Beneath the surface of Medicaid’s state-federal partnership lies a tangled web of financial sleight-of-hand that quietly drains federal coffers, shifts enormous costs from states to the federal government, and raises premiums on working people.
To explain the issue, last month, Paragon Health Institute released a report titled “Addressing Medicaid Money Laundering.” The term “Medicaid money laundering” was coined by the Wall Street Journal in a 2008 editorial, but some criticize our use of the term and defend these “creative” financing arrangements. In doing so, critics use innocuous, often misleading terms and provide superficial descriptions that downplay the egregiousness of these schemes. To paraphrase famed radio announcer Paul Harvey, let’s give you the rest of the story.
Since Medicaid’s inception, the federal government has given states money for a portion of the program’s costs, while states administer the program and shoulder the remaining cost. States pay just 10% for able-bodied adults without children. But when it comes to the most vulnerable — children, the elderly, pregnant women, and people with disabilities — the state share can rise to as much as 50%, depending on the state. But states are sidestepping financial responsibility and laundering money from healthcare providers to maximize federal loot.
Provider Taxes
One mechanism for these practices is the “provider tax,” in which states tax providers, then later pay those funds back to those same providers through Medicaid. Those payments trigger funds from a federal match, which states and providers can split among themselves.
Recognizing this was a major problem, Congress restricted provider taxes in 1991. These restrictions were intended to limit money laundering schemes driving federal spending. But states were still allowed to tax and return funds within a “safe harbor” cap of no more than 6% of a provider’s patient revenue. Today, states and providers continue to use that safe harbor, as well as other new mechanisms, to siphon federal dollars.
Critics invoke the 6% cap as if it were a summary judgment acquitting these practices. However, supporters of “provider taxes” intentionally omit explanations on what the 6% safe harbor means, because to do so would expose how the practice undermines Medicaid’s original structure.
The Congressional Budget Office recently published a paper analyzing the effects of hypothetical policy changes, including “provider taxes.” However, the paper contains contradictory statements regarding the structure of these taxes and their potential limitations. To clarify, there is no federal limit on how much states can tax providers, and there is no policy being discussed that would limit the ability of states to tax providers.
The “safe harbor” basically means that as long as the tax is no more than 6% of an entity’s revenue, the entity can be guaranteed to get all its money back. If the entity weren’t guaranteed to get the money back, there would be no other logical reason why tax-exempt hospitals are fighting to keep paying these taxes. No one pays a tax knowing that when they pay it, they will get every dime back. This clearly does not meet the definition of a tax.
Managed Care Organization Taxes
Paragon’s paper highlighted California’s use of Medicaid managed care taxes to pay for illegal immigrants. Critics of the paper correctly point out that it is illegal to use federal funds to support illegal immigrants. A closer examination of the California managed care tax shows how states can launder federal money to get around that prohibition.
California taxes insurance plans $1.75 per member per month for those with private insurance, but taxes insurance plans $182 per member per month for those in Medicaid plans — more than 100 times higher than private plan taxes. So, the state can most effectively target the windfall federal revenues raised through the scheme to Medicaid providers and insurers while holding commercial insurers virtually harmless.
The scheme is simple. California taxed Medicaid plans $16.7 billion, and it then sent the money right back to the plans. The state then told the federal government: “This is money we spent on Medicaid, so give our federal match.” That match equals $9.5 billion. Thus, the insurance plans got their $16.7 billion back through higher payments, and California deposited the $9.5 billion from the federal government into its general fund. It is both a political and fiscal win for the Golden State, but a loss for federal taxpayers.
While it is illegal for states to use federal dollars to cover illegal immigrants in Medicaid, that ignores the clear money laundering occurring. In the criminal world, one launders money by moving it around in different accounts, thereby making “dirty” money look “clean.” This enables the use of funds in ways that would otherwise be illegal. Similarly, California moved money around and generated a clean $9.5 billion from the Treasury for its general fund. Since the state receives the money through financing schemes, it is now state money that can be used to cover illegal immigrants in the Medicaid program. Both the Wall Street Journal and Paragon have used the correct term, Medicaid money laundering, for this egregious practice.
State-Directed Payments
Another program under scrutiny is state-directed payments: additional payments that states, using almost entirely federal money, direct Medicaid insurers to make to hospitals and other providers. Hospital lobbyists claim SDPs are a needed source of revenue for hospitals and want the story to end there. But there is much more to them, as states often pay hospitals two to three times the rate of Medicare for the same service under these schemes.
If the state paid its fair share of Medicaid services, few states would say they could afford to pay hospitals rates where they can make large profits through Medicaid. However, for able-bodied working-age adults, the state pays no more than 10% of the Medicaid cost. The hospitals, even those that would otherwise be tax-exempt, work with consultants to develop a provider “tax” on themselves, which the state gets to use toward its 10% share of spending. In essence, the state received $900 for every $100 it says it spent, even though none of that $100 was actual state spending.
As long as the tax is not more than 6% of its revenue, the hospital system can be guaranteed to get its money back. Meanwhile, the hospitals convince the legislature that increasing their reimbursement rates won’t cost the state anything, and in some cases, states end up with more money in their general funds from the scheme. So, with permission from the Biden administration, the federal government is paying many hospitals two to three times more for Medicaid services than for services given to seniors on Medicare. And, while Medicaid payments are required to mirror those for Medicare through fee-for-service arrangements, this cap does not apply to payments funneled through insurance companies that run a Medicaid plan.
Raising these payments is a large reason why the amount of money the federal government is projected to pay for Medicaid beyond already assumed spending over the next 10 years increased by over $1.2 trillion during the Biden administration.
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As offensive to taxpayers as that scheme is, it also increases insurance premiums for everyone else who has private insurance. By tying Medicare rates to the average rate paid for the same service by commercial insurance, larger hospitals with dominant market share have an incentive to demand higher commercial rates because they will also get an increase in their Medicaid rates. Thus, these higher commercial rates lead to higher healthcare costs and premiums for everyone else.
Whether through California’s laundering to fund illegal immigrant coverage or through creative tax schemes, states are laundering Medicaid dollars. And, now you have the rest of the story.
Ryan Long is the director of congressional relations and a senior research fellow at Paragon Health Institute.