Function 550 - Health
Limit State 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||2023||2024||2025||2026||2027||2028||2029||2030||2031||2032||2023–
|Lower the Tax Threshold to 5 Percent|
|Change in Outlays||0||-2||-3||-4||-5||-5||-5||-6||-6||-6||-14||-42|
|Change in Revenuesa||0||*||*||*||*||*||*||*||*||*||*||-1|
|Decrease (-) in the Deficit||0||-2||-3||-4||-5||-5||-5||-6||-6||-6||-14||-41|
|Lower the Tax Threshold to 2.5 Percent|
|Change in Outlays||0||-11||-14||-17||-21||-25||-30||-31||-32||-34||-63||-215|
|Change in Revenuesa||0||*||*||*||-1||-1||-1||-1||-1||-1||-2||-6|
|Decrease (-) in the Deficit||0||-11||-14||-17||-20||-24||-29||-30||-31||-33||-61||-209|
|Eliminate the Tax Threshold|
|Change in Outlays||0||-28||-35||-44||-53||-63||-74||-78||-82||-86||-160||-542|
|Change in Revenuesa||0||-1||-1||-1||-2||-2||-2||-2||-2||-3||-5||-16|
|Decrease (-) in the Deficit||0||-27||-34||-43||-51||-61||-72||-76||-80||-83||-155||-526|
Medicaid is a joint federal-state program that covers acute and long-term health care for groups of low-income people, chiefly families with dependent children, elderly people (those 65 or older), nonelderly people with disabilities, and—at the discretion of individual states—other nonelderly adults whose family income is up to 138 percent of the federal poverty guidelines. 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 vary on the basis of enrollees' eligibility category and the state's per capita income. The rest of the funding for Medicaid comes 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 2021, states collected a total of $23 billion from health care providers through such taxes.
In the late 1980s and early 1990s, states increasingly used taxes on health care providers to increase the amount of state funding available for Medicaid. That funding was used to generate additional federal matching payments to the states. A number of states established "hold harmless" arrangements with providers, wherein they taxed providers who received a large amount of Medicaid payments or taxed Medicaid providers at higher rates than other providers of the same type. The intention was to return the collected taxes to those providers in the form of higher Medicaid payments. The result was that states could collect revenues from providers that would be returned to those same providers, leaving them at least no worse off (that is, held harmless), while adding revenues to the states in the form of federal matching payments. Those arrangements effectively shifted some of the cost of funding Medicaid from the states to the federal government without the use of states' general funds. Between 1989 and 1993, federal Medicaid spending increased by an average of 20 percent annually, peaking at 29 percent in 1992.
In response, lawmakers began to require states that taxed health care providers to collect those taxes at uniform rates, regardless of the number of Medicaid patients served, from all providers of the same type (hospitals, for example). In addition, states generally were no longer allowed to establish hold-harmless arrangements in which they offset taxes on providers with increased Medicaid payments to those same providers. However, federal law provided for a "safe harbor" exception that allows a state to use hold-harmless arrangements when it collects taxes at a rate that does not exceed 6 percent of a provider's net revenues from treating patients.
Any tax revenues collected under hold-harmless arrangements that exceed 6 percent of providers' revenues are deducted from a state's total Medicaid expenditures before the federal government determines the amount of matching funds for that state.
This option consists of three alternatives, all of which would take effect in October 2023.
- Under the first alternative, the safe-harbor threshold would be lowered to 5 percent.
- Under the second alternative, the threshold would be lowered to 2.5 percent.
- Under the third alternative, the threshold would be eliminated; that is, states would no longer be allowed to collect revenues under hold-harmless arrangements.
Lowering or eliminating the safe-harbor threshold would reduce the amount of federal matching payments that were available to states on the basis of revenues collected from taxes on providers.
Effects on the Budget
The Congressional Budget Office and the staff of the Joint Committee on Taxation (JCT) estimate that capping the safe-harbor threshold at 5 percent (the first alternative) would reduce the deficit by $41 billion from 2024 to 2032 and that capping it at 2.5 percent (the second alternative) would reduce the deficit by $209 billion over that period. Eliminating the safe-harbor threshold (the third alternative) would reduce the deficit by $526 billion from 2024 to 2032. The estimated growth in savings over that period under all three alternatives reflects CBO's expectation that states' collections of tax revenues would increase at the rate of growth of overall health care spending for the types of providers that are typically taxed.
The large difference in savings generated by the three alternatives is a result of the distribution of taxes that states impose on providers. Those tax rates vary widely, from under 1 percent to the maximum allowable rate of 6 percent. Therefore, the lower the threshold, the greater the effects would be on tax revenues collected from providers. Lowering the threshold to 5 percent would eliminate the tax revenues collected above that rate, whereas lowering the threshold to 2.5 percent would go further and eliminate the revenues collected above that rate. Eliminating the threshold would affect all tax revenues collected from providers under hold-harmless arrangements. States that collected the most revenues as a share of their spending from such arrangements would be disproportionately affected.
The amount of savings generated by the option would depend significantly on the extent to which states chose to adjust their Medicaid programs in response to the lower thresholds. With less revenues from taxes on providers, states would face two choices: whether to spend the same amount on Medicaid using other state revenues or whether to cut Medicaid spending by the difference in revenues collected under the old and new thresholds. In the first case, states might replace lost revenues 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 revenues and instead cut their Medicaid spending by lowering payment rates to providers or by reducing optional medical services, which would reduce federal spending because the amounts matched by the federal government would be smaller.
CBO expects that different states would respond to a lower safe-harbor threshold in different ways. Most states would probably not replace all of the revenues lost as a result of implementing the lower threshold. The reason states would not replace all of the lost revenues is that the health care providers being taxed typically benefit directly 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 probably not attempt to replace the full amount of the lost revenues by cutting Medicaid spending because they would deem other choices to be preferable. For the purposes of these estimates, CBO anticipates that different states would choose their own mix of those approaches, and, on average, states would replace half of the lost revenues.
CBO therefore estimates that the gross savings from establishing caps on overall spending would be partially offset because of states' responses to the reduction in the safe-harbor threshold. CBO expects that some states would adopt the strategies described above, including discontinuing coverage for enrollees made eligible by the Affordable Care Act (ACA). In addition, some states that would have adopted such coverage in the future would no longer choose to do so. Among people who lost Medicaid coverage, some would gain access to subsidized health insurance coverage through the marketplaces established by the ACA, and the rest would enroll in other health insurance, principally through an employer, or become uninsured.
The magnitude of the offsets would be proportional to the amount of federal Medicaid savings—equal to about 12 percent or 13 percent of the gross savings. CBO and JCT estimate that, if the threshold was lowered to 5 percent, $46 billion in Medicaid savings would be offset from 2024 to 2032 by additional subsidies for employment-based coverage and for coverage obtained through the health insurance marketplaces. Those added subsidies would increase outlays by $4 billion and decrease revenues by $1 billion. If the threshold was lowered to 2.5 percent, CBO and JCT estimate, $239 billion in Medicaid savings would be offset by additional subsidies that would increase outlays by $24 billion and decrease revenues by $6 billion. If the threshold was eliminated, CBO and JCT estimate, Medicaid savings would total $605 billion and the offsets would total $79 billion, for a net federal savings of $526 billion.
Uncertainty About the Budgetary Effects
A large source of uncertainty in the estimates is how states would respond to the change in the safe-harbor threshold. The estimate that states would replace half of the lost revenues with other revenue sources or by reducing spending in other areas is highly uncertain. To the extent that the average response by the states would be to make larger cuts to Medicaid, the federal government's savings would be greater, and to the extent that the average response by the states was to make smaller cuts to Medicaid, the savings would be smaller.
In its distributional analysis, CBO allocates reductions in spending directly to the beneficiaries of that spending program. Most Medicaid enrollees' income is under 138 percent of the federal poverty guidelines, so the effects of reduced Medicaid spending would fall principally on households toward the bottom of the income distribution. (In 2022, the federal poverty guideline is $13,590 for single-person households in the 48 contiguous states and the District of Columbia and increases by $4,720 with each additional household member.)
Medicaid enrollees are not the only group that would be affected by a reduction in Medicaid spending. Medicaid payments from the federal and state governments go directly to health care providers, health care plans, and companies that sell prescription drugs. If, in response to lower tax revenues from providers, states reduced providers' payment rates, discontinued coverage for optional services, or covered fewer people, compensation throughout the health care industry would fall, affecting people across the income distribution, including some health care providers at the top of the distribution.
For the purposes of these estimates, CBO anticipates that, on average, states would replace half of the lost revenues; however, the agency does not project how individual states would respond to the change. To replace lost revenues, states could reduce spending in other areas, increase existing taxes, or introduce new taxes. Each of the potential responses would have its own specific distributional effects, and the net effect of the option would reflect the impact of reduced Medicaid spending and the consequences of those other changes.
In addition to having the behavioral effects reflected in conventional budget estimates, such as the ones shown above, a reduction in Medicaid spending could affect the labor supply and people's saving; those effects would apply both to enrollees and to employees in the health care industry. For enrollees, a reduction in Medicaid spending could lead to poorer health outcomes and thus reduce the number of able-bodied workers and their productivity. Because many enrollees are disabled, elderly, or children, and do not or cannot work, the decrease in the labor supply would most likely be small. But, for those who do work, a loss of benefits could increase the number of hours they work to compensate for the need to spend more of their own resources on health care. Whether the combination of those two effects would increase or decrease the total number of hours that enrollees work is uncertain, but the economywide effect on hours worked would probably be small.
A reduction in benefits that caused enrollees to increase their own medical spending could cause them to cut back on other types of consumption and on saving. Because lower-income households have lower saving rates, which can be zero or even negative, the effect on such households' finances could be consequential, possibly leading to a significant increase in medical debt and bankruptcies. Economywide, the effect on saving would probably be small.
Across the health care industry, the effect of Medicaid cuts would vary widely and would depend on each provider's mix of Medicaid patients and other types of patients. The labor supply of health care workers and the amount they save could be reduced because of a decrease in their income. That decrease in income would result if there was a drop in the demand for services or a reduction in Medicaid payment rates. Reductions in Medicaid eligibility and enrollment could also lead to increased enrollment in higher-paying private plans, increasing some health care workers' income, the number of hours they work, and the amount they save. Economywide, the net effect on hours worked and saving would probably be small.
As with distributional effects, CBO does not project how individual states would respond to the change and does not estimate the specific economic effects of each potential response. The net effect of the option would reflect the impact of reduced Medicaid spending and the consequences of those other changes.