[Federal Register Volume 73, Number 36 (Friday, February 22, 2008)]
[Rules and Regulations]
[Pages 9685-9699]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-3207]


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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Centers for Medicare & Medicaid Services

42 CFR Part 433

[CMS 2275-F]
RIN 0938-AO80


Medicaid Program; Health Care-Related Taxes

AGENCY: Centers for Medicare & Medicaid Services (CMS), HHS.

ACTION: Final rule.

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SUMMARY: This final rule revises the collection threshold under the 
regulatory indirect guarantee hold harmless arrangement test to reflect 
the provisions of the Tax Relief and Health Care Act of 2006. When 
determining whether there is an indirect guarantee under the 2-prong 
test for portions of fiscal years beginning on or after January 1, 2008 
and before October 1, 2011, the allowable amount that can be collected 
from a health care-related tax is reduced from 6 to 5.5 percent of net 
patient revenues received by the taxpayers. This final rule also 
clarifies the standard for determining the existence of a hold harmless 
arrangement under the positive correlation test, Medicaid payment test, 
and the guarantee test (with conforming changes to parallel provisions 
concerning hold harmless arrangements with respect to provider-related 
donations); codifies changes to permissible class of health care items 
or services related to managed care organizations as enacted by the 
Deficit Reduction Act of 2005; and, removes obsolete transition period 
regulatory language.

DATES: Effective date: This rule is effective April 22, 2008.
    Compliance date: CMS will not consider a State to be out of 
compliance with the revision to the definition of permissible classes 
until October 1, 2009.

FOR FURTHER INFORMATION CONTACT: Charles Hines, (410) 786-0252 or 
Stuart Goldstein, (410) 786-0694.

SUPPLEMENTARY INFORMATION: 

I. Background

A. General

    Title XIX of the Social Security Act (the Act) authorizes Federal 
grants to the States for Medicaid programs to provide medical 
assistance to persons with limited income and resources. While Medicaid 
programs are administered by the States, they are jointly financed by 
the Federal and State governments. The Federal government pays its 
share of medical assistance expenditures to the State on a quarterly 
basis according to a formula described in sections 1903 and 1905(b) of 
the Act. The amount of the Federal share of medical assistance 
expenditures is called Federal financial participation (FFP). The State 
pays its share of medical expenditures in accordance with section 
1902(a)(2) of the Act.
    The Medicaid Voluntary Contribution and Provider Specific Tax 
Amendments of 1991 (Pub. L. 102-234), enacted December 12, 1991, 
amended section 1903 of the Act to specify limitations on the amount of 
FFP available for medical assistance expenditures in a fiscal year when 
States receive certain funds donated from providers and revenues 
generated by certain health care-related taxes. We issued regulations 
to implement the statutory provisions concerning provider donations and 
health care-related taxes in an interim final rule (with comment 
period) published on November 24, 1992 (57 FR 55118). A final rule was 
issued on August 13, 1993 (58 FR 43156). The Federal statute and 
implementing regulations were designed to protect Medicaid providers 
from being unduly burdened by health care related tax programs. Health 
care related tax programs that are compliant with the requirements set 
forth by the Congress create a significant tax burden for health care 
providers that do not participate in the Medicaid program or that 
provide limited services to Medicaid individuals.

B. Health Care-Related Taxes

    Section 1903(w) of the Act requires that State health care-related 
taxes must be imposed on a permissible class of health care services; 
be broad based or apply to all providers within a class; be uniform, 
such that all providers within a class must be taxed at the same rate; 
and avoid hold harmless arrangements in which collected taxes are 
returned directly or indirectly to taxpayers. Section 1903(w)(3)(E) of 
the Act specifies that the Secretary shall approve broad based (and 
uniformity) waiver applications if the net impact of the health care-
related tax is generally redistributive and the amount of the tax is 
not directly correlated to Medicaid payments. The broad based and 
uniformity requirements are waivable through a statistical test that 
measures the degree to which the Medicaid program incurs a greater tax 
burden than if these requirements were met. The permissible class of 
health care services and hold harmless requirements cannot be waived. 
The statute and Federal regulation identify 19 permissible classes of 
health care items or services that States can tax without triggering a 
penalty against Medicaid expenditures.
    The regulatory language at 42 CFR 433.68(f) sets forth tests for 
determining the presence of a hold harmless arrangement that were 
directly based on the language contained in section 1903(w)(4) of the 
Act. The preamble to the 1993 regulation provided guidance and some 
illustrative examples of the types of health care-related tax programs 
that we believed would violate the hold harmless prohibitions. In a 
June 29, 2005 decision, however, the HHS Departmental Appeals Board 
(DAB), DAB No. 1981, found that these regulations did not clearly 
preclude certain types of arrangements that we believe to be within the 
scope of the

[[Page 9686]]

statutory hold harmless prohibition and implementing regulations. The 
DAB consequently reversed disallowances issued by CMS to five States. 
In each of these reversed disallowances, the States had created 
programs that imposed a tax on nursing homes and simultaneously created 
programs that awarded grants or tax credits to private pay residents of 
those nursing homes. These grants and/or tax credits were designed by 
the States to compensate private pay residents of nursing homes for the 
costs of the tax passed on to them by their nursing homes through 
increased charges. The DAB, however found that CMS regulations did not 
clearly identify that such grants and tax payments amounted to hold 
harmless arrangements that would preclude FFP.
    One of the hold harmless tests, set forth in current rules at Sec.  
433.68(f)(3)(i), defines arrangements that are considered to be 
prohibited indirect guarantees. Taxes imposed on health care-related 
providers may not exceed 6 percent of the revenue received by the 
taxpayer unless the State makes a showing that, in the aggregate, 75 
percent of taxpayers do not receive 75 percent or more of their total 
tax costs back in enhanced Medicaid payments or other State payments. 
Prior to the enactment of the Tax Relief and Health Care Act of 2006, 
States could tax individual classes of health care services and 
providers, including inpatient hospital services, outpatient hospital 
services, and nursing facility services up to 6 percent of the net 
patient revenue attributable to the assessed permissible class of 
health care items or services without violating prohibitions on the 
indirect hold harmless arrangements. The 6 percent limit was 
established to maintain consistency with the average level of taxes 
applied to other goods and services in the State, as discussed in the 
November 24, 1992 preamble to the interim final rule implementing the 
statute.
    On December 20, 2006 the Tax Relief and Health Care Act of 2006 was 
signed into law as Public Law 109-432. Section 403 of that law 
incorporated the existing regulatory test for an indirect guarantee 
into the Medicaid statute but provided for a temporary reduction in the 
allowable tax rate under the first prong of the test. Specifically, the 
indirect hold harmless threshold has been reduced from 6 percent to 5.5 
percent effective January 1, 2008 and before October 1, 2011. We want 
to remind States that the collection threshold test is an annual test 
and while the effective date of this change does not coincide with the 
beginning of any State's fiscal year the test must still be performed 
on an annual basis. Therefore, if a State chooses to impose a health 
care related tax at a rate in excess of 5.5 percent prior to January 1, 
2008, it will have to appropriately adjust the tax rate after January 
1, 2008 so that health care related tax collections will not exceed 5.5 
percent on a per class basis going forward. Compliance in State fiscal 
year 2008 will be evaluated from January 1, 2008 through the last day 
of State fiscal year 2008. Beginning with State fiscal year 2009 the 
5.5 percent tax collection will be measured on an annual State fiscal 
year basis.

II. Provisions of the Proposed Rule

    In the March 23, 2007 proposed regulation we proposed to:
     Codify section 6051 of the Deficit Reduction Act of 2005 
(Pub. L. 109-171) which amended section 1903(w)(7)(viii) of the Act to 
expand the previous Medicaid managed care organization (MCO) class of 
health care items and services to include all MCOs.
     Clarify the provisions of the hold harmless tests found at 
Sec.  433.68(f).
     Modify and clarify the positive correlation test set forth 
at Sec.  433.68(f)(1), to specify that a State or other unit of 
government will violate this test if they impose a health care-related 
tax and also provide for a direct or indirect non-Medicaid payment and 
the payment amount is positively correlated to the tax amount or to the 
difference between the Medicaid payment and tax amount. We proposed to 
interpret the phrase ``direct and indirect non-Medicaid payment'' 
broadly. These payments may take many forms, such as grants or tax 
credits, although there will undoubtedly be other types of payments 
that we have not yet anticipated.
     Clarify the definition of tax amounts and payment amounts 
for purposes of hold harmless analyses. We proposed to unify these 
definitions so that they would have identical meanings in all three 
hold harmless tests under Sec.  433.68(f).
     Clarify within Sec.  433.68(f)(2) that a Medicaid payment 
would be considered to vary based on the tax amount when the payment is 
conditional on the tax payment.
     Clarify the guarantee test at Sec.  433.68(f)(3) to 
specify that a State can provide a direct guarantee through a direct or 
indirect payment. A direct guarantee would be found when a State 
payment is made available to a taxpayer or a party related to the 
taxpayer (for example, as a nursing home resident is related to a 
nursing home), in the reasonable expectation that the payment would 
result in the taxpayer being held harmless for any part of the tax. An 
indirect payment to the taxpayer would also constitute a direct 
guarantee. One such example of this indirect payment providing a direct 
guarantee would be found where a State imposing a tax on nursing 
facilities provided grants or tax credits to private pay residents of 
those facilities that could be used to compensate those residents for 
any portion of the tax amount that the State has allowed to be passed 
down to them by their nursing homes. This represents a direct guarantee 
of an indirect payment to taxpayers.
     Modify under Sec.  433.68(f)(3)(i), the indirect hold 
harmless threshold percentage to be consistent with the Tax Relief and 
Health Care Act of 2006, which lowered the collection threshold under 
the indirect hold harmless provision from 6 percent of net patient 
service revenue to 5.5 percent effective for portions of fiscal years 
beginning on or after January 1, 2008 through September 30, 2011, prior 
to a State being required to demonstrate the second prong of the 
indirect hold harmless provision.
     Clarify at Sec.  433.56(a)(4) the permissible class for 
purposes of health care-related taxes to only those services of ICF/MRs 
by removing narrow exception for similar services of community-based 
residences for the mentally retarded if certain criteria are met.
     Modify parallel hold harmless provisions with respect to 
provider-related donations at Sec.  433.54(c).
     Remove transition periods related to provider-related 
Donations and health care related taxes provided under section 
1903(w)(1)(C)(ii) of the Act since the last transition period expired 
in 1993.

III. Analysis of and Responses to Public Comments

    We received 21 items of timely public comments which contained 
approximately 190 public comments that raised 47 individual issues, in 
response to the March 23, 2007 proposed regulation (72 FR 13726 through 
13734). The comments came from a variety of correspondents, including 
health care provider associations, national and State organizations and 
State Medicaid agencies. The majority of commenters urged us to 
reconsider proposed changes to the hold harmless provisions. The 
following is a summary of the comments received and our response to 
those comments.

[[Page 9687]]

A. General Comments

    Comment: One commenter expressed support for the codification of 
the 6 percent maximum tax amount allowed and agreed with CMS' 
implementation of section 403 of the Tax Relief and Health Care Act of 
2006. The commenter indicated that while health care provider taxes are 
not an optimal approach to sustainable appropriate and equitable 
Medicaid funding, but stated that cutting the maximum tax rate allowed 
substantially below 6 percent would have resulted in Medicaid payment 
reductions and thus harmed low income populations needing care. The 
commenter also suggested that such taxes create a significant tax 
burden for health care providers that provide limited services to or no 
services to Medicaid beneficiaries.
    Response: We appreciate the support for our implementation of 
section 403 of the Tax Relief and Health Care Act 2006. We understand 
the concern about the burden of health care related taxes on providers 
that have little or no Medicaid revenues. Medicaid limits on health 
care related taxes protect those providers at the same time as ensuring 
that such health care related taxes do not effectively shift a 
disproportionate burden of the Medicaid program to the federal 
government. We also recognize that States use revenues received from 
permissible health care related taxes to support Medicaid payment 
rates, but States have other sources of revenue that can support 
Medicaid payments and ensure that low income populations receive needed 
care. This rule balances all these concerns in clarifying the 
definitions of permissible classes and hold harmless arrangements.
    Comment: A couple of commenters asserted that the proposed rule 
violated the Administrative Procedure Act provision codified at 5 
U.S.C. 553(b). The commenters took issue with the preamble 
clarifications regarding interpretations of regulatory provisions that 
were included in the proposed rule. The commenters argued that CMS 
should have included precise regulatory language to implement such 
changes and that CMS cannot implement the proposed rule until it 
publishes sufficient notice in the form of substantive regulatory 
language. Other commenters stated that CMS provided no rational support 
for the proposed rule.
    Response: We disagree with the suggestion of any procedural 
deficiency. Through publication of the proposed regulation, CMS adhered 
to all requirements of the Administrative Procedure Act. Proper notice 
was given of proposed changes and a public comment period was provided. 
Those comments were considered, and are discussed in this final rule. 
The final rule includes all necessary changes to the regulatory 
framework and gives States clear guidance on how that regulatory 
framework will be applied to health care related tax programs.
    Comment: Numerous commenters argued that the proposed regulatory 
changes directly contradict provisions of the Social Security Act and 
that CMS exceeded its statutory authority. These commenters cited 
section 5(c) of the Medicaid Voluntary Contribution and Provider-
Specific Tax Amendments of 1991 (Pub.L. 102-234) which mandated that 
the Secretary consult with States before issuing any regulations under 
this public law. The commenters asserted that significant changes were 
made through this proposed regulation and that consultation with States 
was required prior to the issuance of the regulatory changes. For these 
reasons, the commenters indicated that CMS should not implement the new 
rule and begin consultations with States.
    Response: We believe the conditions of section 5(c) of the Medicaid 
Voluntary Contribution and Provider-Specific Tax Amendments of 1191, 
Public Law 102-234 were fully satisfied by the process the Secretary 
undertook when the regulations implementing that Act were issued in 
1992 and 1993. Even if these conditions were read to extend in 
perpetuity, however, they have been met with respect to this final 
rule. The notice and public comment procedures used to issue this final 
rule have provided a full and fair opportunity for consultation with 
States. This opportunity is in addition to the ongoing dialogue between 
CMS and the States over proposed State financing in the review process 
for Medicaid State plan amendments.
    Comment: Several commenters believe that CMS' approach will harm 
State Medicaid programs by decreasing the resources necessary to 
support the growing and changing nature of Medicaid services. Another 
commenter raised concern about the financial and administrative burden 
for States of the proposed rule. One commenter argued that the changes 
proposed in the regulation will compel States to dismantle already 
approved financing. One commenter asserted that the negative effect of 
the proposed rule could exceed approaches rejected by Congress. One 
commenter was concerned that CMS did not fully consider the significant 
financial issues confronting States and the continual pressure to 
contain Medicaid spending in the face of State budgets. Another 
commenter stated that the proposed regulation will cause a shift in 
burden of health care financing from the federal government to the 
States.
    Response: This final regulation implements section 403 of the Tax 
Relief and Health Care Act of 2006 and clarifies existing Federal law 
related to permissible classes of health care services and the hold 
harmless provisions. We do not agree that the statutorily-mandated 
reduction in the indirect guarantee threshold will result in excessive 
financial and administrative burdens or reductions in program benefits. 
In any case, CMS is bound by the law to make this change. Moreover, the 
clarifications provided in this regulation were not designed to target 
particular existing health care related tax programs for which States 
have received waiver approval from CMS of the broad based and/or 
uniformity requirements. These clarifications were instead to ensure a 
consistent and uniform understanding of the application of the hold 
harmless provisions. We refer to them as clarifications because they 
reflect CMS's understanding of how the hold harmless provisions should 
be applied. These clarifications are based on the need to ensure that 
the regulations effectively identify hold harmless arrangements in 
which health care related taxes operate to effectively shift a 
disproportionate burden of the Medicaid program to the federal 
government. Although the clarifications are not targeted toward any 
particular financing arrangements, CMS reserves the right to perform 
financial management reviews of any tax structures to ensure compliance 
with Federal statute, expressly approved by CMS or otherwise.
    Comment: Several commenters requested that CMS affirm that the 
proposed rule would not jeopardize already approved State plan 
amendments (SPAs) and provider tax programs. The commenters also 
requested that CMS confirm that it will continue to approve SPAs and 
provider tax submissions with similar features as those already 
approved. In the absence of such confirmations, the commenters 
requested that CMS identify with written explanations which specific 
approved SPAs and provider tax submissions would be problematic under 
the proposed regulation. Another commenter suggested that if these 
provisions are adopted in final, they should only apply to payments 
contained in SPAs adopted after the effective date of the final rule.
    Response: With respect to the change in the indirect guarantee 
test, Congress

[[Page 9688]]

did not make any provision to exempt or grandfather existing approved 
tax provider programs. Under the direction of the Congress, the final 
regulation is effective January 1, 2008. With respect to the other 
changes contained in this final rule, we considered and rejected a 
possible exception for already approved provider tax programs. Such an 
exception would not be uniform and would not achieve the objective of 
ensuring that provider taxes did not shift the effectively shift a 
disproportionate burden to the federal government. As part of the 
routine CMS review of Medicaid State plan amendments (SPA) that affect 
Medicaid payment to providers, CMS examines the sources of the non-
Federal share of Medicaid payments, including the revenues received by 
States from health care-related taxes. Such SPAs are reviewed and 
decided upon on a case-by-case basis under the consistent application 
of Federal statute and regulations. Because these clarifications 
reflect current CMS practices regarding ongoing reviews, CMS is not 
aware of any approved tax programs that are not in compliance with the 
final rule. However, CMS always reserves the right to ensure any State 
Medicaid financing source and associated reimbursement methodologies 
comply with Federal requirements.
    Comment: A few commenters were concerned that the proposed rule 
would ultimately decrease funding for the Medicaid program and threaten 
access to important long-term care services. Another commenter was 
concerned that the proposed rule will adversely affect safety net 
providers by lowering Medicaid payments and as a result patients' 
access to essential health care services would be disrupted.
    Response: This final regulation along with the Federal Medicaid 
statute governing health care related taxes was designed in part to 
protect health care providers. Specifically, the reduction to the 
allowable collection threshold serves to minimize the burden imposed on 
health care providers by States through taxation in order to support 
the State's Medicaid program. The effect of this reduction is that 
health care providers can realize a greater net revenue base when they 
are no longer obligated to fund a portion of their Medicaid payments 
through a State imposed tax. Further, those health care providers that 
do not participate in the Medicaid program would experience an overall 
reduction in their tax rate. In addition, States have the option to 
replace any tax revenue lost as a result of the reduction to the 
allowable collection threshold with other sources of non-Federal share 
payment, including additional State and local general fund dollars. If 
such general fund dollars are used health care providers may experience 
no reduction in the level of their Medicaid funding. States still have 
many available resources to ensure that necessary services are 
available to the most vulnerable populations. The purpose of this 
regulation was not to reduce access to any health care services but to 
strengthen the fiscal integrity of the Medicaid program.
    Comment: One commenter stated that addressing perceived problems 
with Medicaid financing would be better addressed through legislation. 
Another commenter specified that CMS should work with the Congress to 
clarify existing statutory language.
    Response: The final regulation implements section 403 of the Tax 
Relief and Health Care Act of 2006 and clarifies existing Federal law 
related to permissible classes of health care services and the hold 
harmless provisions. The clarifications are to ensure that the 
regulatory framework effectively implements existing statutory 
provisions setting permissible classes and prohibiting hold harmless 
arrangements that shift a disproportionate share of the cost of the 
Medicaid program to the federal government.
    Comment: One commenter noted that, given the most recently issued 
proposed regulations restricting IGTs and CPEs, CMS should not further 
limit States' ability to fund the non-federal share of Medicaid 
payments.
    Response: This final regulation implements and clarifies statutory 
provisions that permit States to fund the non-federal share of Medicaid 
payments with permissible health care related taxes. The statutory 
provisions, and these regulations, are a response to States that 
imposed health care related taxes that had the effect of shifting 
financial burdens from the States to the federal government. This shift 
resulted from hold harmless arrangements under which providers were 
effectively repaid some or all of the tax burden, and the federal 
government was left with a disproportionate share of the tax burden. 
The changes made in this final regulation should assist States in 
determining the permissibility of tax programs. While the temporary 
reduction in the indirect guarantee threshold test may reduce the 
amount of permissible tax revenues, States have the option to replace 
any tax revenue lost as a result of the reduction to the allowable 
collection threshold with other sources of non-Federal share payment, 
including additional State and local general fund dollars.
    Comment: One commenter expressed concern that the proposed rule 
unnecessarily grants CMS authority to delve into relationships between 
States and local governments and does not provide sufficient clarity on 
the criteria for evaluation of these relationships. The commenter 
believes that open ended interpretations of tax and reimbursement 
programs could result in case by case inconsistencies and confusion 
while States attempt to structure a permissible provider tax program.
    Response: This final regulation implements section 403 of the Tax 
Relief and Health Care Act of 2006 and clarifies existing Federal law 
related to permissible classes of health care services and the hold 
harmless provisions. This rule does not specifically require review of 
relationships between States and local governments. Under existing 
statutory law, however, CMS must ensure that State claims for federal 
funding are supported by non-federal expenditures and comply with all 
provisions of the law. This includes review of health care related 
taxes and associated payment or grant arrangements, whether on a State 
or local level. In other words, our review is limited to tracing the 
flow of funds to verify the non-federal share of Medicaid expenditures. 
This final rule makes changes to the regulatory framework to ensure 
that this review is consistent, uniform, and effectively implements the 
statutory requirements.
    Comment: A couple of commenters specified that CMS did not have the 
statutory authority to go beyond the explicit direction provided in the 
Tax Relief and Health Care Act of 2006 to only temporarily reduce the 
maximum allowable tax rate.
    Response: CMS' responsibility is to ensure that the Federal 
statutory requirements governing health care related taxes are met. In 
addition to codifying in regulation section 403 of the Tax Relief and 
Health Care Act of 2006, the new regulation clarifies some issues that 
have arisen since the issuance of the 1993 rule. Therefore, we believe 
it is necessary and appropriate for the Secretary to issue new 
regulatory provisions to address these issues so that States will have 
clear guidance on which health care related tax programs will be 
entitled to FFP. Furthermore, this final rule fully complies with the 
requirements of the Administrative Procedure Act.
    Comment: One commenter noted that changes to tax programs will 
further exacerbate health care challenges in

[[Page 9689]]

areas impacted by major natural disasters.
    Response: We do not agree that either the statutorily mandated 
reduction in the indirect guarantee test, or the clarification of 
permissible classes or hold harmless tests, will exacerbate health care 
challenges in areas impacted by major natural disaster. The reduction 
to the allowable collection limit serves in part to minimize the burden 
imposed on health care providers through health care related taxation. 
This result should help to minimize the cost structure of providers in 
areas impacted by major natural disasters.
    Comment: One commenter stated that the proposed regulations reflect 
a fundamental suspicion of States' Medicaid financing practices. The 
commenter encouraged CMS to address any inappropriate financing 
arrangements through enforcement of current regulatory standards on a 
case by case basis rather than regulatory changes.
    Response: Our responsibility is to ensure that the Federal 
statutory requirements governing health care related taxes are met in a 
consistent and uniform manner. Revision to the regulatory framework 
ensures consistent and effective implementation of the statute.

B. Implementation

    Comment: Several commenters recommended that CMS delay the 
implementation of the new rule until State legislatures can adequately 
assess its implications and take the necessary action to ensure proper 
funding of their Medicaid programs. A few commenters recommended that 
the proposed rule be delayed until CMS works closely with States to 
establish some optional funding solutions for Medicaid services. 
Another commenter suggested that, at a minimum, States should be 
provided an adequate transition period to implement the new rule. 
Another commenter recommended that the effective date of the rule be 
delayed by at least 6 to 12 months.
    Response: As required by section 403 of the Tax Relief and Health 
Care Act of 2006, the final regulation with respect to the reduction in 
the indirect guarantee threshold percentage is effective January 1, 
2008. We have provided for a transition period until October 1, 2009 
for States to come into compliance with the statutory revision to the 
permissible class of health care services identified as ``services of a 
managed care organizations.'' Since the other provisions of the 
regulation are clarifications that reflect CMS's existing understanding 
of the law, further transition is not warranted.

C. Permissible Classes of Health Care Items and Services--ICF/MR (Sec.  
433.56(a)(4))

    Comment: Several commenters, including a commenter from a State 
that the commenter believes was the intended beneficiary of the 
provision, expressed concern that CMS did not explain why community 
based residences included in the ICF/MR class in 1993 would be excluded 
from the class. One commenter stated that CMS violated the APA by not 
providing a reasoned analysis for the proposed change. Another 
commenter stated that this proposed change would adversely affect the 
provision of home and community based services.
    Response: We proposed to delete this exception because we believed 
it was no longer applicable to any State. In response to these 
comments, we have determined that there is one State to which the 
exception applies. Therefore, we are no longer deleting the exception.
    In the 1993 interim final rule implementing Medicaid Voluntary 
Contribution and Provider Specific Tax Amendments of 1991, the 
statutory class of health care items and services at section 
1903(w)(7)(iv) of the Act for services of intermediate care facilities 
for the mentally retarded (ICF/MR) was defined to include similar 
services furnished by community-based residences for the mentally 
retarded, under a waiver under section 1915(c) of the Act, in a State 
in which, as of December 24, 1992, at least 85 percent of such 
facilities were classified as ICF/MRs prior to the grant of the waiver. 
This exception was very narrow and was only intended to capture those 
States that were granted section 1915(c) waivers that converted most of 
their ICF/MRs to community-based residences prior to the effective date 
of the interim final rule.
    Over the past several years, a few States have requested CMS 
approval to expand their ICF/MR services tax programs to include 
certain home and community-based services. None of those States were 
able to demonstrate compliance with the parameters of this permissible 
class of health care items or services. Therefore, when CMS proposed 
deleting the exception, CMS did not believe there were any States that 
did or could meet these specific requirements.
    In response to public comments, CMS was able to identify one State 
that meets the requirements for this class of health care services. 
Rhode Island has a long-standing tax program that meets these 
requirements and as a result, the final regulation retains the original 
regulatory language.
    Comment: Several commenters asked for CMS to expand the inclusion 
of home and community-based service providers in the ICF/MR class for 
all States, arguing that it is not equitable to accord different 
treatment to States that converted ICF/MRs into waiver facilities 
before 1992 than to other States. These commenters noted that this 
policy would generally benefit home and community-based service 
providers. These commenters argued that, in order for the class to be 
truly broad-based, all types of home and community-based residences for 
persons with mental retardation and developmental disabilities should 
be included. One commenter specifically asserted that this policy would 
allow States to impose health care-related taxes to help fund home and 
community-based services, and would increase access and availability of 
such services. Many commenters cited the benefits of home and 
community-based waiver services, and mentioned Federal policies 
supporting the expansion of such services.
    Response: The statutory provision at section 1903(w)(7)(iv) of the 
Act refers only to ICF/MR facilities as the permissible class. As 
discussed above, in 1993, we provided for a limited exception to 
address the unique situation of States with existing waivers that 
converted most of their ICF/MRs to community-based residences prior to 
the effective date of the interim final rule. We do not believe a 
broader exception would be consistent with the statutory language. 
Moreover, we were not persuaded by the arguments that higher taxes on 
home and community-based services would actually encourage and 
stimulate the provision of such services. It appears counterintuitive 
that taxes that make such services more costly would stimulate broader 
use and availability.
    Comment: One commenter requested that CMS more precisely define 
intermediate care facilities for the mentally retarded (ICF/MR) to 
include all facilities licensed as ICFs/MR, no matter the size of the 
facility.
    Response: The regulation was not intended to redefine ICF/MRs or 
any other provider type. Instead, in part, the rule proposed to clarify 
a permissible class of health care services for purposes of health 
care-related tax requirements. For purposes of health care-related 
taxes, if a State were to impose a tax on ICF/MR services, in order to 
be considered broad-based, all licensed

[[Page 9690]]

ICF/MR providers within the State would need to be subject to the tax.
    Comment: One commenter suggested that CMS exercise its statutory 
authority to update the historical listing of permissible classes by 
adopting additional provider classes through regulation. The commenter 
noted that CMS has reminded States of this opportunity. The commenter 
specified that inviting proposals to add classes helps update the 
Medicaid program by recognizing change in providers, acknowledging 
State environments are different, supporting Congressional intent and 
recognizing that individual States and providers should be free to 
collaborate and choose the best means suited to address financing 
relationships to meet their State's needs.
    Response: The preamble to the 1993 final rule stated that the 
Secretary would consider adding additional classes if States can 
demonstrate the need for additional designation and that any proposed 
class meet the following criteria: (1) The revenue of the class is not 
predominantly from Medicaid and Medicare (not more than 50 percent from 
Medicaid and not more than 80 percent from Medicaid, Medicare, and 
other Federal programs combined; (2) the class is clearly identifiable, 
for example, by designation through State licensing programs, 
recognition for Federal statutory purposes, or inclusion as a provider 
in State plans; and (3) the class is nationally recognized rather than 
unique to a State. At this time, we do not see a reason to alter this 
policy or to add new permissible classes of health care items or 
services.

D. Permissible Classes of Health Care Items and Services--Managed Care 
(Sec.  433.56(a)(8))

    Comment: One commenter recommended that CMS consider a definition 
for the term ``preferred provider organizations'' so that States will 
know what entities must be included in a tax program on this class of 
providers for it to comply with the broad-based requirement of the 
statute and associated regulations.
    Response: Inclusion of the term preferred provider organization 
(PPO) as a type of managed care organization that would be in the 
permissible class of services for health care-related taxation purposes 
mirrored the statutory language enacted under section 6051 of the 
Deficit Reduction Act which amended section 1903(w)(7)(A)(viii) of the 
Social Security Act. The statutory language was designed to more 
broadly encompass services provide by all managed care organizations 
without regard to their status as Medicaid or commercial health plan or 
the form of such plans. The statutory language included examples to 
clearly establish that all types of managed care businesses must be 
included in order for a health care-related tax to be truly broad 
based. For Medicare accreditation purposes it is established that MCOs 
are licensed as both HMOs or PPOs. The intent is to fully encompass the 
types of managed care products available to individuals in commercial 
markets for coordinated care plans. This is a generally accepted term 
and type of entity in the managed health care market and we do not feel 
that a definition is necessary for Medicaid regulation purposes.

E. Hold Harmless Sec.  433.68(f)--General

    Comment: Some commenters expressed concern that the new rule 
appears to replace a purely objective test for hold harmless 
arrangements with one that is subjective. They argued that the 
Secretary had rejected the introduction of a subjective analysis when 
he published the original hold harmless prohibitions in 1993 and that 
the new rule should continue along this same course.
    Response: We believe that the new regulation continues to apply a 
largely objective analysis in determining whether state tax programs 
contain hold harmless arrangements. This regulation is intended to 
carry out the purposes originally outlined in the Medicaid Voluntary 
Contribution and Provider Specific Tax Amendments of 1991 (Pub. L. 102-
234) and the implementing regulations, by prohibiting FFP for health 
care-related taxes where the state has implemented a hold harmless 
provision. One lesson we have learned in the years since we first 
endeavored to implement Congress's prohibitions on taxes with hold 
harmless arrangements is that it is simply impossible to anticipate 
every hold harmless arrangement that may be implemented by States. As a 
result, it would not be true to Congressional intent to implement a 
mathematical model to be applied in detecting hold harmless 
arrangements that violate the statutory prohibitions. We do not believe 
the Medicaid statute contemplates such a formula, but anticipates that 
the Secretary will carefully analyze all circumstances relevant to the 
creation and operation of a state health care-related tax and attendant 
tax relief programs in carrying out his mandate to prohibit FFP where 
hold harmless arrangements exist. The analysis of state provider taxes 
remains an overwhelmingly objective process, but the unique and 
individual nature of State tax programs means that the analysis is 
always on a case-by-case basis. The individualized analysis outlined in 
this rule is not the type of subjective analysis that the Secretary 
expressly rejected in the 1993 final rule. In that rule, the Secretary 
rejected a suggestion that CMS should assess the egregiousness of a 
hold harmless violation in determining whether to take a disallowance.
    Comment: One commenter opined that Congress did not authorize the 
Secretary to expand the tests for determining when an impermissible 
hold harmless arrangement exists, arguing that the regulations should 
mimic the statutory language. Other commenters suggested that the 
existing rules were appropriate and the new rules could place existing 
tax programs at risk.
    Response: It is not our intent to expand the test for determining 
when an impermissible hold harmless arrangement exists beyond the 
original purposes authorized by Congress and underlying the 1993 rules. 
As noted above, we are not aware of any state tax programs that would 
have been permissible under the Secretary's prior interpretation of the 
rules, but are no longer permissible under the new rules. The new rule 
endeavors to address issues that have arisen since the issuance of the 
1993 rule, which effectively repeated the statutory language but did 
little to elucidate that language. That rule proved largely successful 
in stopping impermissible hold harmless arrangements, with the 
overwhelming majority of States ending such programs. A recent decision 
issued by the HHS Departmental Appeals Board, however, has indicated 
confusion concerning the degree of flexibility in the application of 
the Secretary's longstanding interpretation of that rule in addressing 
new issues that have arisen. (DAB No. 1981, June 29, 2005.) Therefore, 
we believe it is necessary and appropriate for the Secretary to issue 
new regulations so that States will have clear guidance on which health 
care-related tax programs will be entitled to FFP.
    Comment: Several commenters requested that they be able to retain 
the ability to use rates that are based on receipt of provider taxes 
rather than overall provider costs.
    Response: The Social Security Act clearly allows States to collect 
permissible health care-related taxes to be used as a source of non-
federal share funding for Medicaid payments to health care providers. 
Further, States can consider Medicaid's portion of a permissible health 
care-related tax as an

[[Page 9691]]

allowable cost for purposes of developing Medicaid reimbursement rates. 
However, basing Medicaid payment rates solely on the receipt of health 
care-related taxes is a clear hold harmless violation.
    Comment: Several commenters noted that broadening the definition of 
hold harmless will penalize States that have other non-Medicaid funding 
initiatives for health care organizations. Under the proposed rule, 
payments made to health care providers as part of regular business 
could become entangled in the enforcement of the new rule.
    Response: The hold harmless clarifications in this regulation are 
necessary to ensure compliance with the statutory limitations on hold 
harmless arrangements. In reviewing a health care related tax program, 
CMS needs to review the tax and associated financial arrangements as a 
whole, including any non-Medicaid payments. Taxes or fees that are 
imposed in the ordinary course of business and are not health care 
related would not trigger such a review, nor would non-Medicaid 
governmental payments that occur in the regular course of business, for 
example through procurements.
    Comment: One commenter stated that the changes to the hold harmless 
provisions could make their current provider tax program non-approvable 
because the fees for the most part are used to pay back the cost to the 
fee payer.
    Response: We are not aware of any State tax programs that would 
have been permissible under the Secretary's prior interpretation of the 
rules, but are no longer permissible under the new rules. If, however a 
State increases Medicaid reimbursement rates based solely on the 
receipt of a health care related tax, rather than on the costs incurred 
for providing Medicaid services, such an arrangement would be 
considered a hold harmless violation. We believe this result is 
consistent with the requirements of the statute and existing regulation 
and is unchanged by this final rule.
    Comment: One commenter requested that CMS include in the rule 
itself the language in the preamble to the proposed rule indicating 
that States using cost-based payment systems may include provider tax 
costs as one of many provider costs that are considered in setting 
individualized provider rates. The commenter argued that including this 
language in the rule would prevent any changes in CMS interpretation.
    Response: We are not including this language in the rule itself 
because the rule is limited to the basic framework and cannot address 
every specific circumstance and nuance. And this is an example of a 
very complex issue. The clarification to the Medicaid payment hold 
harmless test states that a Medicaid payment will be considered to vary 
based on the tax amount when the payment is conditional on the tax 
payment. This provision does not prevent States that use cost-based 
reimbursement methodologies from including Medicaid's share of health 
care related tax costs as one of many health care provider costs that 
are considered in setting individualized Medicaid reimbursement rates. 
However, where a Medicaid payment is conditional on receipt of health 
care related taxes, we would view the Medicaid payment to be, in part 
or in full, the repayment of the health care related tax to repay the 
taxes in a hold harmless arrangement rather than as a protected 
reimbursement for cost of Medicaid services.
    Comment: A few commenters addressed the DAB decision that CMS 
acknowledged it was attempting to respond to with this regulation, 
suggesting that a more appropriate response to that decision would have 
been to simply clarify that the hold harmless standard applies to 
situations where the benefits accrue to private pay patients rather 
than to the taxpaying facilities directly.
    Response: We do not believe that the commenter's suggestion would 
address all of the confusion created by the Board's decision. We agree 
that clarifying the rules to explain that the hold harmless standard 
applies to situations where the state payments are made to third 
parties would help to clarify the questions raised by the Board's 
decision and we have attempted to do that in this rule. However, we do 
not believe such a clarification alone would be sufficient.

F. Hold Harmless--Sec.  433.68(f)(1)--Positive Correlation

    Comment: Several commenters stated that by including any positive 
correlation over any amount of time, the proposed rule destroys any 
standard by which a State may assess whether or not a tax based 
Medicaid funding arrangement will be determined by CMS to be a hold 
harmless violation. Other commenters disagreed with CMS' statement that 
the current regulations related to positive correlation led to 
confusion. The commenters believe that the subjective analysis proposed 
will only lead to additional confusion.
    Response: Our experience is that States and providers are typically 
very aware of the overall character of a tax based Medicaid funding 
arrangement. Moreover, it is clear that to achieve the statutory 
purpose of ending hold harmless arrangements that result in shifting a 
disproportionate burden to the federal government, the test must be 
applied flexibly. Otherwise, financing arrangements will be structured 
to meet the letter but not the underlying purpose of the statutory 
limitations. This regulation is intended to further clarify the 
existing hold harmless provisions and not to lead to additional 
confusion.
    Comment: Several commenters asserted that the test for a ``positive 
correlation'' under Sec.  433.68(f)(1) is too subjective, and should 
instead remain a statistical test. They expressed concern that under 
the proposed test, CMS could find a positive correlation in almost any 
situation.
    Response: The 1993 rule does confine the statutory term ``positive 
correlation'' to a test requiring mathematical certainty. The insertion 
of the statistical concept suggests that a positive correlation 
contemplates a positive relationship between two variables. Such a 
correlation would exist, for example, where a state passes a tax on 
nursing home beds that a facility is permitted to pass on to its 
residents in the form of rate increases. If at or about the same time, 
the state passes a grant program that pays private pay residents of the 
nursing home an amount similar to the bed tax, the grant money would be 
available for use to compensate the nursing facility for the tax and a 
positive correlation would be found to exist between the tax and the 
grant. The correlation would not be destroyed by altering one variable 
over time and would not necessarily need to be measured in a 
statistical sense. This has always been CMS's position with respect to 
the 1993 regulations, but unfortunately the description of positive 
correlation as a statistical concept in the 1993 rule created some 
confusion. In retrospect, we now believe that characterizing positive 
correlation as having ``the same meaning as the statistical term'' in 
the 1993 rule was imprecise. The use of this language caused some 
readers to view the test as requiring a mathematical certainty with 
specifically measurable statistical significance over the life of the 
grant and tax programs, or measured with respect to specific amounts 
collected and paid out under the specific programs. Where we did impose 
a mathematical test in evaluating a tax program it was clearly spelled 
out in the 1993 rule, as it was with respect to the ``indirect 
guarantee test'' described at page 43182 of the 1993 rule. The rule 
was, however, never meant to bring

[[Page 9692]]

mathematical certainty into the positive correlation examination. We do 
not consider the current rule to signal a significant change in our 
analysis; rather, it clarifies our interpretation of the statutory term 
``positive correlation.'' We will continue to evaluate health care 
related tax programs to determine whether there is a positive 
correlation with a state payment program.

G. Hold Harmless Sec.  433.68(f)(2)--Medicaid Payment Test

    Comment: Many commenters argued that, by prohibiting States from 
conditioning Medicaid payment on receipt of the tax, the proposed rule 
would prevent the State from using the tax to reimburse providers. 
These commenters stated that Congress clearly intended provider taxes 
to be used for purposes of Medicaid reimbursement purposes. The 
commenters noted that section 1903(w)(4) of the Social Security Act 
specifies that the hold harmless provisions ``shall not prevent use of 
the tax to reimburse health care providers in a class for expenditures 
under this title nor preclude States from relying on such reimbursement 
to justify or explain the tax in the legislative process.''
    Response: We agree States can use permissible health care related 
tax revenues to increase Medicaid reimbursement rates. However, section 
1903(w)(4) of the Act specifies three conditions under which a State or 
local government is determined to hold taxpayers harmless for their tax 
costs. If any of these conditions are met the tax program would be 
determined to have a hold harmless provision and the tax would be 
impermissible. The final rule does not change the conditions of the 
hold harmless provisions under Federal law. Consistent with these 
provisions, where a Medicaid payment is conditional on receipt of 
health care related taxes, we would view the Medicaid payment to be, in 
part or in full, the repayment of the health care related tax to repay 
the taxes in a hold harmless arrangement rather than as a protected 
reimbursement for cost of Medicaid services.
    Comment: Several commenters stated that by expressly 37 
conditioning Medicaid payments on the tax amount, States are explicitly 
explaining how the tax is being used for Medicaid reimbursement as part 
of the legislative process. The commenters believe that it is 
reasonable to condition payment on the approval and receipt of the tax 
and to not do so would be fiscally irresponsible. The State would be 
obligated to make payments without having a funding source to finance 
them and without conditioning States would not be able to adopt tax 
programs. Other commenters noted that health care providers are 
reluctant to support taxes unless there is an explicit assurance that 
the revenues from the taxes will be dedicated to increasing Medicaid 
payments and that State legislatures are reluctant to increase Medicaid 
liabilities with the ability to make them contingent on the funding 
source.
    Response: There is a distinction between using health care related 
tax revenues to support Medicaid payments and specifically guaranteeing 
repayment of some or all of the tax amount or otherwise ensuring a 
direct correlation between payments to taxpayers and the amount of 
their taxes. States have and continue to maintain the ability to 
justify the imposition of a health care related tax by indicating 
through the State legislative process that proceeds from the health 
care related tax will be used to increase Medicaid reimbursement and 
that such funding must be approved by CMS. However, the statute is very 
clear that health care related taxes cannot contain hold harmless 
arrangements and any failure to comply with any of the three hold 
harmless ``tests'' would render a health care related tax 
impermissible. There is a distinct difference between explaining a 
health care related tax and its purposes through the legislative 
process and extending conditional guarantees to provider taxpayers. 
States must ensure that no payment is conditioned upon receipt of a 
health care related tax payment.
    Comment: A few commenters requested that CMS clarify preamble 
language related to State use of tax proceeds and federal match to 
increase Medicaid rates in the form of Medicaid supplemental payments. 
The commenters believe that this should not prohibit States from using 
tax proceeds and federal match to increase Medicaid rates in the form 
of Medicaid per diem add-ons or rate supplements.
    Response: Section 1903(w)(4) expressly provides that States may use 
permissible tax revenues to fund provider payments for covered services 
furnished to eligible individuals. This provision does not authorize 
States to use tax revenues for a hold harmless arrangement that 
effectively repays provider taxpayers. In other words, the payment 
methodology related to such increases to Medicaid reimbursement rates 
must be designed in a manner that recognizes the volume or nature of 
the covered services provided to Medicaid individuals, and cannot be 
related simply to the amount of tax proceeds.
    Comment: Several commenters disagreed with any suggestion that a 
Medicaid payment increase funded by tax revenue is necessarily 
uneconomical, because the funding source of the payment is irrelevant 
to rate development. The commenters stated that Congress rejected the 
position that, because provider taxes reduced actual expenditures made 
by the State, the amount of the provider tax should be deducted from 
total State spending so that only ``real'' or ``net'' State 
expenditures would be matched. One commenter stated that the proposed 
rule would interfere with permissible taxation by presupposing that 
rates explicitly supported by tax revenue are too high and therefore 
not economical.
    Response: These commenters appear to have misread the preamble of 
the proposed rule. We agree that States may collect permissible health 
care related taxes, and may use those tax revenues as a source of non-
federal share funding for Medicaid payments to health care providers. 
Our specific concern is when the Medicaid payments are conditional on 
payment of the taxes. In that instance, the Medicaid payment is not 
linked to any rate-setting determination based on the cost or volume of 
services. Instead, the Medicaid payment is in the nature of a hold 
harmless arrangement to return all or part of the tax liability to the 
taxpayer. We are clarifying the Medicaid payment test to provide that a 
Medicaid payment will be considered to vary based on the tax amount 
when the payment is conditional on the tax payment. This clarification 
would only affect States that seek to use rates that are based on the 
receipt of provider taxes rather than on overall provider cost. In 
other words, the final regulation rule would limit the ability of 
States to expressly condition payment rates on tax receipts rather than 
on a process that determines rates that are consistent with efficiency, 
economy and quality of care in compliance with section 1902(a)(30)(A) 
of the Act.
    Comment: A few commenters disagreed with the definition of enhanced 
Medicaid payment as a payment for which any branch of government has 
indicated that the payment can be reduced or eliminated if the provider 
tax is discontinued. The commenters were concerned that CMS is 
asserting that this would represent a structural repayment of the tax 
and violates hold harmless provisions. The commenters disagreed with 
this position.
    Response: The phrase ``enhanced Medicaid payments'' relates to the 
second prong of the indirect hold harmless test (``75/75 test''). This 
test

[[Page 9693]]

stipulates that if a health care related tax exceeds the regulatory 
percentage threshold, CMS would consider a hold harmless to exist if 75 
percent or more of the taxpayers in the class receive 75 percent or 
more of their total tax back in enhanced Medicaid payments or other 
State payments. We clarified that if a State ever had to provide a 
demonstration for purposes of the ``75/75 test'' we may consider any 
amount that any branch of the State, including legislative and 
executive branch, has indicated could be subject to reduction in the 
absence of provider tax revenues as an enhanced Medicaid payment. This 
comparison is between Medicaid payments and tax costs and we were not 
asserting in this instance that this would be a structural repayment. 
We were clarifying that, for purposes of the ``75/75 test'', payments 
which would no longer be provided if the tax funding source were 
eliminated, would be considered enhanced Medicaid payments, even if the 
State did not characterize them as such.
    Comment: Several commenters stated that eliminating conditional 
Medicaid payments would undermine provider support for health care 
related taxes. The commenters asserted that assurances that provider 
tax revenue will be used for a specific category of Medicaid 
expenditures is not equivalent to holding taxpayers harmless for the 
cost of the tax.
    Response: States have and continue to maintain the ability to 
justify the imposition of a health care related tax by indicating 
through the State legislative process that proceeds from the health 
care related tax will be used to increase Medicaid reimbursement and 
that such funding must be approved by CMS. However, the statute is very 
clear that health care related taxes cannot contain hold harmless 
arrangements and any failure to comply with any of the three hold 
harmless ``tests'' would render a health care related tax 
impermissible. There is a distinct difference between explaining a 
health care related tax and its purposes through the legislative 
process and extending conditional guarantees to repay provider 
taxpayers. We recognize that high volume Medicaid providers could 
benefit from a health care related tax that funds a Medicaid rate 
increase, however, States must ensure that no payment is conditioned 
upon receipt of a health care related tax payment.
    Comment: Several commenters stated that the definitions of ``tax 
amount'' and ``payment amount'' in the proposed rule are too broad. One 
commenter argued that the shift in terminology in Sec.  433.68(f)(2) 
from ``amount of the total tax payment'' to ``tax amount'' represents a 
significant departure from the statutory and prior regulatory language.
    Response: As explained in the preamble to the proposed rule, the 
change in terminology is not a substantive change from what was 
intended in the original 1993 rule. We are using the terms ``tax 
amount'' and ``payment amount'' throughout the new rule in an effort to 
be consistent. We have found that the use of differing terms in the 
various sections of the 1993 rule has led to some confusion. 
Accordingly, we consolidated the terms ``total tax cost,'' ``total tax 
payment,'' ``amount of the payment,'' ``amount of such tax'' into the 
terms ``tax amount'' and ``payment amount'' to be used in each section 
of the hold harmless rule. We explained our reasoning at more length in 
the proposed rule and believe that reasoning remains valid (72 FR 
13729, 13730). This does not represent a significant departure from 
prior statutory or regulatory language. It clarifies that we are not 
looking at the total amount of the tax payment received by the state, 
but we will be looking at the tax program as a whole, including whether 
taxpayers are being held harmless for increments of the tax. With 
respect to subsection (f)(2) this means that we will look at whether 
any portion of the Medicaid payments made by the state to providers, 
varies based upon the health care related tax levied upon the 
providers. The ``tax amount'' is the amount of the tax levied upon the 
provider (either directly, or indirectly).
    Comment: Several commenters stated that the phrase ``including 
where Medicaid payment is conditional on receipt of the tax amount'' is 
problematic. Some commenters noted that the proposed language would 
appear to have the effect of prohibiting States from enforcing tax 
obligations on delinquent providers through intercept of Medicaid 
payments. Another commenter expressed concern that this would prohibit 
States from requiring overdue taxes as a condition for payments due to 
a taxpayer. Other commenters stated that it may result in situations 
where health provider taxes that are statutorily established in a 
manner that complies with the broad based and uniformity requirements 
of the statue cannot be enforced.
    Response: This regulation does not prevent State enforcement of the 
collection of health care related taxes. It is the State's obligation 
to ensure that any health care related tax program is collected in a 
manner consistent with legislation enacting the health care related tax 
program and any approved waiver of the broad-based and/or uniformity 
requirements. To suggest that the phrase ``including where Medicaid 
payment is conditional on receipt of the tax amount'' would prohibit 
States from enforcing tax obligations on delinquent health care 
providers is erroneous. If States do not enforce the proper collection 
of the health care related tax, the State is at risk of violating 
statutory broad-based and/or uniformity requirements which could render 
the entire tax program and its collections impermissible.
    Comment: A few commenters specified that the word ``total'' is 
critical within the Medicaid payment test because a Medicaid payment 
that varies based on the Medicaid portion of the tax is permissible. 
The commenters stipulated that only a Medicaid payment that varies 
based on the total provider tax amounts constitutes a hold harmless. 
Other commenters stated that the portion of a provider's health care-
related tax payment attributable to Medicaid services is an allowable 
cost, and Medicaid reimbursement may be furnished for it. The 
commenters recommended that the word ``total'' be restored.
    Response: The regulation specifies that a hold harmless arrangement 
exists if all or any portion of the Medicaid payment varies based only 
on the amount of the tax payment. The removal of the word total does 
not represent a significant departure from prior statutory or 
regulatory language. As explained in the preamble to the proposed rule, 
the change in terminology is not a substantive change from what was 
intended in the original 1993 rule. We are using the terms ``tax 
amount'' and ``payment amount'' throughout the new rule in an effort to 
be consistent. We have found that the use of differing terms in the 
various sections of the 1993 rule has led to some confusion. 
Accordingly, we consolidated the terms ``total tax cost,'' ``total tax 
payment,'' ``amount of the payment,'' ``amount of such tax'' into the 
terms ``tax amount'' and ``payment amount'' to be used in each section 
of the hold harmless rule. We explained our reasoning at more length in 
the proposed rule and believe that reasoning remains valid (72 FR 
13729, 13730). This was intended to clarify that we are not looking 
simply at the total amount of the tax payment received by the state, 
but will be looking at the tax program as a whole, including whether 
tax payers are being held harmless for increments of the tax.
    Comment: One commenter suggested that supplemental payments should 
be permitted to be paid to those providers

[[Page 9694]]

who are providing Medicaid services based on receipt of provider taxes.
    Response: Generally, States can collect permissible taxes and use 
such tax receipts as the non-federal share to make supplemental 
payments for the provision of Medicaid services. However, a hold 
harmless arrangement exists when States seek to use reimbursement rates 
that are based solely on the receipt of health care related taxes and 
effectively repay the taxpayer (such as supplemental Medicaid payments 
conditioned on receipt of a health care related tax payment), rather 
than on overall health care provider costs. The clarifications in this 
rule are necessary to ensure that Medicaid payments are not made simply 
to repay providers for the cost of the health care related tax beyond 
Medicaid's allowable share, but also to ensure the integrity of the 
development of sound Medicaid payment rates in compliance with the 
requirements of section 1902(a)(30) of the Act.

H. Hold Harmless 433.68(f)(3)--Guarantee Test

    Comment: Numerous commenters asked for clarification of the 
proposed interpretation of the phrase ``direct and indirect'' in the 
guarantee test, and should confirm that use of provider tax receipts to 
increase Medicaid rates for or to enhance the Medicaid rate methodology 
applicable to the taxed provider class is not prohibited.
    Response: The clarification of the guarantee test is meant to 
specify that a State can provide a direct or indirect guarantee through 
a direct or indirect payment. A direct guarantee will be found when a 
State payment is made available to a taxpayer or a party related to the 
taxpayer with the reasonable expectation that the payment would result 
in the taxpayer being held harmless for any part of the tax (through 
direct or indirect payments). A direct guarantee does not need to be an 
explicit promise or assurance of payment. Instead, the element 
necessary to constitute a direct guarantee is the provision for payment 
by State statute, regulation, or policy. An indirect guarantee is 
distinct from a direct guarantee in that such guarantee is initially 
measured by a percentage threshold that limits tax collections to 5.5 
percent of net patient revenue attributable to the assessed service. 
States collecting a tax in excess of 5.5 percent of assessed patient 
service revenue must perform the second prong of the hold harmless test 
to demonstrate permissibility.
    Comment: A few commenters expressed concern that CMS has taken too 
broad a view in stating that monies ``controlled or influenced by the 
state'' will be considered in applying the guarantee test in Sec.  
433.68(f)(1).
    Response: The language of concern to these commenters appears in 
the preamble to the proposed rule. In the preamble we provided an 
illustration of how a health care related tax and grant program could 
be found to violate both the positive correlation test and the 
guarantee test. We believe that discussion accurately reflects existing 
statutory provisions governing health care related taxes. The specific 
language of concern to the commenters appears in a discussion of 
problematic indirect payments that States may make to taxpayers. The 
preamble notes that ``money is fungible and, as long as the payment is 
from a source controlled or influenced by the State, it will be 
considered in determining whether it has been made available for the 
tax.'' In evaluating whether the state has made monies available to 
hold providers harmless for any portion of a health care related tax, 
it makes little difference which part of the state treasury makes the 
funds available to the taxpayer, or if the state monies are funneled 
through some other third party, because all State monies are fungible. 
For example, it would be impermissible for the state to impose a 
nursing home bed tax to be paid to the state Medicaid agency and have 
the Governor's office control a separate grant payment designed to 
reimburse private pay residents for the amount of the tax passed on to 
them by the nursing homes. Even though the state may argue these are 
separate funding sources, CMS would consider all of the money state 
money and would consider the positive correlation between the two 
programs a violation of the hold harmless provisions. Similarly, States 
will not be permitted to recycle monies through third parties, by 
making payments to such third parties and requiring that the money be 
used to reimburse taxpayers for any portion of their health care 
related tax. This is the point the preamble was trying to address when 
it embraced payments ``influenced by the state.'' However, we agree 
with the commenters that ``influenced by the state'' is too broad a 
term. We believe ``controlled or directed by the state'' is a more 
accurate description of the types of payments that will be considered 
in evaluating whether an impermissible hold harmless arrangement 
exists.
    Comment: Several commenters stated that the term ``reasonable 
expectation'' under the guarantee test in Sec.  433.68(f)(3) is too 
broad and/or subjective.
    Response: In the preamble to the proposed rule we stated that ``A 
direct guarantee will be found when a state payment is made available 
to a taxpayer or a party related to a taxpayer (for example as a 
nursing home resident is related to a nursing home), in the reasonable 
expectation that the payment would result in the taxpayer being held 
harmless for any part of the tax'' (72 FR 13730). We chose to use the 
term reasonable expectation because we recognized that state laws were 
rarely overt in requiring that state payments be used to hold taxpayers 
harmless. For example, state laws providing grants to nursing home 
residents who incur increased rates as a result of bed taxes on nursing 
homes, rarely required the residents receiving the grants to actually 
use the money to pay the increased nursing home fees. Accordingly, 
arguments have been made that such grants do not actually guarantee to 
hold the nursing homes harmless for the tax. We disagree. Because the 
residents must pay the increased rates passed on to them as a result of 
the tax and because the state has made money available to those 
residents to pay those increased rates, it is reasonable to expect that 
the payments going to the nursing home residents will promptly be sent 
to the nursing home as resident fee payments. This would result in a 
hold harmless for the nursing home. The only way to avoid this 
conclusion would be for the resident to leave the facility and/or not 
pay the rate increase. Therefore, we do not believe the use of the term 
reasonable expectation is overly broad or vague.
    Comment: Several commenters stated that collection of unpaid 
provider taxes by withholding amounts of Medicaid payments due under 
the new rule would constitute a hold harmless because it would cause 
the Medicaid payment to be contingent on the payment of the tax.
    Response: Withholding Medicaid payments to health care providers 
who have not paid their taxes would not constitute a hold harmless 
arrangement. This is a matter of State enforcement. States are, by 
themselves, obligated to ensure that any health care related tax is 
collected in a manner consistent with Federal law, authorizing State 
legislation and if applicable any CMS approved waiver of the broad-
based and/or uniformity requirements. Typically, such enforcement 
provisions are authorized through the health care related tax's 
enacting legislation and are identified as enforcement collection 
provisions and/or penalties.
    Comment: A few commenters disagreed with CMS' assertion in the

[[Page 9695]]

proposed rule that the direct and indirect tests differ on the kind of 
payment involved. The commenters stated that there is no basis for this 
distinction.
    Response: A direct guarantee will be found when a State payment is 
made available to a taxpayer or a party related to the taxpayer in the 
reasonable expectation that the payment would result in the taxpayer 
being held harmless for any part of the tax. An indirect guarantee is 
distinct from a direct guarantee in that such guarantee is initially 
measured by a percentage threshold that limits tax collection to 5.5 
percent of patient revenue attributable to the assessed service. States 
collecting a tax in excess of 5.5 percent of assessed patient service 
revenue must perform the second prong of the hold harmless test to 
demonstrate permissibility.
    Comment: A few commenters indicated that they do not object to CMS' 
proposal to the direct guarantee test to clarify that payment to a 
taxpayer may be indirect. Nor do they disagree with CMS that, under the 
amended language, a grant or benefit to private pay patients or 
residents could be considered an indirect payment to the taxpayer for 
purposes of the ``direct guarantee.''
    Response: We appreciate the support to ensure the fiscal integrity 
of the Medicaid program. Clarifying our current regulations helps us 
achieve this goal.

I. Hold Harmless 433.68(f)(3)(i)--Indirect Guarantee

    Comment: One commenter stated that, in implementing the indirect 
percentage threshold changes as mandated by Congress, CMS went beyond 
the legislative directive by further amending the regulatory text to 
specify that the percentage threshold applied to net operating 
revenues. The commenter argued CMS' position that the safe harbor 
percentages are restricted to net revenue is not supported in the 
legislative history. The commenter believes that States should be 
permitted to interpret the phrase ``revenue received by providers'' as 
either gross or net revenue.
    Response: The phrase ``revenues received by the taxpayer,'' has 
been interpreted by CMS to be, the net patient service revenue, 
received by the health care provider. This would include all revenues 
received from all payers for providing the particular service that is 
assessed by the State and would not include revenues unrelated to the 
service being assessed. In addition, the safe harbor percentage 
originally created by the 1992 interim rule was never addressed in the 
statutory language and therefore would not be addressed in any 
legislative history. However, the legislative history clearly 
demonstrates that Congress requires CMS to evaluate the permissibility 
of a health care related tax on a per service basis, as the 1991 law 
separately identified permissible classes of health care items or 
services. Finally, we believe that the phrase ``net operating revenue'' 
used in the regulatory text may have caused confusion. We have altered 
the final regulation to refer to net patient service revenue.
    Comment: One commenter specified that under the proposed broad 
interpretation of the Medicaid payment hold harmless provision, CMS can 
find a violation in any situation where provider tax revenues are used 
to make Medicaid payments to taxed providers. The commenter argued that 
the impact of this results in the omission of the ``indirect guarantee 
test'', whose importance was affirmed by Congress in the Tax Relief and 
Health Care Act of 2006.
    Response: As we have mentioned earlier, this regulation carries out 
the purposes originally outlined in the Medicaid Voluntary Contribution 
and Provider Specific Tax Amendments of 1991 (Pub. L. 102-234) and the 
implementing regulations, by prohibiting FFP for health care related 
taxes where the State has implemented a hold harmless provision. It has 
not been our intent to expand the test for determining when an 
impermissible hold harmless arrangement exists beyond the original 
purposes underlying the 1993 rules. We are not aware of any State 
health care related tax programs that would have been permissible under 
the Secretary's prior interpretation of the rules but are no longer 
permissible under this regulation. Therefore, we do not agree that we 
have nullified the indirect guarantee test that the commenter argues 
was reaffirmed by Congress.

IV. Provisions of the Final Regulations

    As a result of our review of the comments we received during the 
public comment period, as discussed in section III of this preamble, we 
are making the following revisions to the proposed regulation published 
on January 18, 2007.

Section 433.56 Classes of Health Care Services and Providers Defined

    We have modified the regulation at Sec.  433.56(a)(4) to return to 
the original regulatory language. The regulation has been revised to 
re-incorporate that similar services furnished by community-based 
residences for the mentally retarded, under a waiver under section 
1915(c) of the Act, in a State in which, as of December 24, 1992, at 
least 85 percent of such facilities were classified as ICF/MRs prior to 
the grant of the waiver can be included in the permissible class of 
health care items or services. CMS has modified the regulation to 
recognize that one State qualifies under this narrow exception.

Section 433.68 Permissible Health Care-Related Taxes

    We have modified the phrase ``net operating revenues'' in Sec.  
433.68(f)(3)(i) to more accurately reflect that the base to which tax 
collections are applied for purposes of the indirect hold harmless 
threshold (i.e., net patient service revenue). Further, in response to 
comments we have clarified that revenues received by the taxpayer 
refers to the net patient revenue attributable to the assessed 
permissible class of health care items or services.
    To increase clarity and ensure implementation of the governing 
statutory provision, we are also removing Sec.  433.68(f)(3)(ii) as a 
technical conforming action. This section is outdated and no longer has 
any applicability.

V. Collection of Information Requirements

    This document does not impose information collection and 
recordkeeping requirements. Consequently, it need not be reviewed by 
the Office of Management and Budget under the authority of the 
Paperwork Reduction Act of 1995 (44 U.S.C. 35.)

VI. Regulatory Impact Analysis

A. Overall Impact

    We have examined the impact of this regulation as required by 
Executive Order 12866 (September 1993, Regulatory Planning and Review), 
the Regulatory Flexibility Act (RFA) (September 19, 1980, Pub. L. 96-
354), section 1102(b) of the Social Security Act, the Unfunded Mandates 
Reform Act of 1995 (Pub. L. 104-4), Executive Order 13132 on 
Federalism, and the Congressional Review Act (5 U.S.C. 804(2)).
    Executive Order 12866 (as amended by Executive Order 13258, which 
merely reassigns responsibility of duties) directs agencies to assess 
all costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory

[[Page 9696]]

approaches that maximize net benefits (including potential economic, 
environmental, public health and safety effects, distributive impacts, 
and equity). A regulatory impact analysis (RIA) must be prepared for 
major rules with economically significant effects ($100 million or more 
in any 1 year). This regulation will surpass the economic threshold and 
is considered a major rule. This rule is estimated to reduce Federal 
Medicaid outlays by $85 million in FY 2008 and by $115 million per year 
in FY 2009 through FY 2011.
    The RFA requires agencies to analyze options for regulatory relief 
of small businesses. For purposes of the RFA, small entities include 
small businesses, nonprofit organizations, and small governmental 
jurisdictions. Most hospitals and most other providers and suppliers 
are small entities, either by nonprofit status or by having revenues of 
$6 million to $29 million in any 1 year. Individuals and States are not 
included in the definition of a small entity. We are not preparing an 
analysis for the RFA because the regulation will not have a direct 
impact on small entities. In this case the regulation directly affects 
payments the States receive from the Federal government and the impact 
on health care facilities is categorized as secondary impact.
    While the impact on health care facilities is secondary, we proceed 
to discuss the potential impact on small entities. First, the reduced 
health care related tax collection threshold under this regulation will 
help alleviate tax burdens on small health care facilities, to the 
extent they were subject to a health care-related tax. If States choose 
to maintain reimbursement rates, small health care facilities may 
receive higher net Medicaid reimbursement in light of the reduced tax 
burden. However, States may be unwilling to maintain reimbursement 
rates without the full revenue from the health care-related tax to 
contribute to the non-Federal share. If States choose to reduce 
Medicaid reimbursement rates to small health care facilities, this 
could result in lower net Medicaid reimbursement even after accounting 
for a reduction in the tax burden.
    Since we are uncertain how States will alter their Medicaid 
reimbursements in response to the reduced health care related tax 
collection threshold, we cannot provide an exact and quantifiable 
impact on such small entities. We did not receive any quantifiable 
information during the public comment process to determine any further 
detailed impact. Commenters did not raise issue with the collection 
threshold reduction. Nor did the commenters indicate how States will 
act in response to such reduction in available health care related tax 
revenue. It is important to note that not all health care related tax 
programs will be impacted. Only those health care related taxes that 
are currently being imposed at a rate in excess of 5.5 percent of net 
patient service revenue will be directly impacted.
    In addition, section 1102(b) of the Act requires us to prepare a 
regulatory impact analysis if a regulation may have a direct impact on 
the operations of a substantial number of small rural hospitals. This 
analysis must conform to the provisions of section 604 of the RFA. For 
purposes of section 1102(b) of the Act, we define a small rural 
hospital as a hospital that is located outside of a Metropolitan 
Statistical Area and has fewer than 100 beds. We are not preparing an 
analysis for section 1102(b) of the Act because we have determined that 
this regulation will not have a direct impact on the operations of a 
substantial number of small rural hospitals.
    Section 202 of the Unfunded Mandates Reform Act of 1995 also 
requires that agencies assess anticipated costs and benefits before 
issuing any regulation whose mandates require spending in any 1 year of 
$100 million in 1995 dollars, updated annually for inflation. That 
threshold level is currently approximately $120 million. This 
regulation will not result in expenditure in any 1 year by State, 
local, or tribal governments, in the aggregate, or by the private 
sector, of $120 million.
    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a final regulation that imposes 
substantial direct requirement costs on State and local governments, 
preempts State law, or otherwise has Federalism implications. While 
this regulation would reduce the collection threshold for permissible 
health care related taxes from 6 percent of the net patient service 
revenue attributable to the assessed permissible class of health care 
items or services to 5.5 percent of the net patient service revenue, 
this change is required by section 403 of the Tax Relief and Health 
Care Act of 2006. This section of the statute was self-implementing on 
December 20, 2006; however, this rulemaking is necessary to include the 
reduction in the regulatory text, therefore ensuring consistency with 
applicable law and thus minimizing any confusion. Furthermore, we do 
not believe the discretionary requirements put in place by this 
rulemaking will impose substantial direct requirements or costs on 
State and local governments.

B. Anticipated Effects

Provider Tax Reform

1. Effects on State Medicaid Programs
    Estimates of the impact of lowering the maximum collection 
threshold for permissible health care related taxes, fees, and 
assessments were derived from Medicaid financial management reports on 
State receipts from these programs (form CMS-64.11). Since we do not 
believe that all States report completely their tax receipts from 
health care-related taxes on the form CMS-64.11, we bolstered our 
estimates by also analyzing information reported by some States as part 
of their request for waiver of the broad-based and/or uniformity 
requirements. These requests include estimated total tax collections 
and total net revenues received by taxpayers applicable to a 
permissible class of health care services. From this available 
information, we identified 15 States whose receipts as of the date of 
the reports are believed to equal the maximum threshold of 6 percent of 
net patient service revenue. In accordance with the new statutory 
language to reduce the maximum threshold from 6 to 5.5 percent, FFP 
corresponding to these receipts would be reduced by 8.33 percent [(1-
5.5/6.0) x 100]. As described below, there are a number of avenues 
available for States to address these reductions. Accordingly, in 
estimating the potential Federal savings, we applied a behavioral 
offset of 50 percent to the savings calculated from reported data as 
described above. In accordance with the statute, savings were estimated 
only for portions of fiscal years beginning January 1, 2008 and ending 
September 30, 2011.
    States have a number of options open to them for addressing the 
reduction in FFP. In order to maintain existing reimbursement rates 
funded by a health care related tax in excess of the 5.5 percent 
threshold, they can restructure State spending and shift funds between 
programs. This could result in loss of State funding for other 
programs. States may also be able to raise funds through increases in 
other forms of generally applicable tax revenue increases. This could 
raise tax costs for other taxpaying entities within States. Finally, 
States, as a last resort, can reduce reimbursement to the taxpaying 
health care providers.
    We are uncertain which options States may employ to address this 
change. We did not receive any further quantifiable information through 
the public comment process that would indicate which option States are 
likely

[[Page 9697]]

to choose in response to such reduction in available health care 
related tax revenue.
2. Effects on Other Providers
    The reduced tax limit in this rule will help alleviate health care 
related tax burdens on health care providers for obligations to the 
Medicaid program that are otherwise the responsibility of the States. 
However, if States choose to reduce reimbursement rates to health care 
providers, this could result in lower net Medicaid reimbursement for 
the health care provider even after accounting for reduction in the 
health care related tax burden. On the other hand, if States choose to 
maintain reimbursement rates by finding other non-Federal share sources 
to support the Medicaid reimbursement rates, health care providers may 
receive higher net Medicaid reimbursement in light of the reduced 
health care related tax burden.
    The new statutory language reducing the maximum threshold from 6 to 
5.5 percent for the period of January 1, 2008 through September 30, 
2011 is estimated to reduce Federal Medicaid outlays by $85 million in 
FY 2008 and by $115 million per year in FY 2009 through FY 2011. These 
savings will not be realized in 2012 because the threshold reverts back 
to 6 percent after September 30, 2011.

        Table A.--Estimated Reduction in Federal Medicaid Outlays Resulting From the Provider Tax Reform Proposal Being Implemented by CMS-2275-F
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Reduction in Federal Medicaid Outlays for fiscal years 2008-2012  (In $ million)
                                                         -----------------------------------------------------------------------------------------------
                                                               2008            2009            2010            2011            2012            Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Provider Tax Reform.....................................              85             115             115             115               0             430
3% discount rate........................................              83             108             105             102               0             398
7% discount rate........................................              79             100              94              88               0             361
--------------------------------------------------------------------------------------------------------------------------------------------------------

C. Alternatives Considered

    In developing this regulation the following alternatives were 
considered. We considered reducing the regulatory collection threshold 
to 3 percent because we have noticed a recent trend in States' efforts 
to maximize non-Federal share funding opportunities under current 
Medicaid law through taxation of health care providers.
    The result has been that the Federal government is providing 
matching funds on Medicaid rate increases that are funded without 
additional State dollars but instead, with revenues collected from 
taxes on health care providers. This shift in fiscal responsibilities 
is typically accompanied by creative payment mechanisms that 
effectively place a disproportionate burden on the Medicaid program 
relative to other payers. In this way, some States are avoiding their 
payment responsibilities to the Medicaid program by shifting their 
share of the increased Medicaid payment rate obligations to the same 
health care providers serving Medicaid beneficiaries.
    The current trend in States' approach to taxing health care 
providers appears to start with a determination of the maximum amount 
of health care-related tax revenue that can be collected from health 
care providers. We have seen this particularly in State health care-
related tax programs targeting high Medicaid utilized services solely 
as the basis for increasing Medicaid rates to those same providers. 
States appear to be exercising their ability under the law to request 
waivers of the broad based and/or uniformity requirements of the health 
care-related tax law in an effort to minimize the tax burden on 
facilities that furnish little to no services to Medicaid patients. 
Although we would only approve such a waiver request within the 
allowable regulatory standards, States requesting the waivers continue 
to propose taxes that collect the maximum 6 percent limit and vary the 
rate of tax to minimize the tax burden on non-Medicaid facilities 
within the slightest margin allowable under current regulations. Most 
waiver requests are initially submitted applicable to a tax structure 
that is inconsistent with the Federal statute and regulations. This 
requires CMS to provide ongoing feedback and assistance to States. 
States ultimately deviate from their initial tax structure until they 
are able to reach an optimal tax structure that enables them to gain 
approval while minimizing the non-Medicaid tax burden.
    Through our review of these practices, we have also noticed that 
many States are applying the current statutory and regulatory authority 
that permits the exclusion of Medicare revenue from a health care-
related tax, which effectively raises the rate of tax on only the 
Medicaid revenues and commercial/private pay revenues above the 
aggregate 6 percent limit (measured on all payers' revenues). We have 
also seen an increase in the tax revenues collected through our 
examination of the revenues reported by States on the CMS 64.11A. Based 
on a review of quarterly expenditures, States reported the collection 
of over $2.2 billion in tax revenues from health care providers.
    However, since the Tax Relief and Health Care Act of 2006 reduced 
the regulatory threshold to 5.5 percent, none of the above mentioned 
alternatives were taken.
    With respect to the other changes contained in this final rule, we 
considered and rejected a possible exception for already approved 
health care-related tax programs. Such an exception would not be 
uniform and would not achieve the objective of ensuring that health 
care-related taxes did not effectively shift a disproportionate burden 
to the Federal government. Because these clarifications reflect the 
understanding of permissible classes and how the hold harmless 
provisions should apply that CMS has been applying in ongoing reviews, 
CMS is not aware of any approved tax programs that is not in compliance 
with the final rule.

D. Accounting Statement and Table

    As required by OMB Circular A-4 (available at http://www.whitehouse.gov/omb/circulars/a004/a-4.pdf), in the table below, we 
have prepared an accounting statement showing the classification of the 
expenditures associated with the provisions of this final regulation. 
This table provides our best estimate of the reduction in Federal 
Medicaid outlays for the years 2008 through 2012 as a result of the 
changes presented in this final regulation. This regulation only 
affects transfer payments between the Federal government and State 
governments.

[[Page 9698]]



Table Number B.--Accounting Statement: Classification of Estimated Reduction in Medicaid Outlays From FY 2008 to
                                                     FY 2012
                                                  [In millions]
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                        Category                                                 Transfers
----------------------------------------------------------------------------------------------------------------
Annualized monetized transfers..........................     3% Units discount rate      7% Units discount rate
                                                                              $87.0                       $88.0
----------------------------------------------------------------------------------------------------------------
From whom to whom?......................................               States to Federal Government
----------------------------------------------------------------------------------------------------------------

E. Conclusion

    Due to the reduction in the statutory language lowering the maximum 
threshold from 6 to 5.5 percent this rule is estimated to reduce 
Federal Medicaid outlays by $85 million in FY 2008 and by $115 million 
per year in FY 2009 through FY 2011.
    For these reasons, we are not preparing analysis for either the RFA 
or section 1102(b) of the Act because we have determined that this 
regulation will not have a direct significant economic impact on a 
substantial number of small entities or a direct significant impact on 
the operations of a substantial number of small rural hospitals.
    In accordance with the provisions of Executive Order 12866, this 
regulation was reviewed by the Office of Management and Budget.

List of Subjects in 42 CFR Part 433

    Administrative practice and procedure, Child support, Claims, Grant 
programs-health, Medicaid, Reporting and recordkeeping requirements.

0
For the reasons set forth in the preamble, the Centers for Medicare & 
Medicaid Services amends 42 CFR chapter IV as follows:

PART 433--STATE FISCAL ADMINISTRATION

0
1. The authority citation for part 433 continues to read as follows:

    Authority: Sections 1902(a)(2), 1903(a) and 1903(w) of the 
Social Security Act (42 U.S.C. 1302).

Subpart B--General Administrative Requirements State Financial 
Participation

0
2. Section 433.54 is amended by revising paragraph (c) to read as 
follows:


Sec.  433.54  Bona fide donations.

* * * * *
    (c) A hold harmless practice exists if any of the following 
applies:
    (1) The State (or other unit of government) provides for a direct 
or indirect non-Medicaid payment to those providers or others making, 
or responsible for, the donation, and the payment amount is positively 
correlated to the donation. A positive correlation includes any 
positive relationship between these variables, even if not consistent 
over time.
    (2) All or any portion of the Medicaid payment to the donor, 
provider class, or related entity, varies based only on the amount of 
the donation, including where Medicaid payment is conditional on 
receipt of the donation.
    (3) The State (or other unit of government) receiving the donation 
provides for any direct or indirect payment, offset, or waiver such 
that the provision of that payment, offset, or waiver directly or 
indirectly guarantees to return any portion of the donation to the 
provider (or other parties responsible for the donation).
* * * * *
0
3. Section 433.56 is amended by--
    A. Republishing the introductory text to paragraph (a).
0
B. Revising paragraph (a)(4).
0
C. Revising paragraph (a)(8).
    The revisions read as follow:


Sec.  433.56  Classes of health care services and providers defined.

    (a) For purposes of this subpart, each of the following will be 
considered as a separate class of health care items or services:
* * * * *
    (4) Intermediate care facility services for the mentally retarded, 
and similar services furnished by community-based residences for the 
mentally retarded, under a waiver under section 1915(c) of the Act, in 
a State in which, as of December 24, 1992, at least 85 percent of such 
facilities were classified as ICF/MRs prior to the grant of the waiver;
* * * * *
    (8) Services of managed care organizations (including health 
maintenance organizations, preferred provider organizations);
* * * * *


Sec.  433.57  [Amended]

0
4. Section Sec.  433.57 is amended by--
0
A. Removing paragraph (a).
0
B. Redesignating existing paragraphs (b) and (c) as paragraphs (a) and 
(b), respectively.


Sec.  433.58  [Removed and reserved]

0
5. Section 433.58 is removed and reserved.


Sec.  433.60  [Removed and reserved]

0
6. Section 433.60 is removed and reserved.
0
7. Section 433.66 is amended by--
0
A. Revising the section heading.
0
B. Revising paragraph (a).
    The revisions read as follows:


Sec.  433.66  Permissible provider-related donations.

    (a) General rule. (1) Except as specified in paragraph (a)(2) of 
this section, a State may receive revenues from provider-related 
donations without a reduction in FFP, only in accordance with the 
requirements of this section.
    (2) The provisions of this section relating to provider-related 
donations for outstationed eligibility workers are effective on October 
1, 1992.
* * * * *
0
8. Section 433.67 is amended by revising paragraph (a)(2) to read as 
follows:


Sec.  433.67  Limitations on level of FFP for permissible provider-
related donations.

    (a) * * *
    (2) Limitations on donations for outstationed eligibility workers. 
Effective October 1, 1992, the maximum amount of provider-related 
donations for outstationed eligibility workers, as described in Sec.  
433.66(b)(2), that a State may receive without a reduction in FFP may 
not exceed 10 percent of a State's medical assistance administrative 
costs (both the Federal and State share), excluding the costs of family 
planning activities. The 10 percent limit for provider-related 
donations for outstationed eligibility workers is not included in the 
limit in effect through September 30, 1995, for health care-related 
taxes as described in Sec.  433.70.
* * * * *
0
9. Section 433.68 is amended by--
0
A. Revising the section heading.
0
B. Revising paragraph (a).

[[Page 9699]]

0
C. Republishing paragraph (f) introductory text.
0
D. Revising paragraphs (f)(1), (f)(2), (f)(3) introductory text, and 
(f)(3)(i).
0
E. Removing and reserving paragraph (f)(3)(ii).
0
The revisions read as follows:


Sec.  433.68  Permissible health care-related taxes.

    (a) General rule. A State may receive health care-related taxes, 
without a reduction in FFP, only in accordance with the requirements of 
this section.
* * * * *
    (f) Hold harmless. A taxpayer will be considered to be held 
harmless under a tax program if any of the following conditions 
applies:
    (1) The State (or other unit of government) imposing the tax 
provides for a direct or indirect non-Medicaid payment to those 
providers or others paying the tax and the payment amount is positively 
correlated to either the tax amount or to the difference between the 
Medicaid payment and the tax amount. A positive correlation includes 
any positive relationship between these variables, even if not 
consistent over time.
    (2) All or any portion of the Medicaid payment to the taxpayer 
varies based only on the tax amount, including where Medicaid payment 
is conditional on receipt of the tax amount.
    (3) The State (or other unit of government) imposing the tax 
provides for any direct or indirect payment, offset, or waiver such 
that the provision of that payment, offset, or waiver directly or 
indirectly guarantees to hold taxpayers harmless for all or any portion 
of the tax amount.
    (i)(A) An indirect guarantee will be determined to exist under a 
two prong ``guarantee'' test. If the health care-related tax or taxes 
on each health care class are applied at a rate that produces revenues 
less than or equal to 6 percent of the revenues received by the 
taxpayer, the tax or taxes are permissible under this test. The phrase 
``revenues received by the taxpayer'' refers to the net patient revenue 
attributable to the assessed permissible class of health care items or 
services. However, for the period of January 1, 2008 through September 
30, 2011, the applicable percentage of net patient service revenue is 
5.5 percent. Compliance in State fiscal year 2008 will be evaluated 
from January 1, 2008 through the last day of State fiscal year 2008. 
Beginning with State fiscal year 2009 the 5.5 percent tax collection 
will be measured on an annual State fiscal year basis.
    (B) When the tax or taxes produce revenues in excess of the 
applicable percentage of the revenue received by the taxpayer, CMS will 
consider an indirect hold harmless provision to exist if 75 percent or 
more of the taxpayers in the class receive 75 percent or more of their 
total tax costs back in enhanced Medicaid payments or other State 
payments. The second prong of the indirect hold harmless test is 
applied in the aggregate to all health care taxes applied to each 
class. If this standard is violated, the amount of tax revenue to be 
offset from medical assistance expenditures is the total amount of the 
taxpayers' revenues received by the State.
    (ii) [Reserved]


Sec.  433.70  [Amended]

0
10. Section 433.70 is amended by--
0
A. Revising the section heading.
0
B. Removing paragraph (a)(1).
0
C. Removing the paragraph designation for existing paragraph (a)(2).
0
The revised heading reads as follows:


Sec.  433.70  Limitation on level of FFP for revenues from health care-
related taxes.

* * * * *
(Catalog of Federal Domestic Assistance Program No. 93.778, Medical 
Assistance Program)

    Dated: October 23, 2007.
Kerry Weems,
Acting Administrator, Centers for Medicare & Medicaid Services.

    Approved: December 3, 2007.
Michael O. Leavitt,
Secretary.

    Editorial Note: This document was received at the Office of the 
Federal Register on February 15, 2008.
[FR Doc. E8-3207 Filed 2-21-08; 8:45 am]
BILLING CODE 4120-01-P