End the Medicaid Shell Game
Hidden loopholes in Medicaid undermine's the program's ability to serve the vulnerable
For decades, state governments have quietly manipulated the Medicaid funding formula through a clever, if deeply disingenuous, scheme involving provider taxes. This fiscal maneuver, now entrenched in many states, allows governments to conjure up federal Medicaid dollars without putting forth real state spending. It’s a budgetary illusion, one that undermines both the intent of the federal-state Medicaid partnership and the integrity of the program itself. Congress should end this practice by prohibiting provider tax schemes that recycle payments to inflate federal Medicaid matches, ensuring that states contribute real funds, not circular accounting entries.
Under this scheme, states impose taxes or fees on Medicaid providers, typically hospitals, nursing homes, or managed care organizations (MCOs). The providers pay this tax to the state. But the twist is that the providers often get their money right back from the state, either directly through enhanced Medicaid payments or indirectly through supplemental programs and rate increases. The state then uses this higher spending level to trigger a larger Federal matching payment, even though much of that spending wasn’t borne by the state at all, and was merely the state returning providers’ money right back to them. Everyone inside the loop wins except, of course, the federal taxpayer, who picks up the tab through increased federal Medicaid outlays sent from Washington.
California provides one of the most blatant examples. The state has been projected to raise nearly $20 billion in under four years through its newly enacted managed care organization (MCO) tax, not by asking more of California taxpayers, but by recycling money from MCOs back to MCOs in a way that allows the state to claim higher Medicaid spending and thereby draw down additional federal matching funds. New York has proposed a similar maneuver. These are not isolated cases but represent a well-worn path that state budget offices and Medicaid administrators have traveled for years, with each new iteration stretching the bounds of legality and ethics just a bit further. As of December 2024, at least 20 states have imposed an MCO provider tax.
To be clear, provider taxes are legal under federal law, so long as they meet certain conditions, most notably, that states are prohibited from repaying the providers who pay the tax, whether directly or indirectly. But this “hold harmless” provision has been undermined through technical loopholes, strategic rate design, and a general lack of federal enforcement.
Federal regulators have been unable to rein in these schemes due to a combination of legal ambiguity, complex financial arrangements, and entrenched political interests. While the “hold harmless” rule technically prohibits states from reimbursing providers for the taxes they pay, states often skirt this rule through cleverly designed rate increases or supplemental payments that achieve the same effect — returning the tax money to providers — without triggering enforcement. The federal Centers for Medicare and Medicaid Services (CMS), tasked with oversight, is hampered by three key obstacles:
Legal ambiguity, which blurs the lines of what constitutes a repayment and makes enforcement difficult;
Complex financial arrangements, which obscure the flow of funds and enable states to mask recycled payments as legitimate expenditures; and
Entrenched political interests, which discourage aggressive oversight and insulate these schemes from scrutiny.
Meanwhile, powerful provider lobbies and state officials, reliant on this revenue loop, have successfully resisted crackdowns and have left CMS hesitating to push back against politically sensitive funding mechanisms. The result is a system where provider taxes are used not to fund healthcare, but to unlock federal money in a circular flow that looks suspiciously like money laundering through the government’s own books.
The damage goes well beyond technical concerns about accounting rules. The scheme distorts the fiscal relationship between states and the federal government, incentivizes expanded Medicaid payments, and allows state governments to appear fiscally prudent while outsourcing the real costs to the federal taxpayer. The Congressional Budget Office estimates that this scheme will cost the federal taxpayer over $600 billion in the coming decade.
Aside from fiscal costs, the tax maneuver erodes transparency and accountability, hiding the true sources of Medicaid funding and weakening the natural budgetary discipline that comes from having skin in the game. Perhaps worst of all, it reduces Medicaid’s effectiveness by shifting the focus from care delivery to revenue maximization.
Congress has allowed this charade to continue for too long, but a new opportunity for reform has emerged. The House recently passed the One Big Beautiful Bill (OBBB), which includes a long-overdue measure: a statutory end to Medicaid provider tax schemes that include hold-harmless guarantees. In essence, the bill would codify what federal regulators have long tried, and largely failed, to enforce: that state spending should be real, not recycled and that provider taxes should not be back-door ATMs for gaming the federal match. The bill prohibits states from creating new provider taxes or expanding existing ones and restricts how provider taxes can be used to finance Medicaid.
While it is promising to see that Congress is finally acknowledging this problem, the OBBB provision is a partial fix and not a complete solution. The provision stops short of dismantling the entrenched structure that allows billions in recycled spending to masquerade as legitimate state contributions. In that sense, it's a bit like telling states to stop building new loopholes while leaving the old ones wide open.
The responsibility to see this through now lies with the Senate. This should not be a partisan issue. It is a test of whether Congress is willing to defend the principle of fiscal honesty in a program that consumes nearly one-fifth of federal mandatory spending. Senators must resist the inevitable lobbying from provider associations and state officials who have grown accustomed to the easy money. They must recognize that reforming this financing abuse is not about cutting Medicaid, it is about restoring integrity to it.
Medicaid should serve the vulnerable, not serve as a conduit for budget gimmicks. States should fund their share of the program with real money, not accounting tricks. And Congress should protect the federal treasury not just with rhetoric about fraud and abuse, but by ending one of the most pervasive and politically tolerated abuses in the system.
The time for technical guidance and administrative delay is over. If lawmakers are serious about safeguarding federal resources and restoring public trust in entitlement spending, they must close the door on this shell game once and for all.