Reconciliation Option: Tackling “Provider Tax” Gimmick in Medicaid

The Medicaid program is designed to be a federal-state partnership. However, many states prioritize maximizing federal payments regardless of the value being provided to patients, abusing the system. This is not only unfair to other states but also untenable as the federal government approaches the maximum amount it can realistically borrow. The most egregious abuse of this sort is the “provider tax,” a policy approach that even Joe Biden has called a scam. Some states levy extra taxes on medical providers with a concentration of Medicaid patients. The states couple these taxes with larger payments to those same providers through the Medicaid system. This has the effect of transferring much of the cost of the tax to the federal government because the federal government reimburses an average of 60 percent of Medicaid payments made by states. These states, most notably California, leverage this loophole to backfill unbalanced budgets. States are careful to make the Medicaid payment increase to providers larger than the provider tax. This ensures support from the powerful medical providers. Medicaid provider tax schemes are simply an accounting gimmick that do nothing to promote higher quality care or protect the most vulnerable Americans. Rather, the provider tax amounts to a money laundering scheme to subsidize state bureaucracies. While there is a federal limit on the scale of provider taxes, a “safe harbor” threshold is set at 6% of net patient revenue for a provider. This is an enormous amount of money given the revenue of even mid-sized medical groups.

Eliminating Provider Tax Loophole Would Save Over $600 Billion

The provider tax shell game cannot change the fact that it damages the shaky fiscal health of the federal government. As such, it should be a top target for legislators through the budget reconciliation process. The Congressional Budget Office estimates that eliminating the “safe harbor” for Medicaid provider taxes would save the federal government $612 billion in just nine years assuming the change takes effect at the start of fiscal year 2026. The savings would reach $101 billion in fiscal year 2034 alone. For perspective, that amount of savings would allow Congress to make capital and R&D tax expensing permanent for business investment with room to spare. Even merely lowering the safe harbor threshold to crack down on the provider tax gimmick could save taxpayers $200 billion or more.