Want To Gut Medicaid? It’s Not So Easy.

Republicans are desperate to slash Medicaid—but a top plan would hit red states the hardest

A woman holds a sign expressing fear of cuts to Medicare, Medicaid and Social Security, at a "Hands Off!" protest against the Trump administration. Photo by David McNew/Getty Images.

Republicans have a math problem. In order to fund massive Trump tax cut extensions for the uber-wealthy and to increase defense spending to $1 trillion annually, they need to cut federal spending elsewhere. But coming up with trillions in cuts is impossible unless you touch the political third rails of either Social Security, Medicare, or Medicaid.

The GOP has decided it will go after Medicaid in search of some $880 billion in savings, or around 11 percent of the total Medicaid budget over the next 10 years. Republicans have asked the Energy and Commerce Committee, which oversees both Medicare and Medicaid, to find the money somehow. They did this knowing the committee can’t possibly achieve this without cutting deeply into federal Medicaid dollars, which their own constituents rely on heavily, especially to fund rural hospitals and nursing homes.

That presents a political problem for Republicans. They can’t come out and say they are slashing funding for the poor in order to fund tax cuts for the rich. So they are trying to pull a fast one on the American public: They plan to claim that they are slashing Medicaid to cut “fraud, waste, and abuse,” because who could be against cutting that, right? This packaging is intended to make these terrible cuts politically palatable.

But as DOGE has recently discovered, while “fraud, waste, and abuse” certainly exist in every system, it’s hard to find that much. DOGE, for example, set out promising to cut $2 trillion, which it refined to $1 trillion, then brought down to $150 billion, and much of even that amount is in serious doubt.

So there’s certainly not $880 billion to be found in Medicaid, right?

That depends on how Republicans spin it. As the New York Times reported, some Republicans believe they have found a “culprit” to point to. The culprit is known as the “provider tax” reimbursement, but expect the GOP to begin to call it by other names such as “Mediscam.” If eliminated, that could save the government just around $600 billion of the $880 billion target, a sizeable chunk of what’s needed.

Cutting $600 billion from a program that abuses the system sounds like common sense. But as with most things in our politics, the picture isn’t nearly so clear.

The provider tax “loophole”

Were you to ask most voters, they couldn’t tell you how Medicaid really works. There’s a common belief, pushed hard by right-wing media, that Medicaid is somehow “bad” while state-funded healthcare for the poor or disabled is still “good.”

The fact is, these programs are one and the same. That’s because the federal government, through Medicaid, provides grants in the form of matching funds to the states to help cover the cost of medical care for their residents. Typically, a state will pay around 30 percent of medical costs while the government picks up 70 percent.

When speaking to lower-information voters, it’s helpful to begin with a shared sense of how important their state healthcare plan is—a name they likely will recognize—before talking about how Medicaid funds that state program.

The problem with a federal matching funds program is that it is inherently vulnerable to abuse. That’s because the higher your state “costs” are, the more money the government will fund. States are incentivized to report higher costs so they get more money.

This is akin to managers within a company who rack up higher bills for their department so that they receive more money from corporate headquarters.

The “provider tax” loophole became a way to pull this off with Medicaid. Once upon a time, a clever state health secretary in New Hampshire came up with a solution for the governor’s budget hole dilemma: raise taxes on state health providers (such as hospitals and nursing homes), causing the state’s “spending” on healthcare to rise on paper. Then seek federal matching funds on the inflated costs, while reimbursing your hospitals and nursing homes the same net amount as before.

Presto! The state receives more money from the government while the hospitals and nursing homes are made whole.

The NYT provided a useful graphic for how this scheme works. The left shows how basic Medicaid payments function, while the right explains how states like New Hampshire began to game the system using healthcare provider taxes.

You can see that the key difference is the total amount of money that the federal government reimburses the state—in this case $18 more on each $1,000 spent by the state. That’s because the federal government reimburses based on the original payment made by the state to the providers (here, $1,030), even though the state later gets back some of those costs (in this case, $30) in the form of taxes assessed on hospitals and nursing homes.

Clever. And totally legal.

Other states quickly took notice, and today, some four decades after the original scheme was hatched in New Hampshire, some 49 states (Alaska being the sole exception) use “provider taxes” to pad their reimbursements from the federal government. And 39 states have implemented three or more different kinds of provider taxes to help fund their share of Medicaid costs. As the Times noted,

In some states, provider taxes and related payments bring in more than a third of overall federal funding for the program.

You can see why this would be a plum target for cost-cutters eager to close an $880 billion funding gap.

Not so fast

Were you to read only the piece in the Times, you might come away agreeing that the federal government ought to close this loophole entirely. After all, this sounds a lot like “abuse” that states shouldn’t get away with.

The original perpetrator so much as admits this. “It was a way of the state basically gaming the federal government, for lack of a better term,” former New Hampshire Governor Judd Gregg said recently.

But the federal government didn’t just let this behavior go on unchecked. It soon realized what the states were doing, and in the 1990s it stepped in to regulate how states were reimbursed for healthcare provider taxes.

According to KFF, a leading health policy organization, formerly known as the Kaiser Family Foundation, federal rules imposed three main criteria such provider taxes had to meet:

1. They had to be broad-based, meaning they applied to all health providers within a category. That meant you couldn’t just single out certain providers for the taxes. That prevented states, for example, from only imposing the tax on providers that primarily saw Medicaid patients, such as rural hospitals and nursing homes.

2. The healthcare provider taxes had to be uniform, meaning they had to be applied to all providers within the specified class. This prevented the tax from being set higher on Medicaid revenue than on non-Medicaid revenue.

3. They couldn’t give guarantees to healthcare providers that they would receive the extra tax assessed on them back through what’s called a “hold harmless” clause. This eliminated the “wink and a nod” aspect of the taxes, where the parties had a side agreement that they would inflate costs in the form of new taxes in order to jointly cause the government to issue larger reimbursements.

That last requirement needs some further explanation. In the federal rules, there’s now a “safe harbor” provision that says that these “hold harmless” rules don’t apply if the tax revenues from the provider tax are six percent or less of net patient revenues.

That’s a complicated way of saying, “If you keep the provider taxes at a sane level, we won’t dig into what reimbursement and tax arrangements you have with your hospitals.”

The upshot of these rules and the safe harbor is that while healthcare provider taxes may have started out as a way to game the federal system into providing more healthcare dollars to struggling states, soon nearly everyone was doing the same thing legally and with the government’s blessing. It’s as if the government responded, “Look, we get it, you’re inflating your state’s costs. Everyone is. But as long as you follow these rules, we’ll allow it because it’s clear you all need the money.”

An easy target

Provider tax reimbursements are likely in the crosshairs of congressional cost slashers. It’s a quick and dirty way to reduce federal Medicaid reimbursements to the states. Just stop reimbursing provider taxes altogether!

This, of course, would blow a huge and immediate hole in the budgets of states that rely on these reimbursements. Services would be slashed across the board, and they would particularly affect rural hospitals and nursing homes.

Rather than come after all such provider taxes, another proposal is to slash costs by reducing the “safe harbor” provision, now set at six percent. It’s not surprising that once the federal government set a safe harbor limit, many states would go right up to it to maximize their allowable reimbursements. Why not, right?

The answer is the risk of dangerous dependence on something that could one day go away. If Congress dropped the safe harbor level by so much as half a percent, the impact would fall disproportionately on any states that are above that new limit.

Guess which states have pushed right up to the maximum allowed safe harbor? That’s right, it’s largely the red states.

Here’s a map from KFF showing states where the provider tax is over 5.5 percent, looking just at instances of such taxes on nursing facilities:

The GOP may be toying with the idea of gutting reimbursements for healthcare provider taxes, but the reality is this will disproportionately impact their own states and constituents.

Three red states with an even bigger problem

The impact of Medicaid cuts, whether through the elimination of healthcare provider tax reimbursements, some kind of reduction in the “safe harbor” limit, or a reduction in the number of eligible recipients (say, through additional work requirements) will hit the states very hard. But the effects may be felt hardest in three red states: South Dakota (where the Senate Majority Leader John Thune is from), Missouri, and Oklahoma.

Why is that? These states now participate in the Medicaid expansion program after enshrining express state constitutional provisions by statewide referenda. Under Medicaid expansion, the federal government pays 90 percent of the costs for working-age adults who enroll through the expansion.

The other 40 participating states (plus D.C.) can stop covering working adults if the federal government chokes off its Medicaid reimbursements. It’s not a great outcome, but at least it wouldn’t bankrupt the states.

But South Dakota, Missouri, and Oklahoma can’t do that because of their state constitutions. As the Times explained,

Because states would become responsible for what had once been paid by the federal government, the states with constitutional amendments would have especially high financial stakes. In Missouri, Medicaid funding makes up about 35 percent of the state’s entire budget. If the federal government pulled back, the state would probably have to raise taxes or cut other parts of its budget, like education or transportation.

That has created some unusual Medicaid bedfellows in Congress. These include Sen. Josh Hawley (R-MO), who has spoken out against cuts to the program, likely because he knows what it would do to his state.

As the Energy and Commerce Committee considers deep cuts to Medicaid this week while it marks up the House version of the budget bill, Republican representatives are starting to see more clearly how this is a bad deal for their districts and states no matter what approach they take.

The question then becomes, whose wrath do they fear more? Is it the Trump White House, which wants to extend those tax breaks for the wealthy? Or is it their own angry constituents, who will have to take grandma out of the nursing facility and bring her home?

Stay tuned.