Paying the 2025 Tax Bill: Medicaid Provider Taxes

Dozens of major individual and business tax policies from the 2017 Tax Cuts and Jobs Act (TCJA) will expire at the end of 2025. The Congressional Budget Office (CBO) estimates that extending those expiring tax cuts will cost $4 trillion over 10 years. With U.S. debt held by the public already at $28 trillion and rapidly climbing, lawmakers must offset, or pay for, tax cut extensions to avoid making the fiscal situation worse. BPC evaluated a series of offset options, working with the Tax Foundation’s dynamic Taxes and Growth (TAG) macroeconomic model on revenue and economic estimates. While not BPC endorsements, these policy options highlight the tradeoffs inherent in achieving fiscally responsible tax reform.

Below, we consider one option: changing Medicaid provider taxes.

Medicaid Provider Taxes Under Current Law

Medicaid is a federal-state partnership that provides health insurance and long-term care to low-income or disabled individuals. Around 79 million Americans (23% of the population) report having Medicaid or Children’s Health Insurance Plan (CHIP) coverage.

To support Medicaid costs, the federal government pays states a federal medical assistance percentage (FMAP) based on the state’s per capita income. This means that for a state with a 60% FMAP spending $200 on a Medicaid service, the federal government would cover $120 (or 60%) of the cost. The Affordable Care Act (ACA) expanded Medicaid, with the federal government covering 90% of medical costs for individuals who become eligible for coverage in expansion states. Forty states plus DC have expanded Medicaid coverage.

Total Medicaid spending was about $880 billion in fiscal year 2023, with about $606 billion coming from federal contributions (69%) and $274 billion from all states (31%).

To increase the Medicaid match from the federal government, most states levy provider taxes on patient revenue generated by a provider, hospital, or other health care entity. Provider taxes are commonly applied to inpatient hospital services and nursing facility services. States then put this new revenue back into their state health care system through payments for Medicaid services. Because the state is adding funds to the program, the federal government matches the state’s FMAP rate. In 2018, provider taxes accounted for about $37 billion of the total Medicaid funding from states. Currently, all states (except Alaska) have at least one provider tax in place.

State Provider Taxes Allow States to Increase Federal Matching in Medicaid While Generally Holding Providers Harmless

As provider taxes became more popular in the 1980s, federal policymakers became concerned that states were using these taxes primarily to draw additional Medicaid funding from the federal government. Congress enacted reforms in 1991 to limit states’ use of provider taxes.

The providers being taxed are largely supportive because the tax revenue—and enhanced federal match—from the provider taxes are primarily directed to additional Medicaid spending. Without this tax in place, states would have to either increase their share of Medicaid spending to sustain the same level of funding; or instead reduce Medicaid services, eligibility, or payment rates.

Provider Tax Reform Options

In response to growing federal deficits, some policymakers have proposed reforming Medicaid provider tax rules.

A central issue for reform is what level the “safe harbor” threshold for provider taxes is set at. States do not risk losing their federal Medicaid match if their provider taxes are 6% or less of a provider’s net patient revenues (i.e., the “safe harbor” threshold).

In December 2024, CBO estimated the budget impact of reducing the “safe harbor” for provider tax rates from the current 6% down to 5%, 2.5%, or 0% (i.e., eliminating the safe harbor). The breakdown of savings can be found in the chart below.

Reductions in Medicaid provider taxes would likely save the federal government significant amounts of money, on the assumption that states would not be able to make up for lost revenue from provider taxes. Reducing the safe harbor amount from 6% to 5% would save an estimated $48 billion over 10 years while a reduction to 2.5% would save an estimated $241 billion over 10 years. In some cases, states may choose to cut payments for services and reduce Medicaid coverage. States may also choose to offset a loss in federal Medicaid funding with tax increases or with spending cuts elsewhere in their budgets.

Democratic and Republican leaders have at various times called for changes to the provider tax practice. In a 2010 report, the bipartisan National Commission on Fiscal Responsibility and Reform (i.e., the Bowles-Simpson Commission) called for a reduction in the provider tax safe harbor threshold to help reduce the deficit. President Obama also called for a phasing down of the 6% threshold in his 2013 budget.

Potential Drawbacks

The health care sector could be negatively affected, with possible reductions in Medicaid payment rates and coverage for fewer people. As noted above, this could affect communities with high numbers of Medicaid enrollees including rural hospitals and providers that typically operate on tight budget margins. States, providers, and advocates have raised concerns that these changes could reduce access to care for Medicaid beneficiaries.

Some Medicaid enrollees who lose coverage may shift to employer-sponsored insurance or marketplace coverage, where out-of-pocket costs are typically higher, while others may remain uninsured. CBO has noted that there is great uncertainty over whether states would choose to increase revenues, cut spending, or utilize a mixture of both to account for lost federal revenue.

To mitigate potential negative impacts on state Medicaid budgets or state planning, federal policymakers could slowly phase down the safe harbor threshold over time. One option would phase down the safe harbor threshold by half a percentage point every two years, recognizing that many states enact budgets on a biennial basis and require extra time to plan.

Gradually Reducing Safe Harbor Threshold Would Cut Federal Deficits, Giving States Time to Plan

This option is illustrative and should not be construed as a specific BPC recommendation.

Conclusion

While provider taxes have made up a growing share of state Medicaid financing in recent years, policymakers in both parties have expressed concerns about misuse or abuse of the current rules. The Medicaid Voluntary Contribution and Provider-Specific Tax Amendments of 1991 put bipartisan guardrails around the use of the provider tax, and additional reforms may be considered in 2025. If new reforms to the provider tax “safe harbor” threshold are implemented, then states would need to devote more of their own revenue to Medicaid spending, make cuts to coverage or payment rates under their Medicaid programs, or make cuts elsewhere in their budgets.

Read BPC’s full set of offset options here and find all of BPC’s tax policy work at https://bipartisanpolicy.org/tax/.