What This Paper Covers

It is rare for taxpayers to lobby the government to take their money, but it is a common feature of the Medicaid program today. In what is best described as legalized “money laundering,” health care providers send money to states through a tax “scam” (former President Biden’s description), states use those funds to grow Medicaid spending using federal matching dollars, and providers (those original taxpayers) benefit from higher payments for services they provide to Medicaid recipients. States support these financing schemes, as they enable them to obtain federal funds without any actual state contribution—and they repurpose these funds for additional Medicaid spending, other state spending, or tax cuts.

Though Medicaid was intended to provide health care for the truly needy, the federal government provides an open-ended federal reimbursement of real state expenditures but also artificial state expenditures. As a result, states, insurers, and providers have used Medicaid to siphon hundreds of billions of dollars from federal taxpayers over the past decade and raise payments well above what can be considered “economical or efficient,” as federal law requires.

This paper reveals how this money laundering dilutes the purpose of Medicaid, raises health care costs for those with commercial insurance, and escalates the financial burden on federal taxpayers. As Congress debates Medicaid reform, we provide policymakers with a menu of options to refocus Medicaid on efficient health care and improved patient outcomes, enhance program integrity, and rebalance the state and federal share of costs.

What We Found and Why It Matters

Over the past 15 years, no area of federal spending has grown in percentage terms faster than Medicaid. With the proliferation of Medicaid money laundering tactics, there has been a substantial shift in costs from the states to the federal government over this period. For decades, government watchdogs—particularly the Government Accountability Office—have raised serious concerns about a lack of transparency and inappropriate cost shifting to the federal government that result from these money laundering tactics. Not only have these warnings been ignored by Congress, but a series of legislative and executive actions have made the problem worse.

The enhanced federal reimbursement rate for the expansion population under the Affordable Care Act (ACA) amplifies money laundering. Under the ACA’s 90 percent federal reimbursement percentage, $100 of financing gimmicks yields $900 in federal funds for the state. Under the average state’s 60 percent federal reimbursement for traditional Medicaid recipients, $100 of financing gimmicks yields $150 in federal funds for the state. Money laundering for spending on the expansion population thus has a rate of return six times higher for the average state—and more so for wealthier states that receive lower federal reimbursements for traditional recipients.

Thus, states have large incentives to develop money laundering schemes in conjunction with payment policies to shift more expenditures to the expansion category, including by neglecting proper eligibility reviews prior to enrolling people under the ACA expansion. Accounting for the growth in state money laundering and the enhanced federal reimbursement for the ACA expansion, the federal share of Medicaid has increased from about 60 percent in fiscal year (FY) 1991 to about 75 percent in FY2023.

These financing schemes have been around since the mid-1980s. They started with provider taxes or donation programs, primarily through hospitals and nursing homes. States collect funds from providers, then return those funds in the form of additional Medicaid spending. These expenditures garner federal matching funds, which are subsequently paid to providers through state directed payments (SDPs) and supplemental payments, with states often keeping a portion of this additional money for other purposes. SDPs are payments that states direct insurers to make to providers.

When Congress made those schemes somewhat more difficult in the early 1990s, states turned to intergovernmental transfers (IGTs) to finance the state share of Medicaid. Through an IGT, a local government or government-owned provider transfers money to the state that the state then uses to make much higher Medicaid payments on providers, which are often the very same providers that make the IGT. IGTs raise significant conflict of interest concerns and result in government-owned providers receiving favorable treatment over private providers.

States have expanded their use of provider taxes and IGTs in recent years. The newest money laundering tactic are taxes on insurance companies that participate in Medicaid managed care. This scheme is particularly nefarious because it always results in additional revenue for the state’s general fund. California has used a recent Medicaid tax on insurers to have the federal government fully fund Medicaid expansion for illegal immigrants and for the state to lift the asset test for Medicaid long-term care so wealthy heirs can fully protect their inheritances, with taxpayers picking up the cost.

The providers, with schemes often developed by consultants, lobby the states to engage in this legalized money laundering apparatus. Historically, states made additional supplemental payments to providers, and they are still a significant component of Medicaid, particularly through the IGT mechanism. As states have largely transitioned Medicaid from fee-for-service to managed care, states are requiring insurers to make extra payments to providers through SDPs.

The growth of Medicaid money laundering has shifted a significant portion of the financial responsibility for Medicaid away from the states and to the federal government. In the case of SDP programs, states used these schemes to shift financing costs to the federal government by an additional 14 percentage points.

States’ reduced financial share means that states are now setting very high Medicaid payment rates for certain providers. In some states, these rates are approaching average commercial rates—rates that are more than 2.5 times above Medicare rates. Linking Medicaid payments to average commercial rates encourages providers and insurers to raise commercial prices, costing hard-working American families in reduced wages as well as higher taxes. Moreover, higher Medicaid rates relative to Medicare rates will produce incentives for providers to favor Medicaid recipients over Medicare recipients and could threaten seniors’ access to care.

SDPs exceeded $110 billion in 2024—more than double the amount from just two years earlier. These are on top of supplemental payments that exceeded $57 billion in 2023. Both provider taxes and SDPs soared in 2024, as provider taxes fuel the legalized money laundering that permits states to substantially increase SDPs. These schemes are projected to show dramatic, increasingly unsustainable growth as more states likely opt to pay commercial-level rates in a welfare program.

Flush with federal funds, states have little at stake as they expand Medicaid. Many hospital systems are making windfall profits through the Medicaid program now because of the growth in supplemental payments and SDPs, as is the case in North Carolina, where the Biden administration approved a state plan to raise hospital Medicaid payments to average commercial rates if they agreed to relieve their bad debt. Universal Health Services saw a windfall profit increase from an expanded SDP program. Other states, such as New York, use these gimmicks to plug large holes in their budgets. Not only do these programs sidestep the truly needy on Medicaid and favor special interests instead, but all this is financed by growing the federal debt, leading to inflation and higher interest rates for all Americans.

What We Recommend

Considering a new Congress and the Trump administration’s intent on cutting waste, fraud, and abuse throughout government, there is a real opportunity for federal policymakers to address and limit Medicaid money laundering. Addressing this issue has been bipartisan in the past. Presidents Bush, Obama, and Trump all pushed to rein in Medicaid financing gimmicks. And in 2011, then-Vice President Biden described Medicaid provider taxes as a “scam” that should be eliminated. Many liberal commentators agreed—even the Washington Post editorial board strongly supported an Obama proposal to reduce states’ ability to use provider taxes.

Among the menu of options for policymakers to pursue, we recommend the following:

• Block grants: The most effective way to promote efficiency and end money laundering is to cap the amount of Medicaid funding states receive from Washington.
• Eliminate provider taxes: Congress should ban the use of provider taxes to finance the state share of Medicaid costs. Of all the provider taxes, the most nefarious is the insurer tax, so Congress should prioritize eliminating states’ ability to fund their portions of Medicaid costs with this tax.
• Reduce the 6 percent provider tax safe harbor threshold: At a minimum, Congress should adopt the Obama administration’s recommendation to reduce the safe harbor threshold to 3.5 percent.
• Eliminate SDPs entirely or, at a minimum, cap them so that the total payment to providers cannot exceed Medicare rates.

Address the IGT scams by prohibiting states from paying government providers more than private providers for delivering the same services.

Medicaid is a joint federal-state program in which the federal government provides an open-ended reimbursement of state Medicaid expenditures. As a direct result, states get more federal money when they spend more on Medicaid. A commonly held view, albeit a mistaken one, is that states must make real expenditures to claim federal funds. But the federal government permits states to develop financing schemes that generate federal Medicaid matching funds without underlying state expenditures. In other words, states deploy what amounts to legalized money laundering practices to collect more federal funds to support the growing price tag of Medicaid at no real cost to themselves

These financing schemes are often developed by health care providers, which benefit from these larger Medicaid payments, and the consultants whom the providers (and occasionally the states) hire. In essence, providers and states coordinate to create financing schemes that deliver higher payments, financed largely or entirely by the federal government, to politically powerful providers in the state.

The implications of state Medicaid maximization schemes include financial inefficiencies and diversion of federal resources away from Medicaid’s core purpose of financing health care and long-term care services for low-income individuals. In many cases, Medicaid payments to providers far surpass the actual cost of services delivered to Medicaid enrollees, with surplus funds being redirected to unrelated projects. According to the Government Accountability Office (GAO), these projects include the construction of new patient facilities or the purchase of non-health-care-related assets.¹ The funds can also be directed to non-health-care services to support general state revenue or for states to lower state-level taxes.

GAO found that states have “maximized federal matching funds by making large payments—significantly above providers’ costs of providing services—to providers that were financing the nonfederal share.”² In 2013, the House Committee on Oversight and Government Reform issued a bipartisan report of problems within Medicaid, noting:

CMS [the Center for Medicare and Medicaid Services] has struggled historically in protecting Federal tax dollars from being misspent through Medicaid. CMS has been hampered by poor data quality, but the agency has historically failed to often adequately detect and address major problems in state Medicaid programs. A Committee majority staff report from April 2012 detailed several examples of how CMS has failed to protect taxpayer dollars spent through the Medicaid program. Moreover, as GAO has widely reported, states have resorted to creative techniques such as provider taxes and large supplemental payments to draw down additional Federal dollars into their states through the Medicaid program without net State contributions. These techniques undermine the nature of joint Federal-state financial responsibility for the Medicaid program by significantly increasing the Federal share of Medicaid expenditures and further undermining State incentives to run efficient Medicaid programs.³

States with fee-for-service (FFS) Medicaid programs make these payments—dubbed supplemental payments—directly to health care providers. As states have transitioned their Medicaid programs to managed care, payments funded by state financing gimmicks have increasingly taken the form of so-called state directed payments (SDPs). SDPs are payments that states tell insurers to make to providers through Medicaid.

The Medicaid money laundering scheme is illustrated in Figure 1.

The entire financing structure is akin to money laundering and puts federal taxpayers at significant risk while weakening the joint federal-state responsibility underpinning Medicaid. The structure also leads to lower value spending in the program as states make decisions designed to pass most of the cost, if not the complete cost, to federal taxpayers. Due to a much higher federal reimbursement rate for the Affordable Care Act (ACA) Medicaid able-bodied, working-age expansion enrollees and increasing state financing gimmicks, there has been a large shift in costs for financing the Medicaid program from states to the federal government over the past decade plus.

Historically, the federal government bore about 57 percent of the costs of the Medicaid program. On paper, that percentage is now 67 percent. But after fully accounting for the financing schemes that result in artificial state expenditures, that percentage is now approaching 75 percent. And as states bear a smaller fraction of the total cost of the program, they are far less sensitive to cost increases and less likely to ensure that expenditures through Medicaid provide requisite benefit to justify the cost.

The ACA exacerbates money laundering because it allows states to obtain much more federal money per dollar of state expenditures, whether a real or artificial state expenditure. Under the ACA’s 90 percent federal reimbursement percentage, $100 of financing gimmicks yields $900 in federal funds for the state. Under the normal 60 percent federal reimbursement, $100 of financing gimmicks yields $150 in federal funds for the state. Thus, states have incentives to develop money laundering schemes in conjunction with payment policies to transition more expenditures to the expansion category, including by neglecting proper eligibility reviews prior to enrolling people under the expansion.⁴

The rise in supplemental payments and SDPs is a natural outgrowth of the money laundering financing mechanism and a feature of Medicaid that states and the politically powerful health care industry within them will aggressively lobby to protect. But, in a time of massively large and rising federal deficits, as well as disappointing program results, serious, reform-minded policymakers should consider changes to the perverse status quo Medicaid funding structure that breeds waste and corruption. The large-scale Medicaid money laundering apparatus would not be a feature of an efficient and effective government. In order for the overall program to improve and provide Americans—both Medicaid enrollees and taxpayers—with greater value, the federal share of Medicaid needs to decline, and politically powerful providers need to receive less in federal Medicaid funding.

Historically, the federal government bore about 57 percent of the costs of the Medicaid program. On paper, that percentage is now 67 percent. But after fully accounting for the financing schemes that result in artificial state expenditures, that percentage is now approaching 75 percent. And as states bear a smaller fraction of the total cost of the program, they are far less sensitive to cost increases and less likely to ensure that expenditures through Medicaid provide requisite benefit to justify the cost.

The ACA exacerbates money laundering because it allows states to obtain much more federal money per dollar of state expenditures, whether a real or artificial state expenditure. Under the ACA’s 90 percent federal reimbursement percentage, $100 of financing gimmicks yields $900 in federal funds for the state. Under the normal 60 percent federal reimbursement, $100 of financing gimmicks yields $150 in federal funds for the state. Thus, states have incentives to develop money laundering schemes in conjunction with payment policies to transition more expenditures to the expansion category, including by neglecting proper eligibility reviews prior to enrolling people under the expansion.

The rise in supplemental payments and SDPs is a natural outgrowth of the money laundering financing mechanism and a feature of Medicaid that states and the politically powerful health care industry within them will aggressively lobby to protect. But, in a time of massively large and rising federal deficits, as well as disappointing program results, serious, reform-minded policymakers should consider changes to the perverse status quo Medicaid funding structure that breeds waste and corruption. The large-scale Medicaid money laundering apparatus would not be a feature of an efficient and effective government. In order for the overall program to improve and provide Americans—both Medicaid enrollees and taxpayers—with greater value, the federal share of Medicaid needs to decline, and politically powerful providers need to receive less in federal Medicaid funding.

The most common Medicaid financing schemes are provider taxes and IGTs. By leveraging the provider tax and IGT mechanisms, states can substantially boost federal reimbursements above the levels established by the federal medical assistance percentage (FMAP), which is commonly viewed to represent the federal share of a state’s Medicaid expenditures.⁵

Provider taxes are state assessments on providers, which are typically accompanied by increased Medicaid payments to those same providers. States use the revenue from provider taxes to claim additional federal reimbursement. They then return the providers’ assessments plus some additional amounts to those providers through Medicaid payments. There is a complicated set of federal rules that govern provider taxes (more on these below). Serious questions have arisen about the transparency of the money flow and the appropriateness—and occasionally the legality—of these provider tax arrangements.

State politicians recognize the political benefits inherent to this money laundering scheme. Oregon State Representative Mitch Greenlick has referred to provider taxes as a “dream tax” for states: “We 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.”⁶

Despite the name, provider taxes are not really taxes. Entities normally avoid taxes and seek to minimize their tax burdens. Such is not the case with the entities subject to provider taxes. They often help develop the tax schemes and then lobby the government to assess them. In many cases, they lobby the government to increase existing ones. GAO found that hospital associations and nursing home associations have worked with states to design the tax structures. The associations’ officials indicated that without the tax revenue, states would likely reduce Medicaid payments and that states typically provide assurances that tax revenue will be used for Medicaid payments that will make the providers better off financially.⁷

States have political incentives to finance substantial portions of their Medicaid programs with accounting gimmicks, because these permit them to reduce the actual amount financed from the state’s tax base. Provider taxes have significantly expanded over the past few decades, and as Figure 2 demonstrates, they increase overall Medicaid spending by making states less sensitive to the costs of the program.

Figure 2 shows the economics of provider taxes, displaying their impact on the federal government, states, and providers. It assumes a state with a 60 percent FMAP. The following discussion and figure are from Brian Blase’s (the lead author on this paper) 2016 paper on Medicaid provider taxes.

In the scenario without a provider tax, a state spends $100 on a provider and receives $60 from the federal government, so the net cost to the state tax base amounts to $40.

The second scenario shows how a provider tax shifts costs to the federal government, assuming states maintain the same level of spending as in the first scenario. The state taxes the provider $100 and then pays the provider $200. Assuming negligible transaction costs, the provider is essentially as well off as in the scenario without a provider tax. The federal government is worse off because it is now reimbursing the state $120 (60 percent of the $200 expenditure). The state gains $20 through these three transactions (receiving $100 in provider tax revenue and $120 reimbursement through the FMAP less $200 in expenditure to the provider). But the state is actually better off by $60 because it was paying $40, on net, to the provider in the absence of the tax.

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—even though the revenue is generally illusory—can be used as the state share of spending. Scenario 3 in the figure shows how provider taxes work if the provider tax mechanism generates an additional $50 for the provider. The provider’s net gain is $150, equal to the $250 state payment minus the $100 paid through the provider tax. The federal government reimburses the state $150 (60 percent of $250), and the state’s net payments sum to zero ($100 in provider tax revenue and $150 reimbursement through the FMAP less $250 for the provider payment).

Comparing scenario 1 (no provider tax) with scenario 3 (provider tax with higher spending) shows that providers are better off from higher payments and the state is better off because of the higher federal reimbursement. The federal government, however, is worse off because it has to reimburse additional state Medicaid expenditures. Although provider taxes increase the federal share of Medicaid spending relative to the state share, the more that the state’s Medicaid expenditures increase as a result of provider taxes, the greater the burden on both the federal and state tax base. It is worth noting that there are two effects on the state tax base financing burden: The provider tax shifts part of the previous burden to the federal tax base but the state bears its share of the financing burden for the marginal increase in Medicaid spending that results from the provider tax reducing the relative cost of Medicaid to the state.

States started using provider taxes and provider donations in the mid-1980s. By the early 1990s, most states had provider taxes or provider donation programs in place. The Congressional Research Service (CRS) notes that “provider taxes were often imposed only on Medicaid providers. These provider tax arrangements were agreed to (and sometimes initiated) by the Medicaid providers because the Medicaid providers could be held harmless from the cost of the tax through increased Medicaid payment rates.”⁸ In a 2016 paper on provider taxes and how Congress tried to address them, Blase wrote:

In response to the increased use of provider taxes and related techniques, Congress passed and President Bush signed the Medicaid Voluntary Contribution and Provider-Specific Tax Amendments (MVCPSTA) in 1991. The MVCPSTA outlawed the use of most provider donations and made provider taxes more costly for health care providers who treated few, if any, Medicaid enrollees.

The MVCPSTA required that provider taxes be uniform (the same tax rate across all providers in a given class) and broad based (the tax would apply to all providers in one of the 19 specified classes of providers subject to the tax, even those who do not provide Medicaid services). The MVCPSTA also attempted to limit the extent to which providers could be held harmless by the tax—providers who receive at least as much money back from the state in higher Medicaid payments as they had paid in tax. In addition to being complex, the rules governing provider taxes are also somewhat arbitrary. For example, the secretary of the Department of Health and Human Services (HHS) may waive the broad-based and uniform requirements if the tax is “generally redistributive” and the amount of the tax is not directly correlated to Medicaid payments (although there is an exception for rural and sole community providers). States commonly apply for these waivers.

Three tests exist to determine whether a provider tax satisfies the “hold harmless” criteria. The key test—the guarantee test—only applies if the tax rate exceeds 6 percent of net patient revenue. The 6 percent threshold is generally referred to as the “safe harbor” provision [2 C.F.R. 433.68(f)(3)(i)(A)]. While states can have provider tax rates that exceed the safe harbor threshold, neither the CRS nor GAO have identified any state that imposes a tax rate exceeding 6 percent of net patient service revenue.⁹

The rules put in place by the 1991 legislation succeeded in reducing states’ use of provider taxes for a time. But in 2008, there was a sharp increase in provider taxes as many states faced much lower state revenue because of the financial crisis and deep recession. The number of states with any provider tax rose from 40 to 49 between 2007 and 2015, with 21 states adding hospital taxes and 14 states adding nursing home taxes during this period.¹⁰ Moreover, many states with existing provider taxes increased the size of them during this period.

Figure 3 demonstrates the increase in provider taxes after state fiscal year (SFY) 2004 and shows the number of states with any provider tax, an inpatient hospital tax, an intermediate care facility tax, and a nursing home tax. Use of provider taxes exploded over the past two decades. According to CRS, 39 states had three or more provider taxes in SFY 2024, and 42 states are estimated to have three or more provider taxes in SFY 2025.¹¹

While states must finance at least 40 percent of their share of Medicaid payments from state funds, which can include general funds and state provider tax revenue, up to 60 percent of the state share may be sourced from local government revenue through IGTs or local provider taxes.¹² In SFY 2024, states reported that about one-third of the state share of Medicaid came from sources outside of general revenue.¹³ Older reports suggest that approximately 88 percent of these revenues from outside general revenue come from provider taxes and IGTs.¹⁴ In essence, for every $2 of actual state revenue, $1 represents funding collected for money laundering.

During the cooling of provider tax use in the 1990s, IGTs were increasingly used to finance the nonfederal or state share of new, often exceptionally high Medicaid supplemental payments made for the benefit of specific publicly owned hospitals, health systems, physician groups, and nursing homes. In a blatant conflict of interest transaction, the local governments, public universities, or medical schools that own these public providers transfer the IGT funds to the state.

Through a supplemental payment mechanism, the state Medicaid agency pays the public providers a sum equal to the IGT funds and the corresponding federal matching funds. The supplemental payments are added on top of the public provider’s base or regular Medicaid rates, often bringing the total Medicaid rates to amounts paid by Medicare rates or higher. Meanwhile, the nonfederal share of public providers’ underlying base Medicaid rates is often financed using proceeds from provider taxes. One financing scheme compounds another, further undermining the fiscal integrity of Medicaid, rewarding irresponsible payment policy, and artificially increasing the burden on federal taxpayers.

Under IGT arrangements, federal taxpayers incur the full cost of increased Medicaid payments. Public providers owned or operated by the public entities supplying the IGT funds are the sole beneficiaries of the resulting supplemental payments. For every $1 in IGT funds transferred to the state, the locally or state-owned public providers receive at least $2 and as much as $4 in return, depending on the state’s FMAP, thereby generating a net 100 percent to 400 percent profit from the transaction.

IGT arrangements do not cost the state, as it is just an intermediary in the transaction. To facilitate favorable action and minimize a state’s administrative burden, local entities, universities, or public providers often retain consultants to do the necessary paperwork and modeling to secure federal approval and optimize and implement the supplemental payments.

States secure a political benefit from the IGT mechanism, with less budget pressure to subsidize politically influential counties, cities, universities, academic physicians, and public providers. Further, because public providers—such as county hospitals and university health systems—are commonly high-volume Medicaid providers, federal and IGT-financed supplemental payments can help mitigate demands for statewide provider rate increases that would require a real contribution from the state treasury.

In 2003, the Health and Hospital Corporation (HHC) of Marion County, Indiana, devised a creative and highly lucrative IGT scheme that has netted billions of dollars in federal funding well in excess of regular Medicaid rates.¹⁵ HHC acquired the bed licenses of numerous skilled nursing facilities (SNFs) throughout the state and leased management back to facility operators or new management companies. For federal payment purposes, this transformed the status of each facility from a privately owned or operated SNF to a non-state-government-owned or operated SNF.

Under a supplemental payment policy in the Indiana Medicaid state plan (approved by CMS), SNFs technically owned or operated by HHC are reimbursed for Medicaid patients based on the Medicare daily rate, which is substantially higher than the state’s Medicaid rate.¹⁶ HHC makes an IGT to the state Medicaid agency to finance the nonfederal share—about 35 percent in Indiana—of the supplemental payments. Federal matching funds cover the other 65 percent of the cost to bring the HHC-affiliated SNF Medicaid payments to the maximum Medicare rate level.

At no additional cost to the state, HHC, as the city-county owner or operator of record, nets 65 percent of the supplemental payments. HHC was able to use the massive annual windfall to build a new public hospital and medical complex and other local health priorities entirely unrelated to the needs of nursing homes or frail, low-income elderly across Indiana.¹⁷ The IGT-financed supplemental payments originally devised for HHC have generated interest from other public hospital systems throughout the country.

IGTs often result in substantially higher Medicaid payment rates for government-owned facilities. According to a 2001 HHS rule to address this problem with IGTs, “The federal government matched these higher payment rates to public facilities. Because these facilities are public entities, funds to cover the state share were transferred from those facilities (or the government units that operate them) to the state, thus generating increased federal funding with no net increase in state expenditures.”¹⁸

According to a 2014 GAO report, New York State used IGTs to transfer additional Medicaid costs to the federal government.¹⁹ In SFY 2009, the state decreased regular Medicaid payment rates and increased supplemental payments for inpatient hospital services. IGTs from two local government-owned hospitals helped finance the higher supplemental payments, and as a result, total Medicaid payments for inpatient services to the two hospitals increased by $157 million, and provider payments net of the IGTs increased by $119 million between SFY 2008 and SFY 2009. While no state general funds were used to finance the supplemental payments in SFY 2008 or SFY 2009, the amount of state general funds used for regular Medicaid payments did not change as the federal government picked up the entire cost increase of the scheme.

A 2012 House Oversight and Government Reform Committee investigation found that New York’s state-run developmental centers had become a cash cow for the state, exploiting a deeply flawed Medicaid reimbursement formula to secure excessive federal funds. While private providers offering the same services were reimbursed at significantly lower rates, the state-run centers charged Medicaid over $5,000 per resident per day, generating billions in unjustified payments over a decade. The committee’s report and other analyses highlighted how New York officials were aware of the windfall but failed to correct it, while federal oversight agencies also dragged their feet despite acknowledging the problem.²⁰ The result was an estimated $15 billion in improper federal Medicaid payments before CMS finally took action, negotiating a deal to phase out the excessive payments and bring reimbursement rates closer to actual costs.

States may also impose special taxes on managed care organizations (MCOs). While taxes on MCOs have some similarities with other provider taxes, they are especially ripe for abuse. There are 22 states with MCO taxes for FY2025—a significant increase from the 12 states that had such taxes in FY2018.²¹ MCO taxes are typically used in addition to existing provider taxes.

A 2016 Obama administration Medicaid managed care rule mandates that state Medicaid capitation rates must compensate MCOs for the cost of state taxes, which guarantees that Medicaid MCOs are held financially harmless from the tax.²² Unlike other types of provider tax schemes, where all of the tax revenues are spent as the state share of federally matched provider rate increases or eligibility expansions, only a portion of MCO tax revenues are necessary to cover the state share of paying Medicaid MCOs back. The bulk of the original tax revenues received from Medicaid MCOs—an amount equal to the federal share of repaying Medicaid MCOs for the tax—remains in the state treasury, available for any use, including the state match for any Medicaid expenditures.

Like provider taxes, MCO taxes are supposed to be broad-based, uniform, and devoid of “hold-harmless” provisions.²³ In principle, this should mean that states must apply the same rate to all MCOs—including commercial insurers that would not benefit from the higher Medicaid payments these taxes finance. Because a broad-based and uniform MCO tax would create losers, states try to minimize the applicability of these taxes on non-Medicaid providers.

Two federal policies make MCO taxes politically easier to enact by effectively exempting non-Medicaid insurers that would otherwise always lose under a state tax. First, federal preemption law exempts Medicare Advantage plans from state provider taxes. Second, under current federal rules, states are often able to meet the statistical tests necessary to exempt commercial health insurers from an MCO. States can apply to waive the uniform and broad-based requirements for commercial insurers, thereby eliminating the possibility of losers among insurance companies. When states apply for the waiver, they must prove that their taxes would be “generally redistributive,” meaning payments must be reasonably funded by non-Medicaid providers.²⁴

In concept, this would structurally prohibit any implied hold-harmless arrangements between the state and the MCOs. In practice, as demonstrated by CMS’s 2023 approval of a California MCO tax, these rules are not effective at guarding against corrupt arrangements.²⁵ The agency approved the Golden State’s new financing scheme even though it acknowledged that “this tax program fails to be ‘generally redistributive’ in nature.”²⁶ CMS noted in a companion letter that it intended to revise the test outlined in regulations to prevent such obviously non-redistributive financing schemes from receiving approval in the future.²⁷

California’s MCO tax applies only to a narrow group of companies, chosen likely for political purposes, with between 208,000 and 333,000 annualized enrollees.²⁸ By applying to only a handful of non-Medicaid MCO providers, the tax is not broad-based, nor is it uniform. The state taxes Medicaid MCO providers 104 times the rate set for private providers—$182.50 for Medicaid MCOs per member-month compared to $1.75 for private insurers per member-month.

The loophole in existing regulations allows California Medicaid MCOs to contribute more than 99 percent of the $8.4 billion total tax revenue in 2025 and then receive this funding back through the federal match.²⁹ This scheme allows the Golden State to collect a projected $19.4 billion over the four-year life of the tax with no commensurate increase in state funding.³⁰ California has used the additional funding to have the federal government fully finance Medicaid for illegal immigrants and to remove the state’s asset test for Medicaid so the wealthiest residents can have taxpayers pay for their long-term care services.³¹

Despite CMS noting its intent to close this loophole, other states have since replicated the California model. New York, for example, received CMS approval at the end of the Biden administration to leverage this financing gimmick to address its budget shortfall with the new stream of federal revenue.³² One policy institute in New York estimated that the Empire State could raise $4 billion in federal Medicaid funds annually with no increase in revenue from the state using this California-modeled MCO tax.³³ CMS also approved an enhanced MCO tax in Michigan before President Biden left office.³⁴ Until the federal government changes the rules, abuse of MCO taxes will continue, because so much revenue is on the line for states, which naturally wish to pass these costs to taxpayers outside their borders.

Certified public expenditures (CPEs) are a Medicaid financing gimmick used by states to claim federal reimbursement for services provided. CPEs are expenditures that public entities have incurred and paid for using nonfederal funds. These expenditures must be certified by an authorized official as costs related to providing eligible services. While intended to leverage federal matching funds, this practice frequently serves as a gimmick to inflate costs and prop up inefficient public providers. This kind of spending makes up a very small proportion of the nonfederal share of Medicaid spending. The most recent estimates are that CPEs made up $4 billion, or about 2 percent of all nonfederal Medicaid spending, in SFY 2018.³⁵

Entities that may use CPEs include state and local governments, public hospitals and health care facilities, public school districts (for Medicaid-covered services provided in schools), and public universities and academic medical centers. The self-certification process, however, invites abuse, allowing states to claim overhead, unrelated expenses, or questionable costs as “legitimate,” particularly where oversight is weak. This distorts the Medicaid program’s intent and disadvantages private providers, which must compete without similar windfalls from federal funds.

The process of claiming CPEs starts with the public entity incurring costs associated with providing Medicaid services. An authorized representative certifies that these costs were paid with nonfederal funds and submits the claim to the state Medicaid agency. The agency then requests federal reimbursement based on the state’s FMAP. Upon approval, federal matching funds flow back to the state. This system incentivizes states to prioritize revenue generation over cost efficiency, undermining Medicaid’s core mission of serving vulnerable populations.

The complexity of the regulatory requirements and the incentives of states and providers to maximize federal funds presents challenges. Self-certification allows for potential abuse, particularly in states with lax oversight. Funds from CPEs can provide disproportionate advantage to public providers that may be less efficient than private providers. A 2021 HHS OIG audit of Tennessee’s Medicaid CPE claims found that the state had improperly certified hundreds of millions of dollars due to inadequate documentation, demonstrating how self-certification without stringent oversight can lead to abuse.³⁶

A main reason for the various Medicaid money laundering schemes is so states can make larger payments to providers, often through supplemental payments. A Medicaid supplemental payment is a lump sum payment to a health care provider. These payments are made in addition to Medicaid payments for specific health care services that have been rendered. Hospitals are the main recipients of supplemental payments. Excluding payments made under managed care arrangements, supplemental payments represented 53.0 percent of total Medicaid payments to inpatient and outpatient hospitals in FY2023, up from 40.9 percent in FY2011.³⁷

But hospitals are not the only beneficiaries. Supplemental payments to mental health facilities represented 46.2 percent of total Medicaid payments outside of managed care arrangements in FY2013, up from 45.7 percent in FY2011. Supplemental payments to nursing facilities and intermediate care facilities for individuals with intellectual disabilities outside of managed care arrangements totaled 5.6 percent of total Medicaid payments in FY2023, up from 2.4 percent in FY2011. Supplemental payments to physicians and other practitioners outside of managed care arrangements represented 21.7 percent of total Medicaid payments in FY2023, up from 7.3 percent in FY2011.³⁸ As of FY2023, the total amount of supplemental payments surpassed $57.1 billion.³⁹

The main types of supplemental payments are upper payment limits, disproportionate share hospital payments, uncompensated care pools, and graduate medical education.

• Upper payment limit (UPL) payments are supplemental payments that enable total Medicaid payments up to a certain limit, as displayed in Figure 4. These payments are limited to the estimated aggregate amount that would have been paid to a provider class for the same service under Medicare payment rules. In some instances, CMS uses an UPL of average commercial rates (ACRs) for “qualified practitioners” (physicians, physician assistants, nurse practitioners, and other non-physician professionals affiliated with academic medical centers and medical schools).⁴⁰ These apply only to FFS payments. By setting the aggregate amount at the provider class, the UPL permits states to deliver excessive payments to some providers in the class. In FY2022, the federal government spent $15.8 billion in UPL payments.⁴¹
• Disproportionate share hospital (DSH) payments are supplemental payments to hospitals treating large numbers of low-income and uninsured patients. DSH allotments, unlike Medicaid funding, are capped. Each state receives an annual DSH allotment. Previous Paragon research highlighted that the DSH program fails to equitably target public resources to safety net hospitals or fairly distribute federal funds across states.⁴² The main reason for the inequity is that, in response to substantial growth in payments, Congress locked state DSH allocations in place in 1993. This rewarded states that had developed the most profligate DSH programs at that time.⁴³ All states except Tennessee receive Medicaid DSH allotments based on the previous year’s allotment increased by the consumer price index for all urban consumers (CPI-U).⁴⁴ The ACA reduced DSH payments, even though it expanded federal subsidies in many other ways. Yet Congress has consistently prevented these cuts from taking effect. This type of supplemental payment constituted $14.9 billion in spending in FY2022.⁴⁵
• Some state Medicaid agencies operate uncompensated care pools (UCPs) under Section 1115 waivers. The purpose of UCPs is to pay providers for uncompensated care costs. Despite their $10.0 billion contribution to Medicaid spending in FY2022, there has been little oversight of these payments.⁴⁶
• For graduate medical education funding, Medicaid makes payments to teaching hospitals to support the training of medical school graduates. The total funding in FY2022 was $4.9 billion.⁴⁷
• Delivery system reform incentive payments (DSRIP) is a less common program that operates under Section 1115 waivers. While the purpose of the program is to “incentivize system reforms” from providers, in practice it is used as another way to steer additional funding to managed care systems.⁴⁸ This program constituted roughly $200 million in spending in FY2022.⁴⁹

The growth in supplemental payments is driven in part by the large share of federal funds directed toward supplemental payments. Supplemental payments, particularly those financed by IGTs, are often made based on political influence of the provider rather than on efficient delivery of care or an individual facility’s financial need for such funds. Supplemental payments are also not distributed equitably across states or within states. GAO conducted numerous studies on the problems with supplemental payments and uncovered a host of problems, most notably inappropriate funding for providers and a lack of data transparency.⁵⁰

GAO found that supplemental payments totaled more than $43 billion in FY2011—nearly double the amount from FY2006.⁵¹ Figure 5 shows the change in supplemental payments between FY2011 and FY2023. The overall level of supplemental payments, which are outside of managed care arrangements, has risen, while the percentage of Medicaid expenditures through FFS payments has significantly decreased.

Overall, hospitals receive most supplemental payments. In fact, the hospital inpatient and outpatient services garnered 84 percent of the total supplemental payment spending in 2023, amounting to $47.8 billion. The hospital share of supplemental payment spending has somewhat decreased over time in part due to the increased incidence of supplemental payments being directed toward physicians and other providers.

As shown in Figure 6, supplemental payment spending rose sharply in recent years, with 33 states seeing increases since FY2019. This increase was more pronounced in some states. For example, supplemental payments more than doubled in Idaho, Maryland, Oregon, Tennessee, Virginia, and Washington state. Virginia had the most growth, with an increase of $2.4 billion in supplemental payments to providers between FY2019 and FY2023, the period that coincided with Virginia adopting Medicaid expansion under the ACA.⁵²

Until 2016, federal regulations prohibited states from making supplemental payments for services delivered through managed care. This restriction created challenges for states looking to expand managed care in Medicaid, as providers that relied heavily on FFS supplemental payments would face significant revenue losses. As a result, as many as 15 states received Section 1115 waivers to exclude certain services or populations from managed care, allowing them to continue making supplemental payments after transitioning to managed care.⁵³

Other states found a way to increase provider pay by increasing capitation payments to MCOs and requiring the MCOs to direct these extra funds to specific providers. Historically, these payments, known as pass-through payments, were not typically linked to Medicaid services or provider performance.

In 2016, CMS issued a regulation requiring states to gradually phase out pass-through payments due to concerns that they resembled supplemental payments and did not comply with the requirement for actuarially sound managed care rates.⁵⁴ CMS allowed for a gradual phase-out, with hospitals given 10 years to adjust and physicians and nursing facilities given five years to adjust.⁵⁵

But the 2016 rule also introduced a new option for states to replace pass-through payments with directed payments under specific conditions. The rule, which is likely not well enforced, required that:

• directed payments be linked to the delivery and utilization of services under managed care contracts (i.e., distributed equally among designated providers in a given state-defined provider class);
• payments support at least one goal in the state’s managed care quality strategy; and
• payments not be dependent on provider participation in IGT agreements.⁵⁶

In most cases, CMS requires states to obtain annual approval for these directed payment arrangements to ensure compliance. In 2020, CMS eliminated the need for states to obtain prior approval for minimum fee schedules.

MACPAC reviewed SDP approval documents and projected total spending based on the time period specified in each SDP contract window or rating period—that is, the time frame when capitation rates are developed under a managed care contract. This period may be the normal 12-month calendar or fiscal year.⁵⁷ MACPAC projected SDPs approved as of December 2020 to total approximately $25.7 billion for that contract window.⁵⁸ For SDPs approved as of February 2023, this figure more than doubled to $69.3 billion for that contract window. In general, SDPs fit into three categories:

1. Minimum or maximum fee schedules: This category sets specific parameters for the base payment rates that MCOs must pay providers for certain services. These fee schedules often require MCOs to pay providers no less than the FFS rate approved in the state Medicaid plan or may be based on Medicare or other state-defined rates. The Medicaid and CHIP Payment and Access Commission (MACPAC) projects that about $16.1 billion would be spent under this type of SDP for payment arrangements approved between February 2023 and August 2024.⁵⁹
2. Uniform rate increases: These arrangements mandate that MCOs pay a uniform dollar amount or percentage increase above the negotiated base payment rates for specified services. Uniform rate increases are the most like supplemental payments in the FFS model. Per MACPAC’s projections, $81.5 billion of uniform rate increase payments were approved between February 2023 and August 2024.⁶⁰
3. Value-based payments (VBP): This category requires MCOs to implement payment models that incentivize providers based on performance or the achievement of quality and efficiency goals rather than the quantity of services provided. VBPs are the least common type of SDP, with total spending of $3.7 billion projected based on arrangements approved between February 2023 and August 2024.⁶¹

MACPAC projects that an additional $8.9 billion will be spent on payment arrangements that span various combinations of these three categories.⁶² The commission projects that the sum of all fee schedules, uniform rate increases, and VBP arrangements will reach $110.2 billion per year for SDPs approved between February 2023 and August 2024.⁶³

In 2024, the Biden administration issued a rule that—while flawed—introduced several significant changes aimed at improving the oversight and transparency of directed payments in Medicaid managed care.⁶⁴ Prior to 2024, the oversight process for SDPs was relatively lax. CMS had weak standards for documentation, transparency, and evaluation related to SDPs. Moreover, the review process often lacked consistency and did not always require detailed reporting. Additionally, states’ use of separate payment terms allowed states to create SDPs outside of base capitation rates, which raised concerns about undermining the risk-based nature of managed care. Finally, evaluation plans were frequently incomplete, delayed, or inconsistent, making it difficult to assess the impact of directed payments on health care quality and outcomes.⁶⁵

Although the rule has large fiscal costs and Congress should consider repealing it (as suggested by Chris Jacobs in a Paragon report from January 2025⁶⁶), there are some constructive provisions that limit abuse. First, it established more rigorous requirements for directed payment submissions, mandating that states provide information about payment amounts and provider eligibility. The rule further required states to submit provider-level payment information to account for where the directed payment spending is going.

Second, the rule implemented stricter evaluation standards with baseline information and performance targets. For SDPs exceeding 1.5 percent of total managed care costs, states must now submit evaluation reports every three years.

Third, and most importantly, the rule mandated the elimination of separate payment terms by July 2027, requiring all SDPs to be integrated into base capitation rates. This change has the potential to better ensure that MCOs bear financial risk for SDP spending and align the payment structures with the risk-based principles of managed care instead of essentially guaranteeing insurers’ profits each year. By removing payment mechanisms that operated outside of capitation rates, the rule addressed concerns that such practices undermine financial accountability and disproportionately benefit politically connected providers. Those are valid concerns: In 2024, MACPAC found that 87 percent of uniform rate increase SDPs, which totaled an estimated $70.6 billion, were delivered through separate payment terms and were thus outside of the managed care construct.⁶⁷

While the rule did make some long-overdue reforms of SDPs, it made it explicitly clear that states could make SDPs up to ACRs.⁶⁸ Such a regulation proves that Medicaid payments can often be excessive and that payments this high are almost prima facie evidence that Medicaid payments violate the statutory requirements to be economical and efficient.

Another problem with basing Medicaid rates on ACR is an incentive of providers to increase commercial rates. ACRs are determined by calculating the mean payment for a service made by a state’s top commercial insurers.⁶⁹ This structure incentivizes providers to increase commercial prices to garner higher commercial payments as well as Medicaid payments—raising costs for taxpayers and consumers.

According to analysis the RAND Corporation made of 2022 medical claims data, prices for inpatient hospital facility services averaged 254 percent of Medicare rates. Prices for outpatient hospital facility services averaged 279 percent of Medicare rates, and professional physician services averaged 184 percent of Medicare rates.⁷⁰ Of note, almost all physicians accept Medicare rates as payment in full for providing services to Medicare enrollees, and more than half of hospitals make money on Medicare enrollees despite industry pleas that Medicare rates are well below sustainable amounts.⁷¹ The reality is that, due to state financing gimmicks and large supplemental payments, Medicaid payments can often be well above what is necessary or appropriate.

The fiscal costs of SDPs are substantial, with estimates suggesting that the explicit allowance of SDPs up to ACR in the 2024 CMS rule could raise Medicaid spending by as much as $220 billion over the next decade.⁷² As shown in Figure 7, among large SDPs that cover inpatient services, outpatient services, and behavioral health (these being some of the most costly services), at least 25 states set their payment levels for SDPs as a percentage of ACRs. The average payment level among these programs was 85 percent of ACR for programs valid in fiscal years 2024 and 2025.⁷³

GAO highlighted the significant impact of these practices on federal Medicaid spending in a 2023 report that assessed SDPs approved through August 2022.⁷⁴ States use SDPs to shift their financial responsibility onto federal taxpayers. The effect is more pronounced in states with SDPs exceeding $1 billion. GAO reported that for SDPs, 21 states achieved an effective FMAP of 80 percent or higher—and nine of them were able to achieve an effective FMAP above 90 percent.⁷⁵

According to the 2023 GAO review, Arizona has a Medicaid money laundering scheme that results in SDPs of nearly $1.4 billion financed by $437 million in provider taxes. There is no contribution from the state general fund. The federal government is footing 91 percent of the payments.⁷⁶ In 2020, Arizona enacted a hospital tax, depositing funds into a “Health Care Investment Fund.” The state then makes expenditures from this fund, bringing in federal matching funds to finance the SDPs. Arizona hospitals applauded the scheme, with the executive director of the Health System Alliance of Arizona stating, “The Health Care Investment Act is an innovative solution to address the Medicaid shortfall for hospitals, doctors, dentists and other providers at no cost to the state, while infusing $1.5B into Arizona’s economy.”⁷⁷ The funds from the first three months of the SDPs, among other factors such as COVID-19 relief funds, contributed to an increase in net operating profits for Arizona’s hospitals by 35 percent between 2019 and 2020.⁷⁸

Tennessee is awaiting CMS approval of a directed payment arrangement that would increase the tax rate on hospitals from 4.9 percent to 6.0 percent, which Barclays projects would increase FY2025 state revenue by $4.3 billion and boost hospitals’ profits by up to $2.7 billion net of provider taxes.⁷⁹

As mentioned, it is difficult to track and audit SDPs due to gaps in reporting requirements for provider-level payments. For example, states are required to report only on IGT-funded payments to providers but not on other funding sources.⁸⁰ According to a March 2014 GAO report, CMS officials “could not attest to the accuracy of the data reported,” and no action had been taken to withhold federal Medicaid funding from states that were underreporting.⁸¹ These deficiencies at both the reporting and analysis levels thwart proper accountability.⁸²

The total number of SDP agreements increased from 201 in 2020 to 302 in 2024. In 2020, minimum or maximum fee schedules accounted for over half of the arrangements, while uniform rate increases comprised roughly one-third and VBP models represented a smaller share. Since 2020, as Figure 8 shows, uniform rate increases have risen in prominence among SDP programs—overtaking minimum and maximum fee schedules. This shift illustrates states’ preference for a set rate for SDP payments—akin to traditional FFS supplemental payments—over a system where MCOs make decisions about distribution. This could largely be explained by regulatory shifts in CMS that exempted certain fee schedules from federal approval, such as uniform rate increases.⁸³

There has been a significant increase in the percentage of SDPs that are uniform rate increases, and as Figure 9 shows, uniform rate increases are by far the largest type of SDP in dollar terms. However, maximum fee schedules are the fastest growing type of SDP in percentage. Maximum or minimum fee schedules represented 15 percent of SDP dollars in 2024, while uniform rate increase SDP declined as the percentage of total SDP dollars for all types from 2020 to 2024 (from 79 percent of all program types in 2020 to 74 percent in 2024).

Since 2020, hospitals have consistently been the primary recipients of SDPs, with their share growing significantly, primarily through uniform rate increases. Behavioral health and substance abuse providers were also common beneficiaries of SDPs, mainly through minimum or maximum fee schedules.

Initially, state general funds were a significant source of funding for SDPs, accounting for 43 percent of total directed payment arrangements in 2020.⁸⁴ However, as SDPs expanded, there was a notable increase in the use of provider taxes and IGTs to fund them. Figure 10 shows that by 2024, the share of arrangements funded by provider taxes had grown to 32 percent from 14 percent in 2020, while IGTs financed 32 percent of all arrangements, up from 21 percent in 2020.⁸⁵ The percentages in Figure 10 do not add to 100 percent, as SDPs can have multiple funding sources.

This shift highlights how states leverage these funding mechanisms to maximize federal matching funds. This in turn allows for the expansion of SDPs without additional pressure on state budgets. The increasing reliance on provider taxes and IGTs reflects a strategic effort to sustain and enhance payments to providers using federal dollars. According to recent data, states collected 20 percent more revenue in provider taxes in 2024 than in 2023.⁸⁶ Not surprisingly, both provider taxes and SDPs soared in 2024, as provider taxes fuel the legalized money laundering that permits states to substantially increase SDPs.

In 2024, Nevada implemented a provider tax for all privately owned hospitals operating in the state to finance higher SDPs to those facilities.⁸⁷ The hospital tax was initially set at 4.4 percent of revenue for inpatient services and 6.0 percent for outpatient services, and it grew to 7.1 percent for inpatient and 6.8 percent for outpatient in SFY 2025.⁸⁸ The state generates higher payments through MCOs with the money raised through the hospital tax. Nevada also recoups a share of those higher payments because of the 3.5 percent premium tax the state imposes on MCOs.⁸⁹ The legalized money laundering apparatus enables Nevada to pay rates for acute hospitals and critical access hospitals at 100 percent of the ACR while other classes of facilities are limited to 100 percent of Medicare rates. The state claims, “These limits were selected … in a manner that maximizes available federal funding to participating private hospitals.”⁹⁰

Nevada originally estimated that the additional revenue would lead to nearly $1 billion in Medicaid payments to hospitals.⁹¹ The SDPs up to ACR are very profitable for Nevada hospitals. One hospital system in particular—Universal Health Services (UHS)—is generating massive and increasing profits through this SDP mechanism, growing from a reported $9 million in SDP revenue, net of provider taxes, in 2023 to $194 million in 2024 and is projected to reach $222 million in 2025.⁹² Supplemental payments in general made up 9.8 percent of total revenue for UHS and 45.2 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA).⁹³

In New Mexico, the state estimated that an SDP program approved retroactively for the second half of 2024 would generate “$1.3 billion in federal funds for hospitals in the state” by leveraging provider taxes.⁹⁴ The program provides a uniform dollar increase for inpatient and outpatient hospital services and extra payments for hospitals that meet certain quality metrics. The SDP estimates payment for inpatient services at 95.0 percent of ACR and outpatient services at 92.7 percent of ACR.⁹⁵

As a result of these high payment rates, hospital operator Ardent Health Partners wrote that it “recorded revenue of $94 million and Adjusted EBITDA of $65 million in the fourth quarter … [which] resulted in 2024 revenue and Adjusted EBITDA well above our guidance ranges.”⁹⁶ The information provided by Ardent does not suggest it needed this surge of federal tax dollars brought in through the SDP program. According to Ardent, “Net patient service revenue per adjusted admission for the fourth quarter of 2024 increased 9.5% year-over-year. Excluding the benefit associated with the New Mexico state directed payment program, the increase in net patient service revenue per adjusted admission was approximately 3.4% for the year ended December 31, 2024.”⁹⁷ Estimates by KeyBanc show that 2024 Medicaid directed payment programs and supplemental payments overall total 51.3 percent of Ardent’s EBITDA.⁹⁸

In 2023, North Carolina passed Medicaid expansion and approved participation in the Healthcare Access and Stabilization Program (HASP). HASP is an SDP in which the state share is funded through assessments on hospitals and other providers. Through this program, North Carolina directs MCOs to increase payments to eligible hospitals for Medicaid-covered services. Acute care hospitals, critical access hospitals, and hospitals owned or controlled by the University of North Carolina Health Care System and East Carolina University Health Medical Center are eligible for the increased payments.⁹⁹

In July 2024, CMS approved an amendment to HASP that increased the amount of federal funds that MCOs pay hospitals to ACRs for inpatient and outpatient hospital services if hospitals take specific measures to forgive debt and increase charity care.¹⁰⁰

HASP debt relief policies include the following:

• Relieving all unpaid debt accrued since 2014 by Medicaid enrollees (an amount estimated to be nearly $4 billion).¹⁰¹
• Relieving all uncollected medical debt for those not enrolled in Medicaid with incomes below 350 percent of the federal poverty level (FPL) and those whose debt exceeds 5 percent of annual income.
• Establishing protections against the accumulation of future medical debt, including discounts on future bills for people in households below 300 percent FPL and auto-enrollment in North Carolina’s charity care program with presumptive eligibility determined through screening and income validation.
• Blocking certain debt collection practices by prohibiting hospitals from selling debt of individuals at or below 300 percent FPL, capping interest rates on medical debt at 3 percent, and prohibiting medical debt reporting to credit agencies.

Table 1 presents data for the hospital systems set to benefit from these HASP payments for SFY 2024 and SFY 2025.¹⁰² Over the next two years, HASP is projected to spend over $10 billion in federal funds. Of this, $4 billion will be tied to increasing rates to ACRs via the debt relief provision.

Table 1 highlights, by system, the total costs of debt and charity care compared to the value of HASP. Most hospital systems receive much higher payments from HASP compared to the current costs of bad debt in their systems, and this is despite the fact that most of the debt would have been either forgiven or donated to Undue Medical Debt—a nonprofit that purchases and cancels medical debts for low-income patients. Additionally, the HASP payments do not correlate with the amount of charity care at the hospital.

The biggest recipient of HASP is Atrium Health, one of the two hospital systems that had previously refused to sell any of its bad debt.¹⁰³ Using data from the National Academy for State Health Policy, we project base HASP payments to Atrium to be $890.2 million in 2024 and $892.5 million in 2025. The debt relief amendment to HASP is projected to increase these payments by $236.7 million in 2024 and $823.8 million in 2025. In total, Atrium Health will receive more than $1.7 billion through HASP in 2025.

According to one study, Atrium accounted for 41.9 percent of medical debt lawsuits in North Carolina between January 2017 and 2022.¹⁰⁴ Established initially as the Charlotte-Mecklenburg Hospital Authority, Atrium has expanded significantly through mergers with Navicent Health, Wake Forest Baptist Health, and Advocate Aurora Health. The system now controls 67 hospitals and has over $27 billion in annual revenue.

Atrium Health’s legal status is unique due to its municipal origins, providing it with significant advantages. Like most nonprofit hospitals, Atrium is exempt from federal, state, and local taxes. However, it also does not pay property taxes on land not used for health care or charitable purposes, including commercial properties such as a chicken restaurant. Furthermore, Atrium holds the power to acquire real estate through eminent domain, and legislation is being considered that could extend this authority.¹⁰⁵

Atrium has also been shielded from antitrust damages. The North Carolina Supreme Court ruled in 2020 that Atrium is immune from state antitrust laws because it is a “quasi-municipal corporation.”¹⁰⁶ Consequently, it is not subject to penalties under North Carolina’s Unfair and Deceptive Trade Practices Act. Additionally, the U.S. Fourth Circuit Court of Appeals affirmed in 2021 that Atrium is protected under the federal Local Government Antitrust Act of 1984, reinforcing its immunity from federal antitrust damages.¹⁰⁷ These rulings emerged from a U.S. Department of Justice investigation that found that Atrium had imposed illegal contract restrictions on insurers, preventing them from incentivizing patients to use lower-cost health care options. Although Atrium agreed to stop these anti-competitive practices in a 2018 settlement, affected consumers received no compensation due to the hospitals’ legal immunity.¹⁰⁸

Additionally, Atrium has faced criticism for aggressive debt collection practices. It has encouraged over 63,000 patients to enroll in “medical credit card” plans offered by AccessOne, a private-equity-backed company that charges up to 18 percent interest on medical debt. Reports indicate that nearly half of the patients enrolled were subjected to high-interest plans, with rates as steep as 13 percent, raising concerns about the financial burden on patients already struggling with medical expenses.¹⁰⁹

Atrium’s example highlights how hospital systems can leverage political power to receive government funding that often significantly exceeds hospitals’ costs. The perverse incentives inherent with this type of system were known from the start. North Carolina’s treasurer, Dale Folwell, penned a letter asking CMS to reject the state’s HASP application.¹¹⁰ He cited concerns about how the program would encourage hospital consolidation and raise the cost of health care for both private payers and Medicaid. This comes even as the state boasts some of the most expensive medical care in the nation, Folwell noted.

Nonetheless, CMS approved North Carolina’s application to implement HASP. Now, the program serves as a prime example of how states and politically powerful medical systems manipulate Medicaid financing rules to raise commercial premiums and taxpayer costs.

Before the implementation of the ACA in 2014, the federal government has historically reimbursed 57 percent of the costs of the Medicaid program leading up to the implementation of the ACA in 2014 (as shown in Figure 11 using data from NASBO).¹¹¹ The exception was during the Great Recession in 2009-2011 when the federal government increased states’ FMAPs as a way to deliver additional money to the states. With the ACA’s significant expansion of the program and higher FMAPs for able-bodied adults brought onto the program through the expansion, the federal share was closer to 67 percent as of 2023.¹¹² Moreover, because much of the state share consists of fake expenditures, the actual federal share of Medicaid spending is now roughly 75 percent of total expenditures in recent years.

A 2020 GAO report found that states relied on provider taxes and local government funds to finance 28 percent of the total nonfederal share of Medicaid payments in SFY 2018—seven percentage points more than in SFY 2008.¹¹³ In that report, GAO also estimated that state financing gimmicks raise the actual share of Medicaid paid by the federal government by about five percentage points, although there is wide variation across the states.¹¹⁴ According to the latest data from NASBO, half of all states funded more than 30 percent of the state portions of their shares of Medicaid spending with non-general funds, which are mostly composed of provider tax revenues (Table 2).¹¹⁵

Figure 11 demonstrates that states have been increasing their reliance on non-general funds through money laundering schemes to finance Medicaid. From 1991 through 2023, “other” funds increased from 4 percent to 10 percent, while the state general funds decreased from 38 percent to 23 percent. In other words, state sources, mostly consisting of laundered funds, went from about 9 percent of total state funding to more than 30 percent over this period. Thus, states—with growing money laundering and reliance on federal funds—have become much less sensitive to rising Medicaid costs over time. Of note, the other funds lines would be higher and the general funds line lower if NASBO were able to capture full expenditures, but according to CRS, “NASBO acknowledges that its State Expenditure Report does not capture 100% of provider taxes, fees, assessments, and local funds used to finance the state share of Medicaid expenditures.”¹¹⁶ According to NASBO, other state funds exceed general funds in five states: Alabama, Illinois, Louisiana, Oklahoma, and Utah.

Figure 12 shows the percentage of actual funding that comes from the federal government. It excludes the state money laundered funds. This percentage equates to federal spending divided by the sum of federal funds and state general funds from Figure 11 — thus omitting provider tax revenues and IGTs. This reveals the true stake that states have in Medicaid costs. By contrast, the purported federal share is merely the ratio of federal funds to all Medicaid spending. Figure 12 shows that the real federal share of spending increased from 60 percent in SFY 1991 to about 74 percent in SFY 2023. From the previous note, the actual federal share would be higher if the “other” funds were fully accounted for.

Figure 13 illustrates the extent that financing schemes reduce states’ financial responsibility and inflate the federal share specifically for SDPs. The expected federal share is what percentage the federal government should reimburse states under their standard FMAPs. The real federal share is the percentage the federal government contributes toward the SDP, excluding any revenues from local governments and providers that are then recycled back to those governments or providers.

In the aggregate, states used financing schemes to raise the federal share of SDPs by 14 percentage points.¹¹⁷ This means the reported federal of 68 percent is actually closer to 82 percent when accounting for financing schemes underpinning SDPs. Nebraska, New Jersey, and Texas have inflated the federal share of SDPs the most, raising their federal shares by more than 24 percentage points above the statutory FMAP.

In 2022, state financing schemes through SDPs alone raised the cost to federal taxpayers by $4.5 billion, which is 20 percent more than they would pay in absence of these schemes (see Table 3).¹¹⁸ Assuming this trend holds for the most recent data on SDP spending, we estimate that the cost federal taxpayers bear through laundering schemes in SDPs is $12.8 billion in 2024 alone—in addition to bearing nearly $62.3 billion based on the purported federal share of the payments at 68 percent.¹¹⁹

Federal action is necessary to curtail Medicaid money laundering schemes that have enabled states to develop kickback arrangements with insurers and providers and manipulate financing mechanisms to maximize federal reimbursements without commensurate state contributions. The financing schemes and payoffs to providers are inextricably linked. States deploy financing gimmicks to draw down excessive federal funds, which they then use to make large payments to providers, with insurers capturing a portion of the loot. These payment schemes not only inflate Medicaid spending but also drive up commercial health care prices.¹²⁰ In many states, these schemes are just used as general revenue to plug budget holes and for purposes other than Medicaid.¹²¹

The Urgent Need for Reform

Federal spending as a percentage of the U.S. economy, or gross domestic product (GDP), has reached unprecedented levels outside of wartime. A nearly $2 trillion federal deficit and a national debt 23 percent larger than the entire economy threaten future American prosperity and contribute to rising inflation, higher interest rates, and the potential for massive future tax increases.¹²²

Over the past 15 years, no area of federal spending has increased more than Medicaid. Importantly, there has been a significant shift in the burden of financing Medicaid away from states and to the federal government. In both 2008 and 2023, state Medicaid spending represented 0.9 percent of GDP. In contrast, federal spending soared, rising from 1.36 percent of GDP to 2.28 percent of GDP from 2008 to 2023

The large shift in costs from states to the federal government has eroded the program’s fundamental principle of shared fiscal responsibility between states and the federal government, with the federal share growing by more than 10 percentage points to an effective federal share now approaching 75 percent of total expenditures. It is time for meaningful reforms to restore the appropriate federal-state financing balance, ensure Medicaid serves its intended purpose and its most deserving enrollees, and place the program on a sustainable trajectory.

The Best Solution: Block Grants

The most effective way to eliminate Medicaid money laundering and inefficient spending is for the federal government to implement block grants in the program, capping the amount of federal Medicaid funding states receive. If states received fixed Medicaid allotments, these schemes would disappear.

Currently, states bear only about 25 percent of the marginal cost of Medicaid spending, meaning they can justify expenditures even if up to 75 percent of the spending is wasteful or low value. The incentives are worse for the Affordable Care Act expansion population given the 90 percent federal reimbursement rate. Under a block grant program, states would bear 100 percent of the marginal cost beyond the amount provided by the federal government, creating strong incentives to ensure that Medicaid spending is efficient and truly benefits enrollees. Ideally, a block grant system would provide states with flexibility to meet the needs of enrollees within federal eligibility and coverage rules while naturally preventing states from artificially inflating Medicaid expenditures to draw down additional federal dollars.

Short of Block Grants: Limiting Financing Gimmicks and Supplemental Payments

Congress seems unlikely to transition Medicaid to block grants, but given the program’s problems, it should still take decisive action to curb states’ use of money laundering tactics. To be most effective, Congress should limit the provider taxes that facilitate these financing schemes.

Eliminate States’ Ability to Use Provider Taxes to Finance Medicaid Payments

Congress should prohibit states from using provider taxes—including taxes on insurers—as a funding source for the nonfederal share of Medicaid expenditures. There is broad bipartisan agreement that provider taxes are highly problematic.

For example:

• •John Holahan of the Urban Institute called states’ use of provider taxes “egregious” and a “national disgrace.”¹²³
• Senator Richard Durbin (D-IL) described provider taxes as a “charade.”¹²⁴
• During the 2011 budget negotiations, then-Vice President Joe Biden referred to provider taxes as a “scam,” stating, “If we can’t do this—come on!”¹²⁵
• Past administrations from both parties—including Presidents Bush, Obama, and Trump—have proposed reforms to restrict provider taxes.¹²⁶ The Bowles-Simpson Commission recommended their outright elimination.¹²⁷

Congress should follow through on this bipartisan consensus and ban states from using provider tax revenue toward the state share of Medicaid expenditures. Extrapolating estimates from the Congressional Budget Office, this reform would reduce federal deficits by nearly $700 billion over a decade.¹²⁸

The Reality of Provider Taxes

As discussed earlier in this paper, despite their name, provider taxes are not real taxes. In practice, providers pay the state, the state uses those funds to claim federal Medicaid matching dollars, and then the providers receive their money back—often with a windfall of many times their initial “tax” payment through inflated Medicaid reimbursement rates.

States claim that restricting provider taxes would force them to cut eligibility or provider payments. However, federal policymakers should be skeptical of these claims given the extensive evidence of excessive Medicaid payments that do not comply with the program’s statutory requirement for efficient and economical payments.

Congress should also ensure that providers are not held harmless or financially rewarded for participating in provider tax schemes. By outlawing these arrangements, states would not be able to use any funds from providers as the state share of the Medicaid reimbursement, and they would not be able to give providers any guarantees of how much Medicaid money they would receive through financing schemes. Congress should also prevent providers from engaging in side deals that ensure that all providers are held harmless or financially benefit from the provider tax mechanism.¹²⁹

Reduce the Medicaid Provider Tax Safe Harbor Threshold

Short of eliminating provider taxes, Congress should reduce the safe harbor threshold for hold-harmless arrangements. This would make provider taxes more difficult for states to leverage, as uniform and broad-based provider taxes would mean that providers and the state could not hold providers who serve fewer Medicaid recipients harmless from the tax scam.

Generally, the federal government prohibits the state from imposing a provider tax that includes hold-harmless arrangements with providers in which the state essentially agrees to pay providers back for the funds that were taxed. This requirement makes it more difficult for states and providers to run the money laundering schemes, because if providers have no guarantee of getting their money back, they will be less supportive of the underlying provider tax. Unfortunately, the safe harbor threshold undercuts this distinction by allowing states to run the schemes so long as the total tax is below 6 percent of a facility’s revenue. Eliminating the safe harbor would close this loophole that states and providers use to engage in money laundering and kickback schemes.

Eliminating or lowering this safe harbor threshold would reduce states’ ability to use provider taxes to generate excess federal funds. In his FY2013 budget, President Obama proposed lowering the safe harbor threshold to 3.5 percent of a provider’s revenue. This reform was estimated to reduce federal deficits by about $22 billion over a decade. That reform would now likely generate federal savings of $200 billion over a decade—a sign of the rampant growth in states’ use of provider taxes to finance the nonfederal share.¹³⁰ According to CRS, 38 states had reported at least one Medicaid provider tax above 5.5 percent of net patient revenue as of July 1, 2024.¹³¹

End Fiscally Irresponsible Managed Care Practices from the Obama and Biden Administrations

In 2016, the Obama administration promulgated an expansive Medicaid managed care regulation that significantly raised federal spending. In 2024, the Biden administration doubled down with a rule making it clear that states could create SDPs up to average commercial rates. Eliminating these policies and instituting sensible caps on Medicaid payments through insurers would likely produce substantial federal budget savings over the next 10 years.

End State Directed Payments in Medicaid Managed Care

In its 2016 rule, the Obama administration allowed for SDPs in managed care. These are a form of supplemental payments, primarily for hospitals, with the nonfederal or state share largely financed with provider tax revenues or IGT payments. SDPs are made on top of the payments providers receive through reimbursement policies set by the state-contracted Medicaid MCO. SDPs are also on top of other Medicaid add-on payments, notably DSH payments and graduate medical education payments.

SDPs have become the single most powerful driver of total federal Medicaid spending growth, and, as GAO has observed, “the process lacks sufficient fiscal guardrails to ensure state directed payments result in provider payment rates that are reasonable and appropriate as is required under CMS guidance. Moreover, these weaknesses are inconsistent with federal internal control standards that require federal agencies to obtain quality and relevant information and use it to conduct oversight and monitor changes over time.”¹³² These schemes are projected to show dramatic, increasingly unsustainable growth as more states adopt SDPs, extend SDPs to more provider types, and use the option to pay commercial-level rates in a welfare program. Congress should rescind the ability of states to utilize SDPs.

Capping Supplemental Payments and SDPs at Medicare Rates

Short of eliminating SDPs, Congress should limit federal reimbursement for Medicaid payments made through insurers to no more than Medicare rates. Congress should not permit states to develop payment schemes in their Medicaid programs that incentivize providers to treat Medicaid recipients over Medicare recipients and dramatically hike federal taxpayer costs. With the advent of SDPs and the financing schemes underpinning them, states are now paying providers up to average commercial rates through Medicaid. Average commercial rates are more than 2.5 times Medicare rates on average for hospital services, and this payment disparity will produce large incentives for providers to prefer Medicaid recipients over Medicare recipients.¹³³

There is already a UPL for most services in Medicaid fee for service at Medicare rates. The UPL is calculated at the aggregate level across providers in a class. At a minimum, Congress should extend this UPL to all providers in Medicaid fee for service and create a parallel UPL for Medicaid managed care at those levels.¹³⁴ States could reimburse providers higher rates than Medicare at their discretion and with their own dollars, but they would not receive federal matching funds for these excess payments.

Prohibit States from Reimbursing Insurers for Provider Taxes

For FY2025, 22 states impose taxes on MCOs.¹³⁵ Under the expansive and costly Medicaid managed care rules adopted by the Obama administration in 2016, states are required to reimburse Medicaid insurers for the cost of state-imposed taxes. About 2.5 percent of Medicaid capitation rates go to reimburse state-contracted insurers for the cost of these taxes.¹³⁶ States receive federal matching funds (50 percent to 90 percent, depending on the state and associated enrollee) for the cost of repaying Medicaid insurers for the tax.

Managed care taxes are particularly nefarious. First, MCO taxes are assessed on a large tax base and thus can result in far greater amounts of money laundering. Second, MCO tax policy mandates that states reimburse the MCOs for the amount of the tax, meaning that MCOs face no financial risk from the tax. Third, unlike other forms of provider taxes where a state may not retain any residual funds, state taxes on MCOs always substantially increase state revenues that may, in turn, be used for any purpose not limited to Medicaid or health care. The regulation requiring states to reimburse Medicaid insurers for state taxes should be rescinded, and federal funding should be prohibited from covering the cost of insurer taxes.

Prohibit Costly Related Party Conflicts of Interest in Medicaid Provider Payments

The Medicaid program is rife with related party conflicts of interest. This means that providers owned or operated by a state or local government or by the parent company, subsidiary, or partner of a state-contracted insurer receive higher rates, higher supplemental payments or SDPs, a larger market share, or more favorable treatment than their competitors do.

There is always an inherent conflict of interest when a state owns or operates a hospital or health system and determines its Medicaid payment and operational policies, because the state can directly favor the state-owned provider over private providers, as demonstrated in the New York developmental center example. In the case of local-government-owned providers, all IGT-funded supplemental payments involve a conflict of interest between the governmental entity and its provider. In many states, government-owned providers have structured Medicaid financing arrangements to maximize federal matching funds without a corresponding increase in actual health care services. For example, a county-owned hospital transfers funds to the state, then the state uses those funds to make a Medicaid payment to the facility and claims federal Medicaid dollars on those expenses. Finally, the state returns a portion of the funds back to the hospital. Moreover, when certain providers or institutions receive undue financial advantages due to their affiliations, it creates an uneven playing field that undermines competition and can reduce the quality of care.

In the case of Medicaid MCOs, the problem is worse and growing more severe. Many insurers already own providers and administrative vendors, and some insurers also own drug products.¹³⁷

Related party conflicts of interest distort market dynamics, increase taxpayer costs, harm program integrity, restrict accountability and transparency, and adversely affect choice, access, and quality of care.

To address these problems, federal policymakers should prohibit states and Medicaid insurers from adopting any payment rates, terms and conditions, or other policies and practices that treat any provider owned or operated by a state or local government or an insurer more favorably than non-related-party providers. Under this policy, states could not provide higher Medicaid payments to a government-owned facility than to a privately owned facility. This policy would prevent overpayments to government providers, a portion of which those providers then transfer back to the state to be used as the state share of Medicaid to claim more federal money.

For Medicaid insurers, this policy should apply to all providers, vendors, drugs, and other products owned or controlled by the parent company or any subsidiary, joint venture, or other affiliate of the parent.

Stop Paying Consultants with Federal Monies

Congress should also address the problem that these state financing gimmicks are often designed by consultants hired by the health care industry. For example, in Michigan, one contract set to last from 2018 to 2023 worth $3.7 million explicitly required the consultant to “[i]dentify federal revenue enhancement opportunities … where the State is not maximizing potential federal revenues.”¹³⁸ These consultants are often paid with contingency fees based on a percentage of the net financial gain from the scheme (i.e., based on how much federal money the scheme generates). In 2005, GAO identified 34 states that used Medicaid contingency-fee consultants “to maximize federal reimbursements.”¹³⁹ Congress should prevent these consultants from being paid on a contingency-fee basis.

Greater Oversight: Reporting and Audits

Federal policymakers should require greater disclosure and oversight of supplemental payments and SDPs. They should require that states submit provider-specific information about Medicaid payments, including supplemental payments and SDPs and states’ sources of funding for the nonfederal share of these payments. They should also require annual independent audits of provider taxes, IGTs, and certified public expenditures to make sure they comply with the law and fine states with schemes out of compliance.

Greater Oversight: Close Integrity Loopholes in Certified Public Expenditures

Any arrangement where states certify the legitimacy of their own expenditures for federal reimbursement, as is the case with CPEs, is ripe for abuse without proper accountability. Though CPEs make up a small proportion of total Medicaid spending, the loopholes they create allow states to inflate Medicaid costs.

Congress should establish a timeline to phase out CPEs, forcing states to fund Medicaid through transparent, accountable budgeting rather than opaque financing tricks. At a minimum, Congress should require states to publicly disclose detailed CPE data, including amounts, certifying entities, and service breakdowns.

Opponents of reforming Medicaid’s opaque and corrupt financing structure argue that providers and states need dollars from these arrangements to sustain their programs. However, as shown above, such claims are likely overblown because of the extent to which states use these schemes to generously pay providers and fund their non-Medicaid priorities. Lawmakers can also consider phase-ins to ease the transition. President Obama’s proposal to lower the provider tax threshold hold from 6 percent to 3.5 percent was phased in over a three-year period and could be a model for policymakers.

Congress created Medicaid to help finance health care services for the most vulnerable—not to serve as a slush fund for states and politically connected providers. These reforms would end or reduce the financing schemes that have ripped off taxpayers and diverted health care funds away from those who need them most. If Congress is unable to implement reforms to meaningfully reduce money laundering in the Medicaid program, then HHS should take aggressive action to protect the Medicaid program for those who most need it and for the hard-working American families that finance the program.

Footnotes