Legalized money laundering schemes in Medicaid are a way for states to funnel large amounts of federal taxpayer dollars to big hospital systems and insurers while using leftover funds for unrelated state purposes.
There has been longstanding bipartisan opposition to these financing schemes. Joe Biden, as Vice President, called Medicaid provider taxes a “scam.” Senator Dick Durbin referred to them as “a bit of a charade.” Former President Obama proposed limiting the scam in nearly the same way Senate Republicans now propose. A Washington Post editorial praised Obama’s proposal in “A Much Needed Medicaid Reform.”
The provider tax is the fuel for large corporate welfare payments to politically connected hospital systems. As Paragon has previously detailed, there are two parts to money laundering schemes. First, the provider taxes and related gimmicks, in which providers send money to the state. Second, the state pays providers back through different kinds of payments with additional funds leveraged from the federal government. These payments increasingly go through health insurers, who thus secure a cut of the loot, and are referred to as state-directed payments (SDPs). Under the Biden administration, a rule from the Department of Health and Human Services caused provider tax-fueled SDPs to explode — quadrupling in size. States are now funneling large amounts of federal dollars to big hospital systems, with Medicaid rates now at least twice as high as Medicare’s. Obamacare further fueled states’ use of provider taxes because, under the law’s Medicaid expansion, Washington sends states $9 of federal funds for each $1 of laundered funds from the state—a very high rate of return.
Lawmakers must recognize the massive cost shift that has occurred from the states to the federal government over the last 15 years. States are now paying the lowest percentage of Medicaid costs ever — only 25 percent of the total bill, which is well below their historic 40 percent share. As a result, states increasingly view Medicaid as a cash cow to deliver federal funds within the state rather than as a welfare program to assist the truly vulnerable with health care access.
The Senate Finance Proposal is a Positive Step Toward Curbing These Schemes
Given these problems, it is vital that Congress preserve the reforms in the Senate version of the One Big Beautiful Bill (OBBB). Doing so will strengthen the integrity of the Medicaid program, improve states’ incentives to achieve desirable outcomes from the Medicaid program, and reverse large abuses of the Medicaid program that occurred under the Biden administration.
While both bills aim to curb Medicaid money laundering, the Senate version goes further by phasing down provider tax use and bringing SDPs under Medicare caps. The House-passed OBBB sensibly froze the provider tax scam so it could not get worse. It also eliminated states’ abilities to design particularly egregious, explicit kickback scams (California designed one of these to obtain federal funds to expand Medicaid to illegal immigrants) and capped future SDPs at or slightly above Medicare rates.
The Senate version brings existing SDPs into the Medicare payment cap over time and phases down states’ ability to use provider tax revenue as the state’s share of Medicaid in expansion states. Phasing down provider tax laundering in expansion states sensibly addresses the fact that expansion states receive significantly more federal funds than non-expansion states and can leverage a higher rate of return from the laundered funds. For this latter reason, nursing home and intermediate care facilities are rightly exempt, as they primarily serve traditional Medicaid enrollees.
The Senate’s approach, which targets the schemes that overwhelmingly benefit large health systems while creating a fund for at-risk rural facilities, is the sensible and efficient way to direct federal taxpayer dollars.
Big Hospital Systems Hide Behind Rural Hospitals
Hospital systems and their allies claim that Senate reforms to limit Medicaid money laundering will harm rural hospitals. These arguments don’t hold up to scrutiny for several reasons.
First, CMS reports rural hospitals account for only 5 percent of total Medicaid inpatient hospital spending. In reality, large hospital systems—not rural facilities—reap the lion’s share of the returns. The overwhelming gains from these schemes go to large health care conglomerates. United Health Services (UHS) shows how provider tax schemes are leveraged. The Wall Street Journal highlighted the large profits that UHS has been able to accrue from the Medicaid money laundering apparatus:
Last year, 68% of UHS’s pretax income came from government outlays commonly known as supplemental Medicaid payment programs, including so-called state-directed payments. …
UHS netted $1 billion of these payments last year, up from $629 million a year earlier. Those payments contributed directly to pretax earnings because there was no incremental expense associated with them. [emphasis added]
Second, rural hospitals already benefit from numerous federal programs designed to prevent service cuts or closures. Most rural hospitals are critical access hospitals (CAHs), which receive higher payments through the Medicare program than other hospitals. Furthermore, they would be exempt from the SDP policy. Other rural hospitals are Medicare Dependent Hospitals (MDHs), which can also get higher payments. Yet others are Low Volume Hospitals (LVH), which also earn add-on payments. There are at least six other federal programs that pay extra dollars to rural health providers.
Third, a forthcoming data analysis from Paragon’s Liam Sigaud shows that rural hospitals — at least in terms of employment — do not appear to have benefited from the hospital tax. In fact, he finds that states with a hospital tax have had markedly lower hospital employment in non-metro areas than states without a hospital tax.
Fourth, these money laundering schemes increase commercial health care prices. At the state level, North Carolina State Treasurer, Dale Fowell, highlighted how these provider tax and SDP schemes would increase health care costs, including commercial rates, in a letter he penned to the Centers for Medicare and Medicaid Services. By linking SDPs to average commercial rates, the damaging effects of these schemes are compounded to put upward pressure on commercial health care prices. The Biden administration approved a particularly egregious money laundering scheme in North Carolina, allowing a plan to raise Medicaid hospital rates to commercial levels in exchange for hospitals forgiving bad debt, most of which they already would have forgiven. Hospitals are poised to net billions in revenue from these schemes, all the while encouraging billing practices that increase prices for everyone.
Hard-working families pay the price of these schemes twice. First, by covering the exploding federal share of Medicaid. Second, as providers inflate prices for people with private health plans to extract even more from SDPs tied to commercial rates. Higher prices drive more money into the cycle, particularly as half of all states pay SDPs based on average commercial rates. This dynamic also contributes to hospital consolidation, which reduces options for care and further inflates prices.
Importantly, the Senate version does not prevent states and localities from using their own funds. It simply prevents them from milking the federal government.
Address the Rampant Money Laundering Mechanism While Targeting Federal Funds Appropriately
Congress must stand firm against special interests and finalize the Senate’s reforms. These measures represent a long-overdue course correction that restores the integrity of the Medicaid program, prioritizes the truly vulnerable, and halts the reckless manipulation of federal dollars by powerful hospital systems. Big hospital systems should not be allowed to hide behind rural hospitals to protect their windfall. A targeted rural hospital fund is the most efficient and sensible way to assist facilities at risk of closure without perpetuating broad-based abuse. Enacting these changes is essential to preserve Medicaid’s mission and ensure a sustainable, accountable safety net.
