2015 health care forum, Urban Institute senior research fellow John Holahan called provider taxes “egregious,” “a national disgrace [that] is not as understood as well as it should be,” and a problem that “needs to be dealt with.”

Medicaid Needs Reform

A study last year by economists at Harvard, MIT, and Dartmouth found “that Medicaid’s value to recipients is lower than the government’s costs of the program, and usually substantially below.” They estimated that recipients only benefit by 20 to 40 cents for each dollar of spending.

Some policymakers have proposed replacing the open-ended federal Medicaid reimbursement of state expenditures with a fixed payment structure in order to concentrate state efforts on improving the value enrollees receive from the program. Under such a structure, all spending above the federal contribution level would be paid from the state tax base, so states would be incentivized to create programs that provide better value for each dollar of spending. A fixed payment structure would also stop states from creatively manipulating complex rules and regulations to maximize federal funding.

The Least We Can Do: Eliminate Provider Taxes

If structural Medicaid reform is beyond political possibilities at the moment because of entrenched interest group power and a lack of political will to confront the unsustainability of the program, we should, at a minimum, implement the recommendation of both the Bowles-Simpson Commission and Vice President Biden and scrap the provider tax “scam.” Adopting the Vice President’s own words, “If we can’t do this…” when will we ever get serious about the fiscal challenges confronting the country?