Mandatory Spending

Function 550 - Health

Limit States’ Taxes on Health Care Providers

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Mandatory Outlays                        
  Lower the safe-harbor threshold to 5 percent 0 -1.4 -1.5 -1.6 -1.7 -1.8 -1.9 -2.0 -2.1 -2.2 -6.1 -15.9
  Lower the safe-harbor threshold to 4 percent 0 -3.4 -3.7 -4.0 -4.2 -4.4 -4.6 -4.9 -5.2 -5.6 -15.3 -39.9

This option would take effect in October 2017.

Medicaid is a joint federal-and-state program that pays for health care services for low-income people in various demographic groups. State governments operate the program under federal statutory and regulatory oversight, and the federal government reimburses a portion of each state’s costs at matching rates that generally range from 51 percent to 80 percent, depending on the per capita income of the state and on the share of enrollees (if any) in each state that became eligible for Medicaid as a result of the optional expansion of that program under the Affordable Care Act. The rest of the funding must come from state revenues, either from general funds or from another source. Most states finance at least a portion of their Medicaid spending through taxes collected from health care providers. In the early 1990s, the Congress required states that taxed health care providers to collect those taxes at uniform rates from all providers of the same type. Those rules were created because some states were taxing Medicaid providers either exclusively or at higher rates than other providers of the same type (hospitals, for example) with the intention of returning the collected taxes to those providers in the form of higher Medicaid payments. Such “hold harmless” provisions were leading to large increases in federal Medicaid outlays but not to concordant increases in states’ Medicaid spending, despite the expectation created under Medicaid’s matching-rate formula.

However, federal law grants a “safe harbor” exception to hold-harmless provisions when a state collects taxes that do not exceed 6 percent of a provider’s net patient revenues. This option would lower the safe-harbor threshold, starting in October 2017, to 5 percent or 4 percent. The Congressional Budget Office estimates that capping the threshold at 5 percent would reduce mandatory spending by $16 billion between 2017 and 2026 and that capping it at 4 percent would reduce mandatory spending by $40 billion over that period.

Lowering the safe-harbor threshold would reduce the amount of taxes that states could collect from providers without incurring reductions in federal payments. Under the new limits, states would need to decide whether to continue spending the same amount (and make up the difference out of other revenues) or to cut spending by the difference between the old and new thresholds. In the first case, states might replace lost revenue by raising additional general revenues or by reducing spending elsewhere in their budgets and transferring those amounts to Medicaid spending. In that case, the federal government would continue to match the same amount of state spending, and there would be no change in federal spending. Alternatively, states could decide not to replace the lost revenue and instead cut their Medicaid spending. That choice would reduce federal spending because the matched amounts would be smaller.

CBO expects that different states would respond to a lower safe-harbor threshold in different ways along a continuum. Most states would probably not replace all of the revenues lost as a result of the lower threshold for the taxation of providers. The health care providers being taxed directly benefit from higher Medicaid payment rates, making the imposition of such taxes an easier choice for states than alternative choices for replacing such revenues. However, most states would be unlikely to cut Medicaid spending by the full amount of the lost revenues because they might deem other choices to be preferable. CBO anticipates that, on average, states would replace half of the lost revenues, but that estimate is highly uncertain.

The main rationale for this option is that it would lower Medicaid spending by limiting a state financing mechanism that has inflated federal payments to states for Medicaid beyond the amount the federal government would have paid in the absence of such taxes. An argument against this option is that, to the extent that states cut back spending on Medicaid in response to the lost revenues, health care providers could face lower payment rates that might make some of them less willing to treat Medicaid patients. Moreover, some Medicaid enrollees could face a reduction in services or possibly lose their eligibility for the program if states restricted enrollment to curtail costs.