CMS proposes tighter guardrails on Medicaid provider taxes funding state-directed payments

By Dave Muoio / May 13, 2025

The Centers for Medicare & Medicaid Services (CMS) proposed a rule Monday afternoon to “shut down [a] Medicaid loophole” related to states’ targeted taxes on privately run managed care organizations’ Medicaid businesses.

The CMS’ proposal acts on calls from conservative critics to reform so-called provider taxes, in which states collect funds from providers and, sometimes, MCOs that are matched anywhere from 50% to 77% by federal dollars.

The combined taxes and federal funds are then distributed by states back to providers under CMS-authorized payment arrangements aimed to incentivize specific areas of care—a setup that hospitals, particularly rural hospitals, often say is necessary to keep the lights on.

Federal law requires that states’ provider taxes are “uniform and broad based,” or implemented similarly across different entities and services. States may apply for a waiver of that requirement to impose a nonuniform tax, but such a bid must past a statistical test to ensure their proposal is generally distributive.

The CMS said its proposed rule aims to crack down on states that have received waivers that gamed the statistical test but “violate the spirit of the law” by allowing higher taxes on MCOs' Medicaid businesses.

“For example, in California MCO tax rates are set at $274 per member, per month (PMPM) for Medicaid while comparable commercial member months are taxed at $1.75 PMPM,” the agency wrote in a fact sheet.

Currently, the approach generates $23.6 billion in federally matched revenue to seven states per year, with California, Michigan, Massachusetts and New York responsible for more than 95% of the projected take-home, CMS said.

“CMS estimates that closing the loophole now, before any additional states adopt this scheme, if the rule is finalized as proposed, will save the federal government over $33 billion over the next five years,” the agency wrote in the fact sheet. “If just two more states adopted this model each year, CMS estimates that excess federal costs could balloon more than $74 billion over five years.”

The CMS said some states have also been directing increased federal funds raised through the disproportionate provider tax to finance “unrelated programs,” such as California’s expanded healthcare coverage for undocumented immigrants.

“States are gaming the system—creating complex tax schemes that shift their responsibility to invest in Medicaid and rob federal taxpayers,” CMS Administrator Mehmet Oz, M.D., said in a release. “This proposed rule stops the shell game and ensures federal Medicaid dollars go where they’re needed most—to pay for health care for vulnerable Americans who rely on this program, not to plug state budget holes or bankroll benefits for noncitizens.”

Alongside nixing the higher tax rates for Medicaid businesses through additional safeguards, the CMS said its proposed rule would prohibit “vague language to disguise Medicaid-specific taxes.”

It also outlines a one-year transition period for noncompliant states with approvals that are two or more years old at the time the final rule goes into effect.

Those with newer waiver approvals are not eligible for the transition period and “may be subject to deduction from medical assistance expenditures,” according to the proposed rule. “… To avoid a reduction in medical assistance expenditures before the calculation of FFP, the State must cease collecting revenue from the healthcare-related tax that does not meet the [updated requirements] immediately.” These states would also be required to submit a new waiver compliant with the CMS’ updated requirements. 

The timeline would impact waiver approvals submitted during the end of the Biden administration by California, Michigan, Massachusetts and New York, the CMS noted.

The agency’s proposed regulation comes as federal lawmakers consider provider taxes tweaks this week in the reconciliation megabill.

Text released this weekend by the House Energy and Commerce Committee for markup includes a moratorium on new or increased provider taxes among states as well as uniformity measures specifying the criteria to be considered “generally redistributive,” similar to the CMS’. It also capped state-directed payments at 100% of the Medicare payment rate for a comparable service.

The American Hospital Association, in a statement submitted ahead of the budget reconciliation text's markup, said it was "greatly concerned" about the bill's moratorium on new provider taxes, which appear to lock in the current amount of dollars and will diminish their ability to close the hospital funding gap over time. The hospital lobby also said that changes to the waiver of uniform tax requirement, the portion similar to CMS' proposed rule, "will undermine state Medicaid financing arrangements and could have implications for coverage disruption."

A crackdown on states’ provider taxes has been a go-to request for budget-minded federal officials as well as conservative policy groups like the Committee for a Responsible Federal Budget and the Paragon Health Institute.

A March report from Paragon, for instance, referred to the increased tax rates on MCOs as “particularly nefarious.” The group has also called for additional changes to provider taxes such as a reduction of the 6% “safe harbor” limit—an upper cap that determines what percentage of a hospital’s income states may tax—though that suggestion has yet to surface in recent policymaking.

Other groups including independent advisors and government watchdogs have more broadly called for greater transparency into state-directed payment arrangements, which was also among the goals of a rule finalized last year under the Biden administration.

Most states have long had provider taxes in place. According to KFF, there are currently 45 states with these in place for hospitals, 46 for nursing facilities, 20 for managed care organizations, 17 for ambulance providers and 11 for other types of providers.

ATI Advisory Director Morgan Craven told Fierce Healthcare the CMS’ proposed rule  would have “significant implications” and should prompt new planning for states, providers and plans alike.

"While there’s long been debate about these tools, the reality is they’re longstanding and widely used," she said. "Providers and plans may experience shifts in funding flows and reimbursement levels, and states will need to revisit their financing strategies within tight budget constraints while maintaining access and market stability. 

"Stakeholders should be thinking now about the operational, budget, and policy changes that could be needed if the rule is finalized—especially in states where these financing structures are deeply embedded. A clear glide path will be critical to support sustainable transitions."

The CMS will be accepting public comment on the proposed rule until July 14.