CMS has issued a proposed rule to close what it describes as a Medicaid tax “loophole” that some states have exploited to increase federal payments while minimizing their state financial contributions. The proposed rule aims to ensure that federal Medicaid dollars are used to support vulnerable populations rather than being redirected to fund other state programs, including healthcare coverage for undocumented immigrants.
“States are gaming the system — creating complex tax schemes that shift their responsibility to invest in Medicaid and rob federal taxpayers,” CMS Administrator Mehmet Oz, MD, said in a May 12 news release. “This proposed rule stops the shell game and ensures federal Medicaid dollars go where they’re needed most — to pay for health care for vulnerable Americans who rely on this program, not to plug state budget holes or bankroll benefits for noncitizens.”
Eight things to know:
The Medicaid tax loophole explained
1. Under federal law, states can levy taxes on stakeholders and count them as part of their state share for Medicaid funding, provided the taxes are broad-based and uniform, or pass specific regulatory tests, according to CMS. However, taxes that are not generally redistributive are prohibited.
2. The agency argues that some states have exploited a loophole by targeting specific entities with taxes that draw down higher federal matches — in some cases up to 77% for traditional Medicaid populations — and then redirecting those federal dollars back to the taxed entities. “That’s what most Americans call money laundering,” CMS said in a news release.
3. For example, some states impose taxes on all managed care organizations but structure them so they primarily impact Medicaid business within those MCOs, effectively ensuring that the same entities receive the redistributed federal funds. In California, for example, Medicaid business can be taxed at $274 per member/per month, while non-Medicaid business is taxed at just $2 per member/per month, according to CMS. These arrangements allow states to benefit from a budget surplus to reinvest in unrelated programs — including the $8.5 billion program in California to cover more than 1.6 million illegal immigrants and other non-citizens.
4. In its final year, the previous administration approved four waivers that leveraged this tax loophole, submitted by California, Michigan, Massachusetts, and New York, according to CMS. Collectively, these four states account for more than 95% of the projected federal taxpayer losses resulting from the loophole. “If CMS had not taken decisive action, more states could have exploited this tax loophole. A CMS estimate shows that if just two more states adopt these schemes each year, excess federal costs could balloon more than $74 billion over 5 years,” the agency said.
What would the proposed rule do?
5. CMS’ proposed rule would:
- Ban states from taxing Medicaid business at higher rates than non-Medicaid business;
- Prevent the use of ambiguous language to obscure Medicaid-specific taxes;
- Continue statistical testing while introducing additional safeguards to deter system manipulation; and
- Implement a phased transition timeline based on the duration of existing waivers.
6. The proposed rule is particularly aimed at curbing alleged tax schemes employed by California, Michigan, Massachusetts and New York, which are responsible for 95% of the projected federal losses under the loophole, according to CMS. The rule would provide a transition timeline based on the age of existing waivers, allowing states to phase out these practices.
7. CMS emphasized that the proposed rule is designed to restore the original intent of Medicaid funding: to support vulnerable populations such as low-income seniors, pregnant women, children and individuals with disabilities.
“This isn’t just wasteful — it’s wrong,” Drew Snyder, CMS Deputy Administrator and Director of Medicaid & Children’s Health Insurance Program Services, said. “Medicaid was designed to protect low-income seniors, pregnant women, children, and people with disabilities — not subsidize coverage schemes that displace our most vulnerable.”
8. The proposed rule has been published in the Federal Register and is open for public comment until July 14.
