Dear Secretary Kennedy and Administrator Oz,
Paragon Health Institute appreciates the opportunity to comment on the Centers for Medicare & Medicaid Services (CMS) proposed rule CMS-2448-P, RIN 0938-AV58, titled “Medicaid Program; Preserving Medicaid Funding for Vulnerable Populations-Closing a Health Care-Related Tax Loophole Proposed Rule.”
Paragon is a non-profit health policy research institute committed to reforming government programs and restoring Americans’ control over their health and health care. We believe empowering consumers, not increasing government control, is the key to lowering costs and improving health outcomes.
The health policy establishment—including much of the health care industry—has long defended and advocated for more government regulation and spending. Often, such policies do more to benefit special interests who convince politicians that catastrophe would ensue if the status quo policy is changed. At best, such measures are a distraction that prevent lawmakers from enacting reforms that would reduce costs and increase access. At worst, such proposals increase costs by protecting providers from competition and giving them leverage to raise prices—to the detriment of both taxpayers and patients. Perhaps nowhere is this dynamic more evident than in the use of Medicaid provider taxes, which this proposed rule would help reform.
We write to express strong support for the proposed rule, which targets integrity and transparency in Medicaid financing. This rule addresses one way in which states use financing tactics that resemble legalized money laundering and that negate actual state contributions to the program. It would also comply with the recently passed requirement in the One Big Beautiful Bill that the Secretary address this issue.
Congress has long recognized that states leverage money laundering-like tactics to take advantage of the federal government’s open-ended reimbursement of Medicaid expenditures. These tactics have helped increase the federal share of Medicaid spending from its historical rate of around 60% to 75%.
In 1991, Congress sought to curb such money laundering tactics by passing the Medicaid Voluntary Contribution and Provider-Specific Tax Amendments (Pub. L. 102-234). The statute’s amendments to Section 1903 of the Social Security Act make the most sense if one considers the problem the federal government faced when it wrote the law: how to curtail states’ ability to use provider taxes to money launder while also providing them with the leeway to raise funds. On one hand, saying that the federal government would not reimburse any tax revenue from providers would significantly hamstring states’ ability to raise money for Medicaid by taxing providers. On the other hand, states can design taxes in ways that disguise their money laundering.
To balance these competing interests, Congress established a framework for CMS to consider multiple factors to determine whether a tax is legitimate and, therefore, whether a state may use it as its share of Medicaid funding—making those funds eligible for federal reimbursement. First, the tax must be broad-based. Second, the tax must be uniform. Third, there cannot be a hold-harmless provision, in which either (1) the state pays providers back for taxes or (2) some providers pay back other providers for their tax burden.
These requirements leverage political forces to prevent states from money laundering, since the states can only use revenue from taxes that affect all providers, not just those that benefit from Medicaid. Money laundering schemes would be easiest if states could concentrate their taxes on providers disproportionately benefitting from Medicaid, since the state could more easily pay those providers back through the Medicaid program. So, the statute’s requirements ensure that the federal government only reimburses states for taxes that affect a broad set of providers.
CMS’s Tests to Receive Waivers from Provider Tax Requirements
To provide further flexibility in certain cases, the statute requires the Secretary to waive the broad-based and uniform requirements if the net impact of the tax is generally redistributive and is not directly correlated to Medicaid payments “for items or services with respect to which the tax is imposed.” The statute gives the Secretary discretion to determine the scope of those requirements.
In regulations, CMS has set up several complicated tests to determine if a state’s tax can receive a waiver from the statute’s requirements. If the state is seeking to waive the broad-based requirement, it must pass a test known as P1/P2 to be deemed generally redistributive. If a state is seeking a waiver from the uniformity requirement, it must pass a statistical test known as B1/B2 to be deemed generally redistributive. The B1/B2 test uses linear regression to measure whether a state’s non-uniform tax (meaning that different tax rates apply to different subgroups of providers) disproportionately affects providers.
This proposed rule seeks to reform the B1/B2 test, which states have abused to engage in money laundering schemes. As CMS notes, states have been able to design taxes that pass the B1/B2 test even though they are not generally redistributive. Since the linear regression is based on the average, states have skewed the average by including or excluding outliers. For example, CMS notes that states abuse this test by excluding some high-volume Medicaid providers from the tax, which skews the average tax burden on each “unit” of Medicaid. This allows them to disproportionately tax providers that accept a large number of Medicaid recipients without violating the B1/B2 test.
MCO Taxes: Special Treatment
Abuse of the B1/B2 test is particularly nefarious when applied to taxes on Medicaid managed care organizations (MCOs), which are insurance companies that Medicaid pays to manage enrollees’ benefits. CMS treats MCO taxes differently than other types of provider taxes. States have increasingly used MCO taxes to engage in money laundering tactics since 2016 when the Obama administration issued a rule that helped states skirt the statute’s provider tax requirements. The rule required states to reimburse MCOs for the cost of state-imposed taxes. This policy not only circumvents the entire purpose of the statute’s prohibition on hold-harmless arrangements, but it also essentially makes such arrangements mandatory for MCO taxes.
MCO taxes are, thus, prone to the most severe abuse for money laundering. First, MCO taxes are assessed on a large tax base and thus can result in far greater amounts of money laundering. Second, the federally mandated reimbursement for MCOs means they face no financial risk from the tax. Third, unlike other forms of provider taxes, in which a state may not retain any residual funds, state taxes on MCOs always substantially increase state revenues. The state can then use those revenues for non-Medicaid purposes, not just health care.
CMS notes that currently, seven out of the eight provider taxes that use this B1/B2 loophole “tax” MCOs, while only “tax” affects hospitals. In recent years, California and New York have used the B1/B2 test to get MCO taxes approved. By any reasonable measure, California’s tax was not generally redistributive. The state imposed the tax on both Medicaid MCOs and private insurance plans, but the burden overwhelmingly fell on Medicaid MCOs. While private insurers only had to pay $2 per enrollee in 2025 with a scheduled increase to $2.25 in 2026, Medicaid MCOs had to pay $187.50 per enrollee in 2025, with an increase to $192.50 in 2026. Despite this disparity, CMS approved the tax in 2023 because it had passed the B1/B2 test. Likewise, New York’s 2024 MCO tax burden disproportionately falls upon Medicaid taxable units.
Through this kind of manipulation, California and New York either have or are projected to collect billions in funding from federal taxpayers. In California, the state garnered an estimated $9.5 billion over a two-year period, which allowed the state to make massive expenditures it would likely have never funded on its own. For example, it lifted the asset test for Medicaid’s long-term care services, which allows the wealthiest seniors to use this welfare benefit. The state also expanded Medicaid to cover unauthorized immigrants. New York projects to collect up to $4 billion in federal funding in the 2025 state fiscal year from their MCO tax scheme to cover a large budget shortfall.
The Proposed Rule’s Positive Provisions
The proposed rule reforms the B1/B2 statistical test that states use to pass the “generally redistributive” requirement for taxes that are not broad-based nor uniform. We support these provisions, which would reduce gaming of the B1/B2 test, thus saving taxpayers tens of billions of dollars over a decade and encouraging states to focus on Medicaid’s original purpose of helping the most vulnerable in ways that ensure states are accountable and have incentives to achieve cost-effective outcomes.
A. General Definitions
This proposal adds new definitions for the terms “Medicaid taxable unit,” “non-Medicaid taxable unit,” and “tax rate group.” These definitions are necessary to implement the proposed rule’s new substantive changes to the test, since they would help CMS and states identify permissible tax structures.
B. Permissible Health-Related Taxes—Generally Distributive
This proposed rule would require states, as a condition to pass the B1/B2 test, to comply with an additional requirement in a newly proposed subsection § 433.68(e). This section also proposes conforming change to § 433.68(e)(1), (2), and (f) to include references to the new general redistributive requirement in (e)(3)
C. Permissible Health-Related Taxes—Additional Requirement to Demonstrate a Tax is Generally Redistributive
This section proposes a new paragraph (e)(3) that would prohibit federal financial participation (FFP) for taxes that target Medicaid units at higher rates (on per class basis). It specifically contains separate tests for taxes that explicitly refer to Medicaid, as well as taxes that use alternate language or proxy measures.
For taxes that explicitly refer to Medicaid, the proposed rule would, in (e)(3)(i), prohibit FFP for tax revenues that explicitly tax Medicaid units at a higher rate. In (e)(3)(ii), it would also prohibit FFP for taxing classes that have a higher volume of Medicaid taxable units.
For taxes that do not refer explicitly to Medicaid, in the new (e)(3)(iii), this regulation prohibits states from passing the test by using proxy language for Medicaid, like “joint Federal and State health care program.” The proposed provision lists certain attributes that immediately disqualify a tax from receiving a waiver from the uniform requirement.
These additions to the B1/B2 test would prevent states from creating taxes that fuel the Medicaid money laundering machine. Paragon Health Institute’s recent analysis, “Addressing Medicaid Money Laundering: The Lack of Integrity with Medicaid Financing and the Need for Reform,” highlights how states “tax” Medicaid MCOs, return the money to the exact same MCOs the state’s pseudo Medicaid contribution, invoice the federal government for this illusory transfer, and then shower the increased federal dollars back to the health care industry through these MCOs. This kind of tactic foists the burden on federal taxpayers and reduces accountability in states’ Medicaid spending. The proposed rule closes this loophole by tightening accounting rules and targeting improperly structured taxes, thereby restoring alignment with Medicaid’s original mission of assisting truly needy patients.
D. Permissible Health-Related Taxes—Transition Period
The proposed rule also contemplates several phase-out timelines for existing waivers exploiting the B1/B2 statistical test loophole. CMS notes that seven states have exploited this loophole to gain waivers for eight taxes.
CMS proposes three different phase-out options:
- First, CMS proposes a phase-out in which tax waivers approved in the last 2 years would get no transition period, while tax waivers approved more than 2 years before the final rule’s effective date would have a 1-year transition period. Taxes for waivers in the first group would immediately be deemed impermissible taxes, and thus CMS would subtract the amount from the state share eligible for FFP. States with tax waivers in the second group would need to submit a compliant proposal or adjust the tax so it complies with all federal requirements, with an effective date no later than the start of the first state fiscal year beginning at least one year from the final rule’s effective date.
- CMS states that 4 tax waivers would immediately be affected under a 2-year timeframe. Within this same option, CMS alternatively proposes a three-year timeframe that would capture a total of 5 taxes.
- Second, CMS alternatively proposes not having any transition period for any B1/B2 loophole waiver, regardless of the waiver’s approval date. This would immediately affect all 8 tax waivers that exploit the B1/B2 loophole.
- Third, CMS proposes a more lenient option, in which states with waivers approved within 2 or 3 years could get a 1-year transition, and older waivers could get a 2-year transition.
Comment on the Proposed Phase Out
Regarding the proposed phase-out timeline, we recommend that CMS employ a minimal-phase-out policy for all states that exploit the B1/B2 loophole, with a preference for CMS’s proposed nophase-out policy. Such a minimal phase-out is fair to all states that exploit the B1/B2 loophole because they have had sufficient notice that CMS would immediately change this rule. It would also be just because it would immediately stop the abusive money laundering practices that the current loophole enables, thus preserving the program for the most vulnerable.
First, this no-phase-down proposal is fair because states have had sufficient notice that CMS would change the B1/B2 test. As CMS recounts, the agency has given states multiple notices that they could change the B1/B2 rule.
- Each tax waiver approval letter includes general language that the waivers are subject to change in federal policy.
- Five tax waivers that were recently approved also received companion letters that CMS is considering changing the B1/B2 test. CMS directly communicated with the three states that did not receive companion letters for their waivers.
However, this list modestly omits another important form of notice, not just that the agency would change the B1/B2, but that it would do so without any transition: the proposed rule itself. Through this notice of proposed rulemaking, published almost three months ago, the agency has notified all seven affected states that it could reform the B1/B2 test without any phase-out or transition period at all.
Given all these instances of notice, all seven states with taxes exploiting the B1/B2 loophole could have reasonably anticipated that CMS would finalize its no-transition proposal and take appropriate action to prepare. CMS correctly notes this logic applies to recently approved states. We argue that the same logic also applies to all states thanks to this proposed rule’s notice. Such reasonable preparatory actions include engaging in budget planning, passing trigger laws, communicating with the agency on permissible types of changes, and as CMS notes, planning changes that they could make without the agency’s approval.
While CMS cannot expect states to take such actions every time the agency proposes a rule, this case is different. Such actions are reasonable here due to the agency’s long-time scrutiny around the B1/B2 test as well as the proposed rule’s notice that there may not be any transition. Therefore, we think that the option of not having any transition period is more than fair to states.
Second, the no-phase-out policy would be a just policy because it would stop states’ abusive practices. The statute only requires the Secretary to waive the broad-based and uniform requirements if the taxes are generally redistributive. By exploiting the B1/B2 test, states violate the spirit of the law by taking advantage of federal taxpayers and gaining much higher federal reimbursements for their highly skewed tax schemes. Such taxes do violence to the words “generally redistributive.” Furthermore, as we have documented, this allows states to expand the program in ways that they would not otherwise. In other contexts, these tax schemes strain the program’s resources and pull funds away from the most vulnerable.
Not only would a no-transition phase out do justice to taxpayers, it would also do justice to those Medicaid was meant to help by encouraging states to effectively use legitimate funding sources—not money laundering tactics—and pursue policies that lead to effective Medicaid expenditures. We believe that such fiscal discipline would primarily benefit the most vulnerable Medicaid populations, since, as CMS notes, states receive a much higher match rate for individuals who are able-bodied working age adults without dependents. This higher match rate incentivizes states to focus resources on those populations, which leaves fewer resources for the most vulnerable.
Furthermore, this policy would do justice to patients, particularly in the states that use these money-laundering tactics. Often, these taxes are coupled with state-directed payments (SDPs), which the Biden administration explicitly allowed up to average commercial rates. Such payments create upward pressures on health care prices, since they encourage insurance companies to raise commercial rates to increase the amount they get through Medicaid. Reforms contained in the One Big Beautiful Bill (OBBB) Act address this scam that exploded during the Biden administration. This proposed rule would complement the OBBB’s reform to SDPs because the OBBB would phase out SDPs that result in Medicaid payments well above Medicare rates. As that phase out is taking place, this proposed rule would take away a reason for states to increase or maintain higher SDPs, since states usually increase SDPs to “pay back” providers that participate in the provider tax scams. In doing so, this rule could help mitigate SDPs price-increasing effects on commercial insurance rates, which hurts American workers and families.
In response to the arguments we lay out, special interests might argue that a no-transition policy is impractical because it would not leave state legislatures with time to adjust their taxes to comply with the regulation. This argument ignores that states had ample opportunity to prepare for such a scenario, given the general and specific instances of notice previously mentioned.
But even if states failed to properly prepare for a no-transition scenario, they would still be able to use the tax revenue to raise funds and pay for Medicaid. The only consequence is that the Secretary would subtract such illegitimate tax revenues from the state’s reimbursable share. Opponents of reforming this test may also argue that this reform imposes a burden on providers. While we agree that ending abuse of the Medicaid program may impact their bottom line, CMS notes this reform may also provide an immediate benefit to such taxpayers in the form of a lower tax burden.
Therefore, since a no transition policy is both fair and just, CMS should finalize this rule without any phase-out period for any state.
Alternative Recommendation If CMS Decides to Use Phase-Out
Alternatively, if CMS decides to include a longer phase-out period for states that did not receive separate companion letters, we strongly recommend that states that received waivers in the last three years immediately stop using those funds for FFP and taxes approved more than three years ago, with 1 year to transition. This option would capture five tax waivers rather than four tax waivers under the 2-year timeframe, thus increasing the benefit from carving back the current loophole. CMS notes that its initial two-year timeframe proposal would save between $33.2 billion and $74.6 billion from 2026 to 2030. Moreover, as CMS acknowledges, these estimates may be low because they do not account for how states recycle these funds back into Medicaid to gain even greater federal reimbursements.
Conclusion
We applaud the agency’s commitment to closing Medicaid financing loopholes and reinforcing federal‑state fiscal integrity in the Medicaid program. This rule represents a bold but necessary step to realign Medicaid with its vital social mission, protect federal resources, shield taxpayers from particularly egregious Medicaid money laundering schemes, and provide states with better incentives for cost-effective spending.
Thank you for considering our views on these reforms and your important proposed rule.
Sincerely,
Brian Blase, PhD
President of the Paragon Health Institute
Niklas Kleinworth
Policy Analyst at Paragon Health Institute
Chris Medrano,
Legal Research Analyst at Paragon Health Institute
(Not admitted to practice law; under the supervision of Demetrios L. Kouzoukas)
