CMS Proposes Tougher Enforcement of Medicaid Provider Tax Limits

The Centers for Medicare and Medicaid Services (CMS) continues its efforts to curb the use of provider taxes as directed by the One Big Beautiful Bill Act of 2025 (OBBBA, H.R. 1). In a proposed rule issued last week, CMS announced it would go beyond what the law requires to further restrict the financing mechanism states use to increase federal Medicaid funding and support provider participation.

Provider taxes are applied to hospitals, Medicaid managed care organizations (MCOs) and others to help pay for the state share of Medicaid spending, and almost all states use provider taxes for this purpose, Modern Healthcare explains. But the OBBBA directed CMS to curb the use of provider tax policies and the agency finalized related provisions in a January rule. Under prior regulations, provider taxes were permissible if they were “broad-based and uniform,” and if it didn’t permit providers to be repaid those taxes – called a “hold harmless” provision.

CMS explains in its new fact sheet that as of October 1, 2027, all states will be prohibited from implementing new provider taxes and the “hold harmless” system will be replaced by specific thresholds. Additionally, it will reduce the threshold by 0.5% every year from 2028 to 2032. The CMS Office of the Actuary estimates that the rule will reduce federal expenditures by $246 billion over the next 10 years.

In 2023 the GAO reported that Arizona used $437 million in provider taxes to generate $1.4 billion in state-directed payments. And like other states, the payments are used to support the financial needs of Medicaid. Arizona officials told the GAO that the state implemented their $1 billion directed payment because their providers were experiencing financial shortfalls. In its report, the GAO explained the process of state directed payments in Arizona with the following illustration:

The new rule will implement a punitive compliance system that goes beyond the scope of what was outlined in H.R. 1. The Georgetown Center for Children and Families explains that the compliance and reporting process is designed to be burdensome, with heavy penalties for even unknowing noncompliance. The reporting process would also allow CMS to retrospectively review all state provider taxes to ensure that the taxes don’t exceed the maximum permissible amount.

Research Professor at the Georgetown University McCourt School of Public Policy’s Center for Children and Families, Edwin Park,

CMS would only consider “significant excesses” yet CMS does not define any of these terms or provide for a de minimis exception in the regulatory language.)  To make matters worse, under the proposed rule, if a provider tax is determined to have exceeded the safe harbor threshold, all revenues raised by such a tax would then be deemed impermissible, not just the amount by which the safe harbor threshold is being exceeded.  As a result, states would be on the hook for returning all federal matching funds associated with the entirety of that provider tax.  This system would likely lead to states further reducing the size of their existing taxes — even if those taxes otherwise comply with H.R. 1 restrictions including the safe harbor threshold phase down in expansion states — in order to avoid the risk that they are later determined to have breached the applicable thresholds and be subject to potentially large and punitive financial penalties.