CONGRESSIONAL RESEARCH SERVICE RELEASES MEDICAID FINANCING REPORT.

October 2, 1991

SUMMARY

Medicaid is a joint Federal-State program providing medical assistance for specified groups of low-income persons who are aged, blind, disabled, or members of families with children. The Federal Government shares in the cost of Medicaid services through a variable formula under which the Federal matching rate is inversely related to a State's per capita income. Combined Federal/State cost in FY 1991 is expected to be $91.2 billion, of which the overall Federal share is 57 percent, or $52.0 billion.

Medicaid spending is projected to double by FY 1996, placing increasing strains on many States' budgets. One solution adopted by many States has been to use funds donated by health care providers or taxes paid by those providers to draw greater Federal matching payments. For example, hospitals may donate funds to the State. The State will use these funds as the State share of Medicaid spending, receive Federal matching funds, then repay the hospitals their donations plus the Federal funds. Similar increases in Federal funds may be generated through taxes or mandatory assessments on providers. In some States, there has been a clear connection between what providers paid in the form of donations or taxes and what they received back in Medicaid payments. In other States, any increased Federal funds have been used for general Medicaid spending, and any benefit to the provider has been indirect.

As of August 26, 1991, 29 States reported that they expected to use donation or tax programs to fund some part of State Medicaid spending during State 1992 fiscal years, raising as much as $7 billion in increased Federal funds. The Administration contends that these financing mechanisms allow States to receive Federal funds without having incurred any real costs. The States have questioned Federal authority to scrutinize State funding sources and have argued that donation and tax programs are essential to maintaining Medicaid services. Congress has repeatedly delayed the Secretary's authority to regulate in this area. The Omnibus Budget Reconciliation Act of 1990 prohibited any change in the rules on provider donations before December 31, 1991. It permanently prohibited any limits on the use of provider taxes as the State share of Medicaid, but allowed denial of Federal funds if Medicaid repaid a hospital or nursing facility for the costs of State taxes.

On September 12, 1991, the Secretary published an interim final rule on donations and taxes, to be effective January 1, 1992. Under the new rule, revenue from donations or other voluntary payments will be deducted from a State's Medicaid expenditures before computing the Federal share, as will repayment of provider taxes. The definition of "repayment" is broad, and critics of the rule contend that it exceeds statutory authority and would ban nearly all provider taxes. There are also questions about the rule's potential effect on transfers of funds among State and local agencies. While there is pressure on Congress to modify the new rules, to do so would be to eliminate anticipated Federal savings. Under current law, the cost of any change would have to be made up through new revenues or cuts in other programs.

CONTENTS

BACKGROUND: MEDICAID AND MEDICAID COSTS

BACKGROUND: MEDICAID AND MEDICAID COSTS

Medicaid is a Federal-State program providing medical assistance for specified groups of low-income persons who are aged, blind, disabled, or members of families with children. Within Federal guidelines, each State designs and administers its own program. Thus there is substantial variation among the States in terms of persons covered, types of benefits provided, and payment rates for covered services.

The Federal Government shares in the cost of Medicaid services through a variable matching formula. The Federal matching rate, known as the Federal medical assistance percentage (FMAP), is inversely related to a State's per capita income and may range from 50 to 83 percent. Currently 12 States, the District of Columbia, and all the territories receive the minimum 50 percent FMAP. ¹ Mississippi has the highest FMAP in FY 1991, 79.93 percent. The Federal share of State administrative expenditures is 50 percent in all States; higher matching is allowed for certain administrative activities. Overall, the Federal share of Medicaid spending is expected to be 57 percent in FY 1991.

When Medicaid was enacted in 1965, it was targeted chiefly at persons receiving cash welfare: Aid to Families with Dependent Children (AFDC) or Supplemental Security Income (SSI) for the aged, blind, and disabled. Over time, the program has begun to serve additional populations. It is the major source of funding for nursing facilities (NFs) and other long-term care; it provides supplemental coverage to low-income Medicare beneficiaries; and it is now covering pregnant women and children with no ties to the welfare system.

In FY 1991, 27 million people are expected to receive services under Medicaid, at a combined Federal/State cost of $91.2 billion. As table 1 indicates, Medicaid spending has risen sharply in recent years after a period of more moderate growth in the mid-1980s. Projected FY 1991 spending is 49 percent higher than the FY 1989 total of $61.2 billion, and costs are expected to rise another 18.7 percent in FY 1992, to $108.2 billion.

                               TABLE 1.

States cite one additional factor in program growth: the recent expansion of Federal minimum requirements for Medicaid programs, or "mandates." Legislation in recent Congresses has affected every major aspect of Medicaid operations:

ELIGIBILITY: Beginning with the Medicare Catastrophic Coverage Act of 1988 (MCCA, P.L. 100-360), Congress has steadily expanded mandatory coverage of pregnant women and children. States must now provide Medicaid to pregnant women and children under age 6 with incomes up to 133 percent of the Federal poverty line. Mandatory coverage of older children up to 100 percent of poverty is being phased in during the 1990s. MCCA also began the phase-in of requirements for States to pay Medicare premiums, deductibles, and coinsurance beneficiaries below the poverty line (known as qualified Medicare beneficiaries, or QMBs). The Omnibus Budget Reconciliation Act of 1990 (OBRA 90, P.L. 101-508) requires payment of premiums for beneficiaries up to 120 percent of poverty by 1995.

SERVICES: Congress has made only minor additions in recent years to the list of basic medical services all States must provide. However, the Omnibus Budget Reconciliation Act of 1989 (OBRA 89, P.L. 101-239) modified the definition of one existing service in a way that is expected to have a significant financial impact. States have for many years been required to provide Early and Periodic Screening, Diagnosis, and Treatment (EPSDT) programs. These programs provide health screenings and referral for follow-up care for Medicaid- covered children. OBRA 89 clarified that States must cover any service required for treatment of a condition found in the course of an EPSDT screen, even if that service would not ordinarily be covered under the State's Medicaid program.

REIMBURSEMENT: While States are generally free to set their own reimbursement levels for covered services, there are some minimum requirements; these, too, have been expanded in recent years. The Omnibus Budget Reconciliation Act of 1987 (OBRA 87, P.L. 100-203) included measures to improve the quality of nursing home care and required States to raise payment rates to reflect some of the changes. OBRA 87 also strengthened requirements for States to make additional payments to hospitals serving a disproportionate share of low-income patients. Finally, courts have begun more vigorous enforcement of the "Boren amendment," a rule enacted in 1980 that requires States' Payments to hospitals and nursing homes to be sufficient to meet the cost of "efficiently and economically operated" facilities. A number of States have been ordered to improve reimbursement, and suits are pending or likely in many more.

The precise extent to which Federal mandates have contributed to recent growth in Medicaid spending cannot be determined from available data. However, the Office of Management and Budget (OMB) and the Health Care Financing Administration (HCFA) have estimated that 59 percent of the growth in spending from 1980 to 1990 was related to general health care inflation, while 22 percent was attributable to the effects of Federal legislation and new State initiatives, such as programs to provide home and community-based long-term care services to the aged and disabled. ³

Whatever the effect of mandates so far, current law requires further expansion of Medicaid eligibility in the future, including broader coverage of children in poverty and of QMBs. States are also under increasing pressure to improve provider reimbursement rates. These factors, along with ongoing health care inflation, are expected to lead to continued spending growth at a rate of 15 percent a year through FY 1996. CBO estimates combined Federal and State spending for that year at $184.7 billion, more than twice the FY 1991 level.

This growth is occurring at a time when the current recession and other factors have placed increasing strains on many States' budgets. Medicaid is already one of the largest components of State funding and is rising much faster than other components. The National Association of State Budget Officers report that Medicaid costs (including administrative costs) accounted in the aggregate for 14 percent of total State spending in 1990 and estimates that Medicaid will reach 22 percent of State spending by 1995. ⁴

States would ordinarily have two basic options for responding to any financial pressures created by growth in Medicaid spending. First, they could cut that spending by eliminating optional services (such as prescription drugs) or by denying coverage to groups for whom coverage is not mandatory (such as higher-income persons in institutions). Second, they could finance program growth by increasing general revenues or by diverting resources from other programs to Medicaid.

Beginning in 1986, States have experimented with a third way of dealing with Medicaid cost increases: using funds donated by health care providers or taxes paid by those providers to finance the State share of Medicaid. The increased State funds generated through these mechanisms have allowed States to draw additional Federal matching payments and thus maintain current levels of Medicaid eligibility or benefits without raising or reallocating general funds.

The Administration has contended that these initiatives are shifting the burden of Medicaid towards the Federal Government in violation of the intent of Congress. In particular, HCFA has expressed concern about arrangements in which it perceives some linkage between the amount the State receives from a provider in donations or taxes and the amount the State returns to the provider in the form of Medicaid payments. HCFA has tried to regulate State practices for several years, most recently in an interim final rule published on September 12, 1991. The States, along with providers and other groups, have questioned HCFA's authority to scrutinize State funding sources and have denied that the linkages seen by HCFA actually exist. They have argued that current donation and tax programs are essential to maintaining Medicaid services in the face of State fiscal constraints.

The next section of this report provides a history of the State donation and tax programs, HCFA's attempts to regulate them, and congressional intervention through 1990. An overview of the status of State programs as of 1991 is followed by a summary of the new Federal rules and their potential impact.

PROVIDER DONATIONS AND TAXES: 1986-1981

The First Provider Donation Programs

Until 1985, Federal Medicaid rules permitted the use of donated funds for the costs of training State administrative personnel (former 42 CFR 432.60), but did not explicitly allow the use of donations for any other purpose. According to HCFA, the use of donations for purposes other than training was not allowed because "a 'kickback' situation could result from private donations made by a proprietary organization, such as a long-term care facility or data processing company, in return for Medicaid business." ⁶

By 1985, however, HCFA had concluded that the likelihood of abuse was small and that private donations could be used to finance the State share of any Medicaid service or administrative spending. A new regulation (42 CFR 433.45(b)) established two conditions for the use of donated funds:

o The funds had to be transferred to the Medicaid agency and be under its administrative control; and

o The funds could not revert to the donor unless the donor was a nonprofit organization and the Medicaid agency decided on its own to use the donor's facility.

The reversion of donated funds to for-profit organizations was prohibited because of a continuing concern about possible kickback arrangements, but no such concern was expressed about arrangements involving nonprofit entities. HCFA expected "little change from current levels of donations" as a result of the change in regulations and projected no financial impact. ⁶

In 1986 and 1987, West Virginia and Tennessee developed programs under which donations made to the State by hospitals were used to finance part of the State's share of Medicaid spending. HCFA initially approved both plans, but later took steps to deny Federal matching for the spending funded by the programs.

Under West Virginia's program, hospitals donated $23 million to the State's indigent care fund. The State used these funds along with Federal matching funds (at an FMAP of 72.6 percent) to generate $83 million in total payments to the hospitals. This device allowed the State to clear up most of a backlog of outstanding claims and make interim payment to the hospitals at higher than usual rates. The Department of Health and Human Services (DHHS) Grant Appeals Board later found that only those hospitals that made donations received the expedited payments, and that the donations were made with the understanding that the State would immediately pay the outstanding claims. Sustaining a HCFA disallowance of the Federal funds obtained by the State, the Board concluded that the donations had been made in return for inducements and were therefore not "voluntary." A Federal court later overruled the Board, finding that the Board had imposed requirements beyond those in the regulations. ⁷

Tennessee's program was similar in some respects. Public and private nonprofit hospitals made donations to the State that were credited to the Medicaid program's account for use as the State share in Medicaid expenditures. The donations came shortly after Tennessee made changes in its Medicaid program that benefited hospitals, including an increase in the annual limit on covered inpatient days per beneficiary (from 14 to 20) and increases in disproportionate share payments and payments for medical education costs. The tie between these changes and the donations was less clear than in West Virginia; some hospitals benefited even though they had not transferred any funds. For this and other reasons, a HCFA attempt to disallow $16.5 billion in Federal matching funds obtained through the donations was overruled by the Departmental Appeals Board. ⁸

While the two cases were pending, HCFA made plans to forestall additional States from implementing donation programs. The President's FY 1989 budget, released in February 1988, indicated that HCFA planned to issue regulations limiting the use of donations as the State share of Medicaid. The Administration indicated that its chief concern was "to ensure that State oversight responsibilities would not be compromised"; that is, that State policies would not be influenced by any conditions attached to donated funds. However, the Administration also expected its proposal to save $176 million in FY 1989 funds. ⁹

While HCFA initially emphasized the issue of possible coercion of the State by providers (or vice versa), it was also concerned that donation programs might allow States to receive Federal funds without having incurred any costs. The hospitals could donate funds, a State would use the money to claim Federal matching, and the State would pay the hospitals their donations plus the Federal funds. In HCFA's view, the State would thus have maintained Medicaid services without spending any State funds. The planned regulations were intended to limit the further use of this approach at a time when the Administration was proposing general cutbacks in Federal Medicaid funding.

From the States' perspective, however, once the hospitals had made their donations, those donations became part of State general funds, just like funds derived from taxes or other sources. When the State issued Medicaid hospital payments, it did so from general funds, and HCFA had no basis for asserting that the payments were derived from any particular source, or that some kinds of Medicaid payments were "real" expenditures and others were not.

The dispute between HCFA and the States thus involved two different ways of viewing a sequence of financial transactions. HCFA perceived a linkage between the hospitals' donations and the payments they later received from Medicaid, while the States contended that no such linkage could be shown.

PROVIDER-SPECIFIC TAXES

Parallel issues were raised by the treatment of taxes imposed by States on providers. Until recently, most Medicaid programs reimbursed institutional providers (such as hospitals and NFs) on the basis of reasonable cost. A facility would report the actual costs it incurred for treating each Medicaid patient and would be paid accordingly. The facility's costs could include the taxes it had to pay, and Medicaid would allow those costs as a necessary part of the facility's overall expenses.

For example, a staff might have a general sales tax that also applied to supplies purchased by a hospital. The hospital could pay the tax for supplies used in treating as Medicaid patient and then include the amount of the tax in the bill for that patient. The State could pay the entire bill, in effect refunding the hospital's tax payment. The State could then report the full amount of the bill (including the tax) to HCFA as a Medicaid expenditure and receive Federal matching.

This kind of transaction, in which Federal funds might appear to be drawn for no net State expenditure, is not unique to Medicaid. For example, when a State uses a combination of Federal and State highway funds to build a road, the contractor's bid price includes any State taxes the contractor must pay. The Federal highway trust fund is even paying itself in this case: it will collect the gasoline tax the contractor must pay on the fuel used to operate machinery. Such circular fund transfers are a routine consequence of governments doing business with persons or entities that pay taxes. A State that has a general income tax is in effect taxing part of each Medicaid payment that a physician receives, along with the rest of that physician's income; the Federal Government is also using a tax on the same physician's income to help fund its share of Medicaid.

The examples cited so far involve ordinary taxes that are paid by health care providers just as they are paid by any other individuals or businesses. In 1987, HCFA accepted Medicaid reimbursement for such taxes in a set of instructions issued to State Medicaid programs (section 2493 of the State Medicaid Manual). ¹⁰ These instructions distinguished between taxes of GENERAL APPLICABILITY, those that were imposed on all kinds of goods or services, and PROVIDER-SPECIFIC taxes, those that applied only to health care providers or services. States could reimburse for general taxes, such as sales or excise taxes applicable to all businesses, and receive Federal matching. ¹¹ However, no Federal matching was available if the State reimbursed for provider-specific taxes, such as a tax on each day of care or each hospital bed.

In HCFA's view, these arrangements could potentially work in the same way as voluntary contribution programs. A State could impose a tax on providers, use the tax to claim Federal matching, then repay the tax to the providers along with the Federal funds without having spent State general revenues.

Federal policies restricting such practices were readily enforceable when providers were paid on the basis of reasonable costs. The provider would include the taxes it had paid on its Medicaid cost report, the State would decide whether to reimburse for the tax, and HCFA could later review whether the reimbursement was appropriate. However, many providers were not paid on the basis of cost reports, but instead received fixed fees from Medicaid for each service they provided. This had always been true for physicians and other individual practitioners in most States. In the 1980s, many States also moved from cost-based payment for hospital and nursing home care to "prospective" systems, in which payment rates per day of care or per admission were set in advance and might bear no direct relation to a provider's costs for treating any particular patient. In such a system, it was no longer possible to trace a direct connection between the tax paid by a provider and the reimbursement received from the State.

Even before the first voluntary contribution programs, South Carolina and Florida began to impose taxes specifically on hospitals and used the proceeds to fund expansions of their Medicaid programs. Both States paid hospitals under a prospective payment system, and there was thus no demonstrable connection between the taxes the hospitals paid and the Medicaid payment they received. As in the case of donations, the States' perspective was that the tax paid by the provider entered general funds and the State's later payment to the hospital was a distinct transaction, while HCFA viewed the two transactions as linked. But the Medicaid Manual provision could not be applied in a prospective system, and some additional authority would be required. HCFA planned to address the issue of provider- specific taxes through the regulatory process, along with the related question of provider donations.

REGULATORY AND LEGISLATIVE ACTION, 1988-1990

Before HCFA could issue new rules, Congress intervened. The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647), enacted in November 1988, included a provision prohibiting the Secretary from issuing final rules that would change the treatment of voluntary contributions or provider-specific taxes before May 1, 1989.

In 1989, the Administration again indicated its intention of regulating the use of donations and provider-specific taxes, beginning in FY 1990. However, Congress again delayed HCFA's authority to act. The House-passed version of OBRA 89 (H.R. 3299) included provisions defining limits on the acceptable use of provider donations. States would have been permitted to use such donations to finance up to 10 percent of the State's total Medicaid share, provided that the funds were subject to the unrestricted control of the State. Funds donated by any particular hospital could not exceed 10 percent of the hospital's revenue in a year (not counting revenue from Medicare, Medicaid, or the Maternal and Child Health block grant). A transfer of funds from a hospital to the State would be regarded as a donation even if the hospital benefited from it, so long as the benefit was not directly related to the transfer in timing or amount. The bill also prohibited the Secretary from limiting Federal matching when the State share of spending was financed through provider-specific taxes. ¹²

The conference agreement on OBRA 89 did not include the House provisions on donations and taxes. Instead, it extended through December 1990 the prohibition on issuance of a final rule by the Secretary.

On February 9, 1990, the Secretary published in the Federal Register proposed regulations on donations and taxes. Under the proposed rules, before determining the amount of Federal matching funds due to a State, the Secretary would subtract from the State's reported expenditures the amount of any provider donations, provider- specific taxes, State-paid taxes, or any other transfers from a provider to the State. In cases in which provider taxes applied to both Medicaid and nonmedicaid patients, the Secretary would attempt to estimate the portion of tax revenues attributable to Medicaid patients.

Table 2 illustrates the effect of the proposed rule on a hypothetical provider donation program in a State whose FMAP is 60 percent. Before the rule, a hospital gives the State $40; the State pays the hospital $100 and receives $60 in Federal matching funds. The State's share is $40, or zero after crediting the hospital donation. After the rule, the hospital donates $40; the State pays and claims Federal matching for $100. However, HCFA deducts the donation before computing Federal matching and pays only 60 percent of the net $60, or $36. The State share of the $100 payment is $64, or $24 after crediting the hospital donation.

                               TABLE 2.

In March 1990, shortly after the proposed rules were published, Representative Cooper reintroduced (as H.R. 4181) the provisions that had been passed by the House in the previous year, regulating the use of donations and prohibiting the Secretary from interfering with the use of provider-specific taxes. These provisions were again passed by the House as part of OBRA 90, H.R. 5835. The Senate amendment to OBRA 90 would have put the issue off for another year, extending through September 1, 1991, the moratorium on issuing regulations governing the use of donations or provider-specific taxes.

The conference agreement on OBRA 90 (enacted as P.L. 101-239) extended the moratorium with respect to voluntary contributions through December 31, 1991. However, it followed the House bill in prohibiting regulation of provider specific taxes except in certain cases. The exact language adopted is important in understanding the current debate on the issue of provider taxes. Section 4701 of OBRA 90 added a new section 1902(t) to the Social Security Act, as follows:

(t) Except as provided in section 1903(i), nothing in this title (including sections 1903(a) and 1905(a)) shall be construed as authorizing the Secretary to deny or limit payments to a State for expenditures for medical assistance for items or services, attributable to taxes (whether or not of general applicability) imposed with respect to the provision of such items or services.

The exception noted at the start of the provision was added as section 1903(i)(10) of the Act:

(i) Payment under the preceding provisions of this section [relating to Federal matching payments] shall not be made --

* * * * (10) with respect to any amount expended for medical assistance for care or services furnished by a hospital, nursing facility, or intermediate care facility for the mentally retarded to reimburse the hospital or facility for the costs attributable to taxes imposed by the State sole[l]y with respect to hospitals or facilities.

The conference report described this exception as "exclud[ing] taxes from a provider's cost base for purposes of Medicaid reimbursement."

In the 102nd Congress, bills have again been introduced that would permanently allow the use of provider donations. Representative Cooper has introduced, as H.R. 1457, the proposal passed by the House in 1989 and 1990, which would establish limits on the total amount of contributions. S. 833, introduced by Senator Fowler, is nearby identical. However, neither bill has been acted on, and the moratorium on new rules pertaining to provider donations is still scheduled to expire December 31, 1991.

CURRENT DONATION AND PROVIDER TAX PROGRAM

In a management advisory to the HCFA Administrator in October 1990, the DHHS Inspector General reported that four States (Alabama, California, Georgia, and Tennessee) had hospital donation programs and five more (Florida, Kentucky, Ohio, South Carolina, and Texas) had provider tax programs. Tennessee and South Carolina also imposed licensing fees on nursing homes and/or hospitals that the Inspector General classed as taxes. Finally, in four States (California, Missouri, South Carolina, and Texas) hospitals helped to pay the costs of maintaining Medicaid eligibility workers on site to process applications from patients. The Inspector General regarded hospital sharing in these costs as a form of voluntary contribution. Overall, it was estimated that the State programs had the potential to generate $497 million in Federal expenditures (assuming that all of the proceeds were used for Medicaid). The February 1990 proposed rule, if adopted, would have reduced this amount by $160 million. ¹⁴

A May 1991 update of this report noted that many additional States had adopted donation and/or tax programs. The Inspector General found that seven States had provider tax programs that would yield $766 million in Federal matching funds during FY 1991. Another 11 were using provider donations to generate an estimated $1,720 million in Federal matching. According to the report, HCFA had determined that an additional 18 States, plus the District of Columbia, were developing or considering donation or tax programs. The joint DHHS/OMB Task Force report on Medicaid spending cited earlier estimates that donation and tax programs will generate $4.4 billion in Federal matching funds in FY 1992 and, in the absence of any regulation, $12.1 billion in FY 1996. ¹⁵

More recently, the American Public Welfare Association (APWA) has surveyed States to determine their use of voluntary provider donations or provider-specific taxes. As of August 26, 1991, 29 States reported that they expected to use such programs to fund some part of State Medicaid spending during State 1992 fiscal years. ¹⁶ Ten States expected to use provider donations, 16 expected to use taxes, and 3 expected to use both donations and taxes.

Table 3 shows the amounts States estimated would be available from these funding sources. States expect to collect $1.6 billion in donations from providers, while estimated revenues from hospital and nursing facility taxes total $3.0 billion.

                               TABLE 3.

The provider taxation programs reported by States vary widely. Some States use broad-based taxes on overall provider revenues and use the taxes to contribute towards general expenses of the Medicaid program. Because there may be little correlation between a provider's revenues and the extent of its participation in Medicaid, what a provider pays under such a system may have no impact on what it receives back from Medicaid. Other States tax only Medicaid revenues or tax only facilities that qualify for a disproportionate share adjustment. In these States, the relation between what a provider pays in and what it gets back is much clearer. (One State, South Carolina, taxes only NONMEDICAID hospital revenues. This tax has the effect of redistributing funds from providers with few Medicaid patients to those with many.)

Finally, some States repay the entire tax on a dollar-for-dollar basis. The new program instituted by Maryland in 1991 is one example that has received considerable attention. Maryland has in the past used a fixed fee schedule to limit payment for physician services; for a given procedure a physician would be paid the LESSER of his actual charge or the established fee for that procedure. Under its new system, Maryland nominally pays the GREATER of the provider's actual charge (subject to certain limits) or the fee schedule amount. However, any amount over the fee schedule is immediately withheld as a tax. The payment actually made to the physician is the fee schedule amount, but the State's records show payment of the full actual charge, and it is this higher amount that is reported to HCFA for the purpose of Federal matching. Maryland's fee schedule is estimated to average half what Medicare would pay physicians for comparable services; ¹⁸ the difference between the check the provider receives and the amount reported to HCFA might therefore average 100 percent. (Maryland has also imposed taxes using similar mechanisms on most other providers, not including hospitals.) HCFA has characterized the Maryland tax as a "fiction" and has notified the State of its intention to deny any resulting claims for Federal matching. ¹⁹

Many of the States responding to the APWA survey have indicated that the funds derived from donations or taxes are dedicated to specific program purposes, such as expanding Medicaid coverage to more pregnant women and children or making additional payments to hospitals serving a disproportionate share of low-income patients. Some States have even established separate funds for these programs. Other States report simply that donations and taxes are being used to prevent deficits and to avoid the need to impose eligibility or service restrictions.

INTERIM FINAL RULE ON DONATIONS AND TAXES

PROVISIONS OF THE NEW REGULATION

On September 12, 1991, the Secretary published in the Federal Register an interim final rule on donations and taxes, to be effective January 1, 1992. Under the new rule, revenue from donations or other voluntary payments will be deducted from a State's Medicaid expenditures before computing the Federal share, as will "repayment applicable to facilities for costs attributable to the Medicaid portion of a provider specific tax." The amount disallowed for a provider tax will be the lesser of the amount of the tax that is Medicaid-related or the amount of Medicaid payment to providers that is deemed to result from the tax. The rules on provider taxes apply only to taxes imposed on hospitals, NFs, or intermediate care facilities for the mentally retarded (ICFs-MR); the rules do not restrict taxes on other types of providers. However, the rules on voluntary contributions apply to donations from any kind of provider or entity related to a provider.

As was noted earlier, OBRA 90 prohibited the Secretary from denying Federal matching funds on the grounds that the State had raised revenue from a provider-specific tax. However, it permitted the denial of Federal funds if Medicaid reimbursed the provider for "costs attributable" to taxes imposed solely on hospitals, NFS, and ICFs-MR. ²⁰ That is, HCFA cannot prohibit a State from collecting a tax, but can prohibit the State from paying the tax back to the provider. The central issue raised by the interim rule is the way in which it makes use of this statutory exception.

When does a payment by Medicaid to a provider constitute reimbursement of costs attributable to a tax? The rule cites three basic circumstances in which a Medicaid payment will be deemed to constitute repayment of a tax:

1. MEDICAID PAYMENT TO THE PROVIDER EXPLICITLY INCLUDES REPAYMENT OF A TAX PAID BY THE PROVIDER.

The tax is actually included on the provider's Medicaid cost report and the provider is paid on a cost basis. This is the situation that was already regulated under the 1987 Medicaid Manual instructions; the rule in effect codifies those instructions.

2. MEDICAID PAYMENT RATE ARE BASED ON DATA ABOUT PROVIDERS' COSTS, AND THOSE DATA INCLUDED THE TAXES PROVIDERS PAY.

For a provider paid under a prospective system, the tax is included in the base year costs used to calculate rates. Although most States no longer pay on a cost basis, many use information about a provider's past costs in developing the fixed rates that will be paid in the future. For example, a hospital's 1991 rates might be based on its 1990 costs per patient plus an inflation factor. Under the rule, HCFA would look behind the rates at the underlying cost data.

3. MEDICAID PAYMENT AMOUNTS ARE FOUND TO BE "LINKED" IN SOME OTHER, LESS DIRECT WAY TO THE TAXES PAID BY PROVIDERS.

The rule does not define precisely what constitutes LINKAGE between taxes and payments. The rule lists examples of cases in which linkage will be deemed to exist, but does not indicate that the list is exhaustive. The examples are as follows:

o The Medicaid payment is "significantly" correlated to the provider's tax payment.

o The State has provided an "effective guarantee" that it will hold providers harmless by making up for most of the tax through enhanced payments.

o Higher payments to providers are "integrally" related to the tax. For example, the tax revenues are deposited in a special fund used only for increased provider payments, or there is language in State law indicating the tax is linked to higher payments.

The concept of linkage is thus used as a basis for regulating programs in which the connection between taxes and Medicaid payments is less direct than under a cost-based system. Again, very few States still use reasonable cost reimbursement to pay hospitals or NFs. The Secretary has adopted a broad interpretation of the statutory language "costs attributable to taxes" in order to reach cases in which a Medicaid agency is not explicitly refunding providers' tax payments.

Critics of the new rule contend that the Secretary has exceeded the authority granted by OBRA 90. At least one participant in the House-Senate conference on the Medicaid portions of OBRA 90 has indicated that the provision allowing denial of matching funds for costs attributable to taxes was intended to apply only to systems in which States made payments directly on the basis of a cost report. In this view, the Secretary's use of the broad concept of linkage may leave almost any tax on hospitals or NFs open to HCFA scrutiny. ²¹

No such question has been raised about the authority to bar Federal matching funds for provider donations. By failing to extend the moratorium on Secretarial action, Congress allowed HCFA to prohibit donations after December 31, 1991. However, some critics of the rule believe that it may interfere with routine transfers of funds between State and local agencies, or from one State agency to another. State and local government agencies often operate or own health facilities, including public hospitals or local health department clinics. States have worked out various arrangements under which Medicaid reimbursement is made for services in those facilities; these arrangements may involve transfers of funds from other agencies to the Medicaid agency. Because the agencies transferring the funds are Medicaid providers, it is conceivable that intergovernmental transfers might be treated by HCFA as provider donations, and hence prohibited. ²² The regulation itself is not clear on this point, although the preamble seem, to indicate that HCFA intends its rule to be more narrow in effect. The preamble cites only one kind of transfer potentially subject to the regulation, one in which a local government accepts donations from providers and turns the funds over to the State for use as the State share of Medicaid.

States have already indicated that they will challenge the new rules on taxes in court; resolution of any suits could take many years. ²³ In the interim, Congress could again intervene with legislation. However, the 1990 budget agreement and the mechanics of scorekeeping under that agreement place significant constraints on congressional action. For reasons to be discussed further below, any congressional intervention might require offsetting new revenues or cuts in other Federal programs. At this time, then, it appears likely that the new rules will take effect on schedule.

IMPACT OF THE REGULATION

The new rules can be expected to eliminate the use of provider donations in State Medicaid financing and to reduce or eliminate the use of hospital and nursing facility taxes. The full potential impact of the rules is difficult to measure, for at least two reasons. First, the lack of a clear definition of the concept of "linkage" between Medicaid payments and provider taxes means that States cannot be certain about what kinds of tax programs will and will not be deemed permissible. Second, States' response to the new rules cannot be predicted. It is possible that some States might accelerate their use of donations and taxes in order to maximize Federal receipts before the rules take effect. Others may develop alternate ways of avoiding Federal disallowances. For example, a State could shift from use of a tax on hospitals or NFs to a tax on other providers that would be exempt from the new rules. ²⁴ Because of uncertainty about State responses, the regulatory impact statement published with the rule in the Federal register includes no estimate of projected Federal savings.

It is at least possible to examine the potential Federal savings if it is assumed that States continue with donation and tax programs already planned. Table 4 provides an illustration of the rule's effect on the donation and tax programs reported by States in the August 1991 APWA as being effective in State 1992 fiscal years. The estimates of proceeds from these programs and resulting Federal matching payments are comparable to those shown in table 3, except that the projected receipts from provider taxes have been adjusted to reflect only the amounts attributable to hospitals and NFs. ²⁵ Again, States expect to collect $1.6 billion in donations from providers, while estimated revenues from hospital and nursing facility taxes total $2.9 billion. (Taxes on other types of providers are negligible.) Again, the FMAPs for FY 1992 have been used, although the Federal and State fiscal years do not necessarily coincide.

The last two columns of the table provide illustrations of minimum and maximum potential reductions in Federal funding that might occur under the new rules on treatment of donations and taxes. Two estimates are provided because the regulations on provider taxes allow some room for the exercise of judgment by the Secretary. The minimum estimate assumes that States lose all Federal funding attributable to voluntary contribution programs but no funding related to provider taxes. The maximum estimate assumes that all spending related to contributions or to taxes imposed on hospitals and NFs is disallowed. In either case, the lost Federal funding is equal to the amount of the donations and/or taxes times the Federal matching rate. (The calculation is the same as that illustrated in table 2 with respect to the February 1990 proposed rule.)

The estimates assume that all the affected State spending for State 1992 fiscal years occurs after the rules take effect on January 1, 1992. While this is improbable, there is no reliable way of adjusting the State projections to include only spending planned for after January 1. Because of all these uncertainties, it should be emphasized that the estimated funding denials shown are not equivalent to estimates of reductions in budgeted Federal Medicaid spending.

                               TABLE 4.

The case of Massachusetts may be used as an illustration. The State expects to impose $490 million in taxes, which will be used to draw $490 million in Federal funds (at a 60 percent matching rate). The State will use the combined funds to pay hospitals a gross total of $980 million. In order to collect Federal matching, the State must document that it actually paid out the full amount. Under the new rules, HCFA will subtract $490 million from this reported expenditure and will treat the remaining $490 million as the "real" Medicaid cost. It will then pay its 50 percent of this amount, or $245 million. The State must then make good the difference between what it expected and what it actually received in Federal matching: it must pay $245 million from allowable funding sources. It cannot just take back the amount from the hospitals, because to do so would merely reduce the gross ("nominal") total against which HCFA applies its disallowance, further reducing Federal matching. Unless the State incurs some "net" cost, this process continues until Federal funding is reduced to zero.

Thus States that cannot find other ways of raising the State share of Medicaid funds may suffer funding reductions much larger than those shown in the table 4. This point is particularly important in the period immediately after the new rules take effect. Federal fund denials will begin on January 1, 1992, in the middle of States' fiscal years. States may be unable to respond to the new rules without legislation, and some States may not have time either to reduce Medicaid spending or to raise additional revenue. Over the short term, then, the rules may create immediate deficits in some States. Again, the longer term effect of the rule may depend on the extent to which States can substitute other financing initiatives (such as taxes on noninstitutional providers) for those that the rule would prohibit or restrict.

FUTURE STATUS OF DONATIONS AND TAXES

Under the 1990 budget agreement, Medicaid and other entitlement programs are on a "pay as you go basis." If Congress makes any legislative changes that would cause Medicaid spending to grow more rapidly than is predicted under current law, it must finance those changes through reductions in other programs or new Federal revenues, or risk a sequester (a mandatory reduction in Federal spending). OMB treats the new Federal rules on donations and taxes as being in the "baseline," the estimates of spending under current law. In their view, the Secretary currently has the authority to issue the regulations and current spending estimates assume that the regulations will take effect. Any curtailment by Congress of the Secretary's authority would raise Medicaid costs above the baseline and thus be scored as new spending. CBO's scorekeeping takes the reverse view. Its baseline assumes that current policy will be continued by Congress; that is, that Congress will extend the moratorium on DHHS action. If CBO's scorekeeping were used, Congress could overturn the new rules without incurring any costs for budgetary purposes. However, it is OMB's estimates that are actually used for determining whether a sequester has been triggered and the amount of that sequester.

The exact price OMB would attach to any legislation cannot be known without details of the particular legislative proposal. However, it is likely that OMB would treat any significant restriction on the Secretary's authority to regulate the use of donations and taxes as requiring that Congress find billions in additional revenue over the next several years. As a result, it would be difficult for Congress to intervene before the new rules take effect on January 1, 1992.

While these constraints appear likely to prevent congressional action in the current session, Congress may still face pressure to overturn or modify the new Federal rules next year, after they take effect. States, health care providers, and other interested groups were urging congressional intervention even before the new regulations were issued, and calls for action are likely to intensify now that the interim final rule has been published. ²⁶ In addition, HCFA remains concerned about the possibility that States may find other mechanisms for increasing Federal matching funds that are not precluded by the new regulations. The joint DHHS/OMB Task Force report indicates that the Administration may seek legislation to restrict further the ability of States to use provider taxes in Medicaid financing. The basic issues presented by the use of donations and taxes are therefore likely to be the subject of continuing debate.

This debate is complicated by the fact that there is not even any agreement about how to characterize what has been occurring. HCFA continues to emphasize the linkage between donations or taxes and the Medicaid spending they help to finance, and depicts the combined transactions as mere "nominal" spending, paper transfers designed solely to draw Federal funds. States and their supporters insist on separating Medicaid expenditures from the methods used to finance those expenditures, which they believe should not be subject to Federal scrutiny. They present the issue as simply one of maintaining State flexibility in raising the funds needed to cover rising program costs.

At the heart of this dispute is the Administration's concern that donations and taxes could lead to a long-term realignment of Federal and State responsibilities for Medicaid. The DHHS/OMB Task Force contends that, if donation and tax programs were allowed to continue unchecked, they would gradually increase the effective Federal share of Medicaid spending. While the "nominal" Federal matching rate would remain at 57 percent, devices to draw additional funds would mean that the Federal share of "real" Medicaid costs would rise to 62 percent by FY 1996.

The States respond that the donation and tax programs are often being used to fund mandatory Medicaid spending, program expansions and reimbursement increases required by legislation and court decisions. The costs (and the resulting Federal expenditures) would have been incurred no matter how States raised the necessary revenue. This would be strictly true, however, only in a State whose Medicaid program met only the minimum requirements of Federal Medicaid. In practice, all States have expanded Medicaid eligibility and coverage beyond the Federal minimum. To the extent that donation and provider tax programs allow States to maintain optional benefits, they may result in Federal expenditures that might not have been made if States had to use other revenue sources.

Some believe that donations and provider taxes are merely a temporary expedient, a short-term response to sudden Medicaid cost increases and recent State deficits. In this view, the programs are a stopgap measure that States may abandon when economic conditions improve. While this is possible, health care costs are widely expected to keep growing at close to their present rate indefinitely. In addition, States' ability to raise new revenue may be limited even after any improvement in economic conditions. Many States have already raised taxes to meet recent deficits, and it may be politically difficult to raise them again in the near future. Pressure on States to maximize Federal funding is likely to continue unless some other way is found to finance the care of the poor. ²⁷ At the same time, the Federal deficit may press Congress to find some way of restraining the Federal share of Medicaid costs.

The rapid growth in medical costs for all sectors, public and private, is leading to a general debate over how those costs should be apportioned. The dispute between the Administration and the States over the division of Medicaid costs may be seen as part of this broader debate, paralleling similar disputes over the allocation of costs between employers and employees, between active workers and retirees, between public programs and private insurance. Controversy over the Medicaid financing question may continue as long as the wider financing issue is unresolved.

² Unpublished calculations by the Congressional Budget Office.

³ U.S. Dept. of Health and Human Services and Office of Management and Budget. Improving Medicaid Estimates: Report of the HHS-OMB Task Force. July 10, 1991. Washington, 1991. (Hereafter cited as Health and Human Services and Office of Management and Budget, Improving Medicaid Estimates)

⁴ Personal communication, Sept. 1991. It should be noted that these estimates include Federal as well as State dollars, both in Medicaid and in other Federal-State matching programs. The State share, as a percentage of wholly State-funded expenditures, was 6.8 percent in 1990.

⁵ 50 Federal Register 46657, Nov. 12, 1985.

⁶ 50 Federal Register 46662, Nov. 12, 1985.

⁷ DHHS Departmental Grant Appeals Board, No. 87-64 and 87-126, Dec. No. 956. May 19, 1988. Regina Lipscomb vs. Otis Bowen. U.S. Dist. Ct., S.D.W.Va., Civil Action No. 2:87-0333, June 28, 1989. Affirmed in unpublished opinion, Taunja Willis Miller, Commissioner of W. Va. Dept. of Human Services vs. Maurice Hartman, CA-4, No. 89- 2777, Aug. 16, 1990.

⁸ DHHS Departmental Appeals Board, Docket No. 88-137, 88-194, and 89-32, Decision No. 1047, May 4, 1989.

⁹ U.S. Dept. of Health and Human Services. The Fiscal Year 1989 Budget. [Press release], Feb. 18, 1988. Washington, 1988.

¹⁰ Such instructions do not have the same legal force as regulations because they are issued without such procedural safeguards as an opportunity for public comment.

¹¹ The instructions only allowed Medicaid reimbursement for general taxes when the provider paid them in the course of rendering care. Medicaid could not pay a tax imposed directly on the goods or services furnished to a beneficiary, such as a sales tax on a Medicaid-paid prescription. This distinction was recently upheld in Louisiana Department of Health and Hospitals vs. Sullivan. U.S. District Court, District of Columbia. Civil Action No. 90-2231, Apr. 2, 1991.

¹² As reported by the Finance Committee, the Senate version of the bill would have included similar provisions relating to provider donations. However, these were deleted on the floor. The deleted provisions were separately introduced as S. 1878 by Senators Graham and Mack in Nov. 1989.

¹³ This way of calculating the disallowance was initially recommended by the DHHS Grant Appeals Board in the West Virginia case cited earlier, before the disallowance was overruled by the Federal appeals court.

¹⁴ U.S. Dept. of Health and Human Services. Office of the Inspector General. Office of Audit Services. Use of Donations and Provider Tax Revenue as the State Share of Medicaid Expenditures. (A- 14-90-01009), Oct. 1990. Washington, 1990. The report did not include information on four State donation or tax programs with an "insignificant" fiscal impact, those of Connecticut, Maine, New Hampshire, and Vermont.

¹⁵ Health and Human Services and Office of Management and Budget, Improving Medicaid Estimates, chart 4. (Backup numbers for this chart were provided in a personal communication from OMB.)

¹⁶ American Public Welfare Association. Medicaid Management Institute. Voluntary Contributions and Provider-Specific Taxes: Survey Results. Washington, 1991. Details were unavailable on two other States: New Mexico, which imposes a gross receipts tax on county governments, and Hawaii, which has a provider tax that produces a $1.8 million Federal match.

¹⁷ APWA's own estimates differ, because they applied FY 1991 Federal rates to State FY 1992 spending.

¹⁸ U.S. Congress. Physician Payment Review Commission. Physician Payment Under Medicaid. (PPRC Report No. 91-4). Washington, U.S. GPO, 1991.

¹⁹ Letter from Maurice Hartman, Regional Administrator, HCFA Region III, to Nelson J. Sabatini, Secretary, Maryland Dept. of Health and Mental Hygiene, June 28, 1991.

²⁰ Under the rule a tax is imposed "solely" on hospitals, NFs and/or ICFs-MR if no other kind of entity is subject to the IDENTICAL tax. A tax is not identical if other entities are paying at a different rate, or if the tax base, deductions or exclusions used for hospitals or NFs are different from those for other entities subject to the tax.

²¹ Waxman Henry A; Chairman, Subcommittee on Health and the Environment, House Committee on Energy and Commerce. Letter to Gail R. Wilensky, Administrator, HCFA. Aug. 15, 1991.

²² This interpretation was advanced by the Children's Defense Fund in testimony before the House Committee on Energy and Commerce, Subcommittee on Health and the Environment, on Sept. 30, 1991.

²³ The ordinary procedure would be for the States to request Federal funds, receive the notice of denial, and appeal the denial through DHHS administrative procedures before turning to the courts. An alternative would be for one or more States to seek an injunction to prevent the regulation from taking effect.

²⁴ The States' ability to do so may be limited to some extent, because the noninstitutional providers that could still be taxed accounted for only 28 percent of total Medicaid spending in FY 1990.

²⁵ When a State's tax applies both to hospitals or NFs and to other providers, the tax has been divided among the types of providers in proportion to their shares of the State's Medicaid spending in FY 1990.

²⁶ Signers of a July 26, 1991, letter to Members of Congress on this subject included the National Governors' Association and 41 other groups, including 15 provider organizations, 9 associations of State or local officials, 5 labor unions, 7 advocacy groups, the Health Insurance Association of America, and 3 other organizations.

²⁷ While provider groups have endorsed the use of donation and tax programs for the time being, some have also signaled their preference that such programs be replaced as soon as possible by broader financing approaches. See American Hospital Association, National Association of Children's Hospitals and Related Institutions, and National Association of Public Hospitals. Financing Medicaid: Assuring State Flexibility Through Voluntary Contributions/Provider Tax Programs. Washington, 1991.