[Federal Register Volume 91, Number 21 (Monday, February 2, 2026)]
[Rules and Regulations]
[Pages 4794-4838]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2026-02040]
[[Page 4793]]
Vol. 91
Monday,
No. 21
February 2, 2026
Part II
Department of Health and Human Services
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Centers for Medicare & Medicaid Services
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42 CFR Part 433
Medicaid Program; Preserving Medicaid Funding for Vulnerable
Populations--Closing a Health Care-Related Tax Loophole; Final Rule
Federal Register / Vol. 91, No. 21 / Monday, February 2, 2026 / Rules
and Regulations
[[Page 4794]]
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DEPARTMENT OF HEALTH AND HUMAN SERVICES
Centers for Medicare & Medicaid Services
42 CFR Part 433
[CMS-2448-F]
RIN 0938-AV58
Medicaid Program; Preserving Medicaid Funding for Vulnerable
Populations--Closing a Health Care-Related Tax Loophole
AGENCY: Centers for Medicare & Medicaid Services (CMS), Department of
Health and Human Services (HHS).
ACTION: Final rule.
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SUMMARY: This final rule addresses a loophole in a regulatory
statistical test applied to State proposals for Medicaid tax waivers.
The test is designed to ensure, as required by statute, that non-
uniform or non-broad-based health care-related taxes, authorized under
a waiver, are generally redistributive. The inadvertent loophole
currently allows some health care-related taxes, especially taxes on
managed care organizations, to be imposed at higher tax rates on
Medicaid taxable units than non-Medicaid taxable units, contrary to
statutory and regulatory intent for health care-related taxes to be
generally redistributive. The final rule closes the loophole by
finalizing the policies in the proposed rule to add additional
safeguards to ensure that tax waivers that exploit the loophole because
they pass the current statistical test, but are not generally
redistributive, are not approvable. By adding these safeguards, the
final rule is also implementing recently added statutory requirements
for a tax to be considered generally redistributive.
DATES: These regulations are effective on April 3, 2026.
FOR FURTHER INFORMATION CONTACT: Jonathan Endelman, (410) 786-4738, and
Stuart Goldstein, (410) 786-0694, for Health Care-Related Taxes.
I. Background
A. Overview
Title XIX of the Social Security Act (the Act) authorizes Federal
grants to States for Medicaid programs to provide medical assistance to
people with limited income and resources. While Medicaid programs are
administered by the States, the program is jointly financed by the
Federal and State governments. The Federal government pays its share of
Medicaid 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 Medicaid expenditures is called Federal
financial participation (FFP). The State pays its share of Medicaid
expenditures in accordance with section 1902(a)(2) of the Act. As
described in more detail in the next section, the State may raise its
non-Federal share obligation in various ways, subject to certain
requirements, including through health care-related taxes (generally,
taxing health care items or services, or providers of such items and
services).
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 or certain related
entities, and revenues generated by certain health care-related taxes.
The Centers for Medicare & Medicaid Services (CMS) issued regulations
to implement the statutory provisions concerning provider-related
donations and health care-related taxes in an interim final rule (with
comment period) published in November 1992 (57 FR 55118, November 24,
1992). CMS issued the final rule in August 1993 (58 FR 43156, August
13, 1993). The Federal statute and implementing regulations were
intended to prevent States from shifting a disproportionate amount of
the tax burden to entities with a high percentage of Medicaid business,
thus shifting the State responsibility for financing of the program to
the Federal government. In these financing-shifting scenarios, Medicaid
payments to providers would be made up of the Federal share plus non-
Federal share raised from the providers themselves, rather than
obtained from general revenue or other permissible source of non-
Federal share. In part, the statute addresses this concern by requiring
that health care-related taxes be broad based (generally, applicable to
an entire permissible class of health care items and services, or to
providers of the same) and uniform (generally, applied at the same rate
to all health care items and services, or providers, in a permissible
class). The statute does permit waivers of the broad-based and uniform
requirements under certain circumstances, including that the Secretary
of Health and Human Services (Secretary) must determine that the net
impact of the tax and associated Medicaid expenditures as proposed by
the State would be generally redistributive in nature, which is an
issue in these provisions and which we discuss more fully later.
However, since that time, we have discovered that, due to an unintended
loophole in the statistical test used to determine if a health care-
related tax is generally redistributive, as specified in the August
1993 final rule, some States are still able to shift the financial
burden of the non-Federal share of Medicaid program expenditures to
entities with a high percentage of Medicaid business, and thus
ultimately to the Federal government, contrary to the statutory
framework.
B. Medicaid Program Financing
Shared responsibility for financing lies at the foundation of the
Medicaid program. Sections 1902(a), 1903(a), and 1905(b) of the Act
require States to share in the cost of medical assistance and in the
cost of administering the State plan. Under this statutory framework,
Medicaid expenditures are jointly funded by the Federal and State
governments. Section 1903(a)(1) of the Act provides for payments to
States of a percentage of medical assistance expenditures authorized
under their approved State plan. Generally, FFP is available when a
covered Medicaid service is provided to a Medicaid beneficiary, which
results in a Federally matchable expenditure that is funded in part
through non-Federal funds from the State or a non-State governmental
entity.\1\ The share of Federal funding for medical assistance
expenditures is determined by the Federal medical assistance percentage
(FMAP), which is calculated for each State using a formula set forth in
section 1905(b) of the Act, or other applicable FFP match rates
specified by the statute.
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\1\ See the Medicaid and CHIP Payment and Access Commission's
(MACPAC) list of ``Federal Match Rate Exceptions'' for a
comprehensive list of higher FMAPs at https://www.macpac.gov/federal-match-rate-exceptions/.
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Section 1902(a)(2) of the Act and its implementing regulations in
42 CFR part 433, subpart B requires States to share in the cost of
Medicaid expenditures, with financial participation by the State of not
less than 40 percent of the non-Federal share of expenditures. These
requirements also permit other units of non-State government to
contribute to the financing of the non-Federal share of medical
assistance expenditures up to the remaining 60 percent of the non-
Federal share. As a result, States must participate in operating an
efficient and fiscally responsible system for providing health care
services to eligible
[[Page 4795]]
beneficiaries. Because States must invest some of their own dollars to
pay for the program, they have an incentive to monitor and operate
their programs competently to ensure the best value for the dollars
that they spend.
There are several manners in which States can finance the non-
Federal share of Medicaid expenditures, including: (1) State general
funds, typically derived from tax revenue appropriated directly to the
Medicaid agency; (2) revenue derived from health care-related taxes
when consistent with Federal statutory requirements at section 1903(w)
of the Act and implementing regulations at 42 CFR part 433, subpart B;
(3) provider-related donations to the State which must be ``bona fide''
in accordance with section 1903(w) of the Act and implementing
regulations at 42 CFR part 433, subpart B; (4) intergovernmental
transfers (IGTs) from units of State or local government that
contribute funding for the non-Federal share of Medicaid expenditures
by transferring their own funds to and for the unrestricted use of the
Medicaid agency; and (5) certified public expenditures whereby units of
government, including health care providers that are units of
government, incur FFP-eligible expenditures under the State's approved
State plan, consistent with section 1903(w)(6) of the Act and Sec.
433.51(b).
C. Health Care-Related Taxes
Section 1903(w) of the Act specifies certain requirements to which
permissible health care-related taxes must adhere. Specifically,
section 1903(w)(1)(A) of the Act states that the Secretary will reduce
a State's medical assistance expenditures, prior to calculating FFP, by
the sum of any revenues from health care-related taxes that do not meet
the requirements under section 1903(w) of the Act. This reduction in a
State's claimed expenditures is codified in regulation at Sec.
433.70(b). Because of the way that the statute is constructed, the
baseline assumption is that all health care-related taxes are
impermissible with limited exceptions for health care-related taxes
that satisfy the parameters specified by the statute.
Health care-related taxes may only be imposed permissibly on
certain groups of health care items or services known as permissible
classes, which are outlined in section 1903(w)(7) of the Act and
expanded upon in Sec. 433.56. In general, and as discussed in the
introduction to this section, such health care-related taxes must be
broad-based or apply to all non-governmental providers within such a
class as specified by section 1903(w)(3)(B) of the Act and Sec.
433.68(c). They generally must also be uniform, such that all providers
within a class generally must be taxed at the same rate or dollar
amount as specified by section 1903(w)(3)(C) of the Act and Sec.
433.68(d). Additionally, the tax must not have in effect any hold
harmless provisions, as specified in section 1903(w)(4) of the Act and
implementing regulations in Sec. 433.68(f).
There is no possibility under the statute of waiving the
permissible class or the hold harmless requirements. However, a State
can request a waiver of the broad-based and/or uniformity requirements.
As discussed earlier, section 1903(w)(3)(E) of the Act states that the
Secretary shall approve a health care-related tax waiver for the broad-
based and/or uniformity requirements if the net impact of the tax and
associated expenditures is ``generally redistributive'' in nature and
the amount of the tax is not directly correlated to Medicaid payments
for items and services with respect to which the tax is imposed. As
previously stated, in the preamble of the August 1993 final rule, CMS
interpreted ``generally redistributive'' to mean ``the tendency of a
State's tax and payment program to derive revenues from taxes imposed
on non-Medicaid services in a class and to use these revenues as the
State's share of Medicaid payments,'' (58 FR 43164). The preamble
stated that assuming a State imposes a non-Medicaid tax and uses the
funds solely for Medicaid payments, we believe a complete
redistribution would exist.
States are not required to use health care-related taxes to finance
the non-Federal share of Medicaid payments; in practice, it is
frequently done. When this occurs, taxes that are generally
redistributive have some entities that benefit financially as a result
of the tax and the associated payment(s) funded by the tax, and some
entities that lose money because the amount of tax they pay is greater
than the amount of tax-funded payments they receive. Under a health
care-related tax that is generally redistributive, entities that have
more Medicaid business would expect to receive greater Medicaid
payments than entities with less Medicaid business. Although the
entities with a higher percentage of Medicaid business may also pay the
tax, they often receive more total Medicaid payments than they pay in
tax and therefore benefit from these arrangements. By contrast,
entities that serve a relatively low percentage of Medicaid
beneficiaries or no Medicaid beneficiaries often do not receive
Medicaid payments in an amount equal to or higher than their cost of
paying the tax. These entities do not benefit financially because they
do not receive Medicaid payments that are sufficient to cover their tax
payments. These results are inherent in a system of Medicaid payments
supported by a health care-related tax that is generally
redistributive, as discussed in the preamble to the August 1993 final
rule.
Entities that do not benefit from a tax, such as through tax-
supported payments, are unlikely to support a State or locality
establishing or continuing a health care-related tax because the tax
would have a negative financial impact on them. Hold harmless
arrangements often either eliminate this negative financial impact or
turn it into a positive financial impact for most or all taxpaying
entities, likely leading to broader support among the taxpayers for
legislation establishing or continuing the tax. Hold harmless
arrangements often result in the Federal government as the only net
contributor to Medicaid payments that are supported by the tax program,
since the non-Federal share is both sourced from and paid back to the
taxpaying providers. This circumstance allows States and/or local
governments to garner widespread support among taxpayers to
successfully enact or continue tax programs that support increased
payments to providers.
As stated earlier, tax programs can result in taxpayers receiving
relatively lower Medicaid payments (typically because they furnish a
lower volume of Medicaid services) than they pay in taxes, experiencing
a negative financial impact. States and providers have sought out ways
to avoid this result and to ensure greater support among taxpayers for
tax programs. For example, groups of providers may collaborate to
ensure that no provider is financially harmed for the cost of the tax.
We described an example of this type of this arrangement, known as a
redistribution arrangement, in a February 17, 2023, Center for Medicaid
and CHIP Services Informational Bulletin (CIB) entitled, ``Health Care-
Related Taxes and Hold Harmless Arrangements Involving the
Redistribution of Medicaid Payments.'' \2\ In these redistribution
arrangements, entities that benefit financially (because their Medicaid
payments that are financed by the tax are greater than their tax
amount) will redirect a portion of their Medicaid payments to those
that are harmed financially, to achieve the
[[Page 4796]]
effect of holding providers harmless for the cost of the tax.
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\2\ https://www.medicaid.gov/federal-policy-guidance/downloads/cib021723.pdf.
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States are aware that arrangements which explicitly guarantee to
hold taxpayers harmless, whether directly or indirectly, such as
through the aforementioned redistribution arrangements, are
unallowable. If CMS identifies such an arrangement, it would then
reduce the State's total medical assistance expenditures by the amount
of revenue collected from the impermissible tax before the calculation
of FFP, as mandated by section 1903(w)(1)(a)(iii) of the Act.\3\ These
types of arrangements are problematic as they improperly shift the
burden of financing the Medicaid program to the Federal government, and
have been identified as such by oversight entities including the
Governmental Accountability Office (GAO) and the HHS Office of
Inspector General (OIG).4 5 In an effort to achieve a
similar effect as a hold harmless arrangement, some States have
attempted to impose taxes using variable rates or provider exclusions
(described in further detail later in this final rule) to increase the
tax burden on the Medicaid program, thus mitigating or eliminating the
tax burden on entities with relatively lower Medicaid business that may
not be able to receive the amount of the tax they paid through
increased Medicaid payments funded by the tax. Essentially, health
care-related taxes designed to tax Medicaid business more than its fair
share make it easier for States to guarantee taxpayers are reimbursed
their tax payments through increased Medicaid payments. Due to the
current regulations governing health care-related tax waiver
determinations, this can occur in certain circumstances despite the
regulatory statistical test designed to ensure that non-uniform or non-
broad-based health care-related taxes meet the statutory requirement to
be generally redistributive.
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\3\ As we stated in the 2008 tax rule described below, ``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.'' https://www.govinfo.gov/content/pkg/FR-2008-02-22/pdf/E8-3207.pdf.
\4\ See, for example, ``Medicaid Financing: Long-Standing
Concerns about Inappropriate State Arrangements Support Need for
Improved Federal Oversight,'' Governmental Accountability Office
(GAO), November 1, 2007; ``Medicaid: CMS Needs More Information on
States' Financing and Payment Arrangements to Improve Oversight,''
GAO, December 7, 2020.
\5\ https://oig.hhs.gov/oas/reports/region3/31300201.pdf.
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As previously discussed, a State seeking a broad-based and/or
uniformity waiver for a tax must demonstrate the tax is ``generally
redistributive,'' which we have established in this context means the
tax program generally generates tax revenues from entities that serve
relatively lower percentages of Medicaid beneficiaries and uses the tax
revenue as the State's share of Medicaid payments. A tax that does the
opposite, by establishing lower tax rates on entities that serve
relatively lower percentages of Medicaid beneficiaries or on non-
Medicaid items or services (compared to entities that serve relatively
higher percentages of Medicaid beneficiaries) is clearly not generally
redistributive or consistent with the statutory requirement that a tax
program be generally redistributive to qualify for a waiver.\6\
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\6\ See Congressional Record-House, November 26, 1991, 35855
https://www.congress.gov/102/crecb/1991/11/26/GPO-CRECB-1991-pt24-1-2.pdf.
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To enforce the requirement that taxes have a net impact that is
``generally redistributive'' in accordance with section
1903(w)(3)(E)(ii)(I) of the Act, CMS established certain tests when a
State is seeking a broad-based and/or uniformity waiver. If a State is
seeking a waiver of the broad-based requirement for its health care-
related tax, the tax must comply with Sec. 433.68(e)(1) to be
considered generally redistributive, which establishes the test known
as the P1/P2 test. If the State seeks a waiver of the uniformity
requirement, whether or not the tax is broad based, the tax must comply
with Sec. 433.68(e)(2) to be generally redistributive, which
establishes the test known as the B1/B2 test. These tests, where
applicable, are intended to demonstrate that the State's tax program
does not impose a higher tax burden on the Medicaid program compared to
a broad-based and uniform tax.\7\
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\7\ ``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.'' 73 FR 9685 (February 22, 2008).
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The P1/P2 test applies on a per-class basis to a tax that is
imposed on all items or services at a uniform rate but is not broad
based because it excludes certain providers. The State must divide the
proportion of the tax revenue applicable to Medicaid if the tax were
broad based (applied to all providers or activities within the class),
called P1, by the proportion of the tax revenue applicable to Medicaid
under the tax program for which the State seeks a waiver, called P2.
The resulting quotient is the P1/P2 figure. Generally, to be granted a
waiver of the broad-based requirement, this figure must be at least 1,
with some exceptions noted in Sec. Sec. 433.68(e)(1)(iii) and (iv).
For taxes enacted and in effect prior to August 13, 1993, States may
pass the P1/P2 test if they have a value of at least 0.90 and only
exclude one or more of the following provider types: providers that
furnish no services within the class in the State, providers that do
not charge for services within the class, rural hospitals as defined at
Sec. 412.62(f)(1)(ii), sole community hospitals as defined at Sec.
412.92(a), physicians practicing in medically underserved areas as
defined in section 1302(7) of the Public Health Service Act,
financially distressed hospitals under certain circumstances,
psychiatric hospitals, and hospitals owned and operated by Health
Management Organizations (HMOs). For taxes in effect after that date,
the same exceptions would apply, and the passing value is 0.95 rather
than 0.90.
The B1/B2 test also applies on a per-class basis to a non-uniform
tax (whether or not it is broad based) that applies different rates to
different tax rate groups of providers within the permissible class.
Under the B1/B2 test, the State calculates and compares the slope
(designated as B) of two linear regressions. Univariate linear
regression attempts to find the line that best fits a series of points,
plotted on a graph using two variables: an independent variable X and a
dependent variable Y.\8\ In the B1/B2 test, the independent variable or
X-axis, for both regressions, represents ``the number of the provider's
taxable units funded by the Medicaid program during a 12-month
period,'' also referred to as the ``Medicaid Statistic.'' \9\ The
regression measures how much impact for the average provider a one-unit
increase in the Medicaid Statistic has on how much that provider is
taxed. For example, if the tax were based on provider inpatient days,
the number of providers' inpatient Medicaid days during a 12-month
period would be its ``Medicaid Statistic.'' Or, if the tax were based
on member months, the number of Medicaid member months for a managed
care organization (MCO) would be the Medicaid Statistic. The Y
variable, or the dependent variable, is the percentage of the tax paid
by each provider in the tax program compared to the total tax amount
paid by all providers during a 12-month period.
[[Page 4797]]
Through this test, CMS seeks to ensure that, as Medicaid units
increase, the tax paid by the provider does not increase more under the
State's waiver proposal (the B2 regression) than it would in a broad-
based and uniform tax (the B1 regression).
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\8\ Linear regression attempts to model the relationship between
two variables by fitting a linear equation to observed data. One
variable is considered to be an explanatory variable, and the other
is considered to be a dependent variable. Linear Regression
(yale.edu) http://www.stat.yale.edu/Courses/1997-98/101/linreg.htm.
\9\ 42 CFR 433.68(e)(2)(A).
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The first linear regression represents the slope of the line for
the tax if it were broad-based and applied uniformly (B1). In other
words, a State would submit data regarding all taxable payers in the
permissible class for the tax and apply a uniform tax rate. The B1 is
the slope of the line for that data. The second linear regression
represents the slope of the line for the tax program for which the
State is requesting a waiver (B2). To calculate the test value figure,
B1 is divided by B2. If the quotient is at least 1, the tax passes the
test, as specified in Sec. 433.68(e)(2)(ii), with certain limited
additional flexibility under Sec. 433.68(e)(2)(iii) and (iv). This B1/
B2 test was intended to indicate that when the B1/B2 figure is equal to
or greater than one (1), the State's proposed tax is not more heavily
imposed on the Medicaid program compared to a tax that is levied on all
providers at the same rate.
D. Concerns About the B1/B2 Test
Since the early 1990s, the B1/B2 test has generally worked well to
ensure health care-related taxes for which States seek waivers of the
uniformity requirement (whether or not the tax is broad based) are
generally redistributive. However, over the last decade, CMS became
aware that some States are manipulating their health care-related taxes
to impose tax structures that the State intends not to be generally
redistributive, but that are still able to pass the B1/B2 test. In
these cases, the State does not impose taxes on non-Medicaid services
in a class to then use the tax revenue as the State's share of Medicaid
payments. Instead, the States derive the vast majority of their tax
revenue from Medicaid services, which they then use to fund the non-
Federal share of Medicaid payments. In essence, this process results in
a simple recycling of Federal funds to unlock additional Federal funds.
Generally, health care-related tax programs can accomplish this by
taking advantage of linear regression analyses' statistical sensitivity
to outliers.\10\ See Figure 1.
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\10\ In statistics, an outlier is ``an observation that lies an
abnormal distance from other values in a random sample from a
population.'' Information Technology Laboratory National Institute
of Standards and Technology (NIST) Engineering and Statistics
Handbook 7.1.6 ``What Are Outliers in Data?'' https://www.itl.nist.gov/div898/handbook/toolaids/pff/prc.pdf.
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Figure 1: Effect of an Outlier on the Slope of a Line
[GRAPHIC] [TIFF OMITTED] TR02FE26.000
In Figure 1, the two data sets, represented by squares (example 1)
and triangles (example 2), have similar data with the exception of the
last data point. In example 2, this data point is an outlier. As a
result, the line that fits the triangle data set is at a different
angle, or slope, from the square data set. We note that this example
uses basic data, not a B1/B2 analysis, to show the effect of an outlier
on a linear regression.
Using these approaches, this loophole counterintuitively allows a
tax program to place a much higher tax burden on Medicaid activities
compared to commercial activities while still passing the B1/B2 test.
Health care-related taxes that exploit the loophole effectively permit
a State to shift most of the tax burden disproportionately onto the
Medicaid program, which is the exact result the B1/B2 test was intended
to prevent. The State may then use the tax revenue to fund the non-
Federal share of Medicaid payments to the same Medicaid entities
subject to the health care-related tax. As a result, the Federal
government pays an artificially inflated percentage of Medicaid
expenditures on health care services, far beyond the Federal matching
rates that Congress has specified in statute. Therefore, payments to
providers consist of Federal funds and funds the providers have
contributed themselves through taxes, without the full contribution of
non-Federal share the statute requires from the State.
At its core, the B1/B2 test is centered on averages. As noted
previously, the regression measures how much impact a one-unit increase
in the Medicaid Statistic has on how much a provider is taxed. The rate
at which each entity's tax changes with every unit of change to
[[Page 4798]]
the entity's Medicaid Statistic is based on the average rate of change
for all the entities in the regression analysis. In many cases, taking
an average of all the points does not necessarily give a useful picture
of the typical participant or the general nature of the population.
Averages can be misleading when they include outliers or other
irregularities. Similarly, outliers can distort the regression model,
masking important deviations within the data.
For instance, imagine that one wanted to assess the relationship
between education level and annual salary for a group of employees at a
corporation. At this corporation, employees with a high school diploma
make between $40,000 to $45,000. Employees with a bachelor's degree
make between $65,000 to $70,000. Employees with a master's degree make
between $80,000 to $90,000. Employees with a doctoral degree make
between $100,000 to $115,000. The founder of the company's highest
education level is a high school diploma, but they make $1.6 million
per year. If one were to exclude the company founder from the linear
regression, the line would have a positive upward slope indicating an
increase in salary with each increasing level of education. However, if
one were to include the founder, the regression line would be diverted
sharply to accommodate the $1.6 million salary. The founder only
represents one data point in the regression analysis, but since this
point is drastically different than the rest, it potentially distorts
the relationship that the regression analysis is trying to assess. In
this example, the average value, while accurate, only represents a
mathematical mean in the data that is not necessarily useful for the
purpose of assessing the relationship between level of education and
salary among the corporation's employees. Likewise, in the case of the
B1/B2 linear regressions, outliers can skew our ability to use the data
to assess effectively if a tax is generally redistributive.
We have found that States can manipulate B2 by excluding from the
tax a few larger providers with much higher Medicaid taxable units than
the average provider in the taxable universe. Doing so drastically
affects the B-coefficient value for B2. Because the Medicaid taxable
units are not evenly distributed among all providers, States can
effectively charge higher rates on the remaining Medicaid taxable units
that make up most of the tax without running afoul of the B1/B2 test.
In other words, excluding a few large providers with high Medicaid
utilization from the tax, but including them in the regression
calculation alters the slope of the line of the regression in a way
that allows the State to pass the statistical test, while
simultaneously imposing outsized burden on the Medicaid program. In
these cases, the proportional percentage of the tax imposed on the
Medicaid program becomes greater than Medicaid's proportion of the
total taxable units.
There are several other mechanisms that States have used to
undermine the efficacy of the B1/B2 test. Some States create tax
programs with extraordinary differences in tax rates within a provider
class based on a taxpayer mix of Medicaid taxable units versus non-
Medicaid taxable units. Tax rates imposed on Medicaid-taxable units are
often much higher, sometimes more than one hundred times higher, when
compared with similar commercial taxable units (for example, Medicaid
member months are taxed $200 per member month compared to $2 for
comparable non-Medicaid member months). The ``tiering'' structure on
some of these tax waivers enable States with these disparate tax rates
to pass the B1/B2 test. Consider an MCO tax with tax rates that vary by
an MCO's member months. Medicaid member months from zero to 1,000,000
are excluded from the tax. Medicaid member months from 1,000,001 to
2,000,000 are taxed $300 per member month. Medicaid member months in
excess of 2,000,000 are excluded from the tax. Commercial member months
from zero to 1,000,000 are excluded from the tax. Commercial member
months from 1,000,001 to 2,000,000 are taxed $3 per member month.
Commercial member months in excess of 2,000,000 are excluded from the
tax. The ``middle tier'' of member months, the only one that is taxed
at all, has a tax rate of 100 times on Medicaid-member months compared
to their commercial counterparts. The State passes the B1/B2 test
because certain Medicaid-paid member months in excess of 2,000,000
artificially ``pull'' the slope of B2 down making it appear as though
the State is giving a larger break to Medicaid-member months than it
actually is.
Historically, these taxes that targeted Medicaid first began with
MCO taxes, one of the permissible classes for health care-related
taxes. We note that in all of these arrangements, Federal rules
prohibit States from taxing Medicare Advantage (MA) Plans,\11\ or
certain plans that contract with the Office of Personnel Management to
provide health care for Federal employees through the Federal Employee
Health Benefits (FEHB) program \12\ or plans that contract with the
Department of Defense to provide care to military personnel, retirees,
and their families under the TRICARE system.\13\ According to Sec.
422.404, States are prohibited from imposing premium taxes, fees, or
other charges on payments made by CMS to MA organizations, payments
made by MA enrollees to MA plans, or payments made by a third party to
an MA plan on a beneficiary's behalf.
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\11\ Under Medicare regulations at Sec. 422.404(a), States are
prohibited from taxing Medicare MCOs. Therefore, a State's taxation
of MCO services is limited to commercial payers and Medicaid. As a
result, taxes that exclude or sharply curtail the tax amount paid by
commercial payers fall exclusively on Medicaid and to a lesser
extent BHP if applicable.
\12\ 5 U.S. Code 8909--Employees Health Benefits Fund.
\13\ 5 U.S.C. 8909(f). 32 CFR 199.17 (a)(7).
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Over several years, the Congress and CMS have actively attempted,
through Federal statutes and regulations, to prevent States from
designing MCO taxes to target Medicaid MCOs or Medicaid activities.
Before the Deficit Reduction Act of 2005 (DRA), the statute included a
permissible class, under which States could only tax services of
Medicaid MCOs, but not other MCOs. In the DRA, the Congress broadened
the permissible class to include all MCO services (no longer limited to
Medicaid MCO services). Realizing that States would need time to
address financial impacts within their State budgets and enact
potentially necessary legislative modifications to health care-related
tax programs, the DRA provided a grace period to allow States to come
into compliance by October 1, 2009. CMS issued a final rule entitled
``Medicaid Program; Health Care Related Taxes'' (73 FR 9685) that
implemented the changes in the DRA. After the DRA and the 2008 final
rule, States were no longer permitted to assess health care-related
taxes only on Medicaid MCOs. Instead, States must assess health care-
related taxes on the services of all MCOs, not just Medicaid MCOs, to
qualify as broad based within the amended permissible class, except for
those excluded by Federal rules from taxation.
In response to these changes, several States attempted to ``mask''
health care-related taxes on Medicaid MCOs within broader taxes that
included non-health care items and activities. See, for example, the
OIG Report, ``Pennsylvania's Gross Receipts Tax on Medicaid Managed
Care Organizations Appears To Be an Impermissible Health Care-Related
Tax,'' issued on May 28, 2014.\14\ Some States did this to continue
[[Page 4799]]
taxing only Medicaid MCOs and thereby maximizing the burden on Medicaid
without needing to tax additional MCO lines of business. Section
1903(w)(3)(A) of the Act and Sec. 433.55(b) establish that a tax is
considered to be a health care-related tax if at least 85 percent or
more of the burden of the tax revenue falls on health care providers.
Section 1903(w)(3)(A)(ii) of the Act and regulations in Sec. 433.55(c)
further specify that taxes will still be considered health care related
even if they do not reach the 85 percent threshold if the treatment of
individuals or entities providing or paying for health care items or
services is different than the tax treatment provided to other
taxpayers. Some States with these taxes in place stated that, since the
percentage of the tax imposed on health care items and services fell
below the 85 percent threshold and the State did not treat health care
items or services differently than other items being taxed, the portion
of the tax imposed on Medicaid MCOs was not considered health care
related and was not governed by section 1903(w) of the Act. In a 2014
State Health Official Letter (SHO),\15\ CMS explained that taxing a
subset of health care services or providers at the same rate as a
Statewide sales tax, for example, does not result in equal treatment if
the tax is applied specifically to a subset of health care services or
providers (such as only Medicaid MCOs), since the providers or users of
those health care services are being treated differently than others
who are not within the specified universe. These taxes were attempting
to continue to tax a subset of services within a permissible class when
paid for by Medicaid, but not when the same services were not paid for
by Medicaid.
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\14\ Department of Health and Human Services Office of the
Inspector General, ``Pennsylvania's Gross Receipts Tax on Medicaid
Managed Care Organizations Appears to be an Impermissible Health-
Care Related Tax'' Issued May 2014 (A-03-13-00201). https://oig.hhs.gov/documents/audit/6720/A-03-13-00201-Complete%20Report.pdf.
\15\ SHO #14-001, ``Health Care-Related Taxes,'' issued on July
25, 2014, available at https://www.medicaid.gov/federal-policy-guidance/downloads/sho-14-001.pdf.
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Oversight agencies, including the OIG, have noted health care-
related taxes as a program integrity concern in Medicaid financing
several times. On January 23, 1996, the Director of Health Systems at
the GAO wrote a letter to the Ranking Member of the United States House
Commerce Committee that outlined some of the ways that States use
``creative financing mechanisms,'' including health care-related taxes,
to finance the non-Federal share of Medicaid expenditures.\16\ In 2014
and 2017, the OIG issued reports highlighting concerns about State
taxes that target Medicaid MCOs or Medicaid MCO business.\17\ Although
the 2017 report discussed a different approach that States used to
target taxes on Medicaid MCOs, it reflects the same State motivations
and implicates the same concerns for Federal fiscal integrity.
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\16\ Letter from Dr. William J. Scanlon to Representative John
Dingell written on January 23, 1996. GAO/HEHS-96-76R State Medicaid
Financing Practices. https://www.gao.gov/products/hehs-96-76r.
\17\ See Department of Health and Human Services Office of the
Inspector General ``Pennsylvania's Gross Receipts Tax on Medicaid
Managed Care Organizations Appears to be an Impermissible Health
Care-Related Tax'' Issued May 2014 (A-03-13-00201). https://oig.hhs.gov/documents/audit/6720/A-03-13-00201-Complete%20Report.pdf.
And ``Ohio's and Michigan's Sales and Use Taxes on Medicaid
Managed Care Organization Services Did Not Meet the Broad-Based
Requirement But Are Now In Compliance'' issued on April 2017 (A-03-
16-00200) https://oig.hhs.gov/documents/audit/6782/A-03-16-00200-Complete%20Report.pdf.
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As the agency responsible for Federal oversight over the Medicaid
program, CMS attempted to address the concerns raised by the OIG, which
mirror our own concerns based on recent experience with particular
health care-related taxes that target Medicaid with a
disproportionately high tax burden. In 2019, we issued a proposed rule
with many financial provisions, one of which proposed to address the
B1/B2 statistical loophole issue (2019 proposed rule (84 FR 63722). The
2019 proposed rule was much broader in scope in terms of the number of
financial topics than this final rule. In addition, the terminology in
this final rule is more precise and technical than the terminology used
in the corresponding provisions in the November 2019 proposed rule.
While the entirety of the November 2019 proposed rule was subsequently
withdrawn in January 2021, we indicated at the time that the withdrawal
action did not limit CMS' prerogative to make new regulatory proposals
in the areas addressed by the withdrawn proposed rule, including new
proposals that may be substantially identical or similar to those
described therein (86 FR 5105).
Since then, as CMS has reviewed State proposals involving these
problematic tax structures, we have advised States, and in some
instances notified States in writing, regarding our concerns. In some
cases, because a State's health care-related tax waiver proposal
satisfied current regulatory requirements to be considered generally
redistributive, we approved the proposal as required under the current
regulations that include the loophole but gave the State written notice
of our concerns. Specifically, CMS sent States with problematic taxes
``companion letters'' to their most recent tax waiver approvals
outlining why CMS believed that their taxes did not meet the spirit of
the law in terms of being ``generally redistributive'' because of the
much higher tax burden they imposed on Medicaid taxable units compared
to comparable non-Medicaid taxable units. In addition, we put these
States on notice through these letters that CMS was contemplating
rulemaking in this area and that those States should prepare for this
possibility in their budget planning.
Recently, we noticed an increase in both the number of health care-
related taxes that exploit the statistical loophole as well as an
increase in the revenue raised by those taxes. Before Federal fiscal
year (FFY) 2024, CMS was aware of five States with six taxes that
exploited the statistical loophole. The estimated total dollar revenue
collected by States related to these taxes at that time was
approximately $20.5 billion annually. In FFY 2025, CMS approved two
additional States' MCO tax waiver proposals that exploit the
statistical loophole that total $3.5 billion in estimated tax revenue
for the States. Notably, the State with the largest MCO tax that
exploits the statistical loophole submitted an update to its previously
approved MCO tax waiver, which increased the tax revenue from
approximately $8.3 billion per year to about $12.7 billion per year.
CMS estimates the total tax collection by States for all taxes that
exploit the loophole currently is approximately $24.0 billion per year.
To address this ongoing and increasing exploitation, in May 2025 we
issued the proposed rule, ``Medicaid Program; Preserving Medicaid
Funding for Vulnerable Populations-Closing a Health Care-Related Tax
Loophole Proposed Rule'' (90 FR 20578, May 15, 2025) hereafter referred
to as the ``proposed rule.''
Since issuance of the proposed rule, one State has formally
submitted a waiver request for a tax on MCO services that would exploit
the loophole. This proposed tax is estimated to generate $1.2 billion
in revenues. We are also aware that other State legislatures have been
considering similar proposals.
Recent examples illustrate what occurs when the B1/B2 test alone
does not ensure that the tax is generally redistributive. In one MCO
tax that exploits the loophole (and that was approved by CMS because it
passed the B1/B2 test and met other applicable regulatory
requirements), Medicaid member months comprise 50 percent of
[[Page 4800]]
all member months subject to taxation, but bear more than 99 percent of
the tax burden due to the difference in tax rates for Medicaid and non-
Medicaid member months. In a different State, Medicaid member months
comprise 53 percent of the total member months taxed but bear over 94
percent of the tax burden. Instead of raising revenue by equally taxing
non-Medicaid and Medicaid services in a class, these tax programs raise
only a de minimis amount of revenue from non-Medicaid member months
while imposing a much greater tax burden on Medicaid member months.
They are examples of States maximizing taxation of Medicaid items and
services by design to minimize the impact for entities that serve
relatively lower percentages of Medicaid beneficiaries. This has an
effect similar to taxing only Medicaid MCOs (as opposed to all MCOs),
which is the practice the DRA amendments sought to eradicate, as
discussed previously. Allowing States to achieve something at odds with
the DRA amendments by exploiting a statistical loophole in the current
regulations undermines the cooperative Federalism central to the
structure of the Medicaid statute, as GAO has noted.\18\ For this
reason, we believe that it is necessary to address the statistical
loophole to ensure fiscal integrity of the Medicaid program.
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\18\ GAO-08-650T ``Medicaid Financing Long-standing Concerns
about Inappropriate State Arrangements Support Need for Improved
Federal Oversight'' April 3, 2008.
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When taxes in the Medicaid program are not generally
redistributive, it can result in the Federal government as the only net
payer for payments funded by those taxes (generally, the non-Federal
share is generated by a tax on entities that receive at least their
total tax cost back in the form of increased Medicaid payments, with no
net contribution of any funds that are not Federal funds). Without any
net cost to the entities paying the tax, States and entities in the tax
class have an incentive to maximize health care-related tax collections
and maximize Medicaid payments possibly without regard to the Medicaid
services delivered or programmatic goals or outcomes, such as quality
or patient outcomes. This creates a substantial risk to the fiscal
integrity and effective operation of the Medicaid program, as reflected
in the impacts calculated in section V of the proposed rule and this
final rule.
Given recent State proposals and technical assistance requests,
national proliferation of taxes that utilize the B1/B2 statistical test
loophole presents a substantial and urgent risk to the fiscal integrity
of the Medicaid program. We stated in the proposed rule that, absent
the regulatory changes described therein, we were concerned that there
will be significant increases in Medicaid expenditures and shifting of
State Medicaid costs onto the Federal government, all without
commensurate benefit to the Medicaid program or its beneficiaries.
As previously noted, CMS has witnessed the proliferation of MCO
taxes that exploit the statistical loophole and, in some instances,
drastically increase the revenues raised by existing MCO taxes. As a
result, CMS was greatly concerned that such increases will continue and
similar tax structures would be developed, further exacerbating the
impact on the Federal government. Moreover, CMS learned as part of our
review of tax waiver proposals and communication with States that
certain States are using the revenue to fill shortfalls that exist in
their State budgets as opposed to reinvesting this money in the
Medicaid program. Furthermore, this influx of Federal share to State
general funds could be used as State-only financing for services not
eligible for FFP, such as the provision of non-emergency medical care
for non-citizens without satisfactory immigration status. Although
States are permitted to use health care-related tax revenue for other
general revenue purposes, it nevertheless highlights the importance of
ensuring Federal matching dollars are limited to the appropriate
Federal share of financing the Medicaid program, or else the Federal
Medicaid contribution is effectively financing these other endeavors.
While CMS has found taxes on MCOs to be the predominant class of
health care items and services utilizing this loophole, CMS is also
aware of other permissible classes vulnerable to this approach. CMS is
concerned that absent regulatory action, additional similar tax
programs that exploit the loophole may be developed. We believe that
this final rule will address concerns of CMS and Federal oversight
agencies by curtailing non-Federal share financing arrangements that
are counter to the statute and do not serve the best interests of
Medicaid beneficiaries, the Federal treasury, Federal taxpayers, nor
the long-term health and fiscal stability of the Medicaid program as a
whole. Health care-related taxes that use the regulatory B1/B2 loophole
create a substantial financial risk to the Medicaid program (see
section V of the proposed rule and this final rule). This rule will
mitigate this risk, safeguard the fiscal health of Medicaid, and ensure
appropriate use of Federal Medicaid dollars.
E. Working Families Tax Cuts Legislation
During the comment period of the proposed rule, Congress passed
what is commonly known as the ``One Big Beautiful Bill Act'' (Pub. L.
119-21, July 4, 2025) (herein after referred to as the Working Families
Tax Cuts (WFTC) legislation). Section 71117 of the WFTC legislation
enacted changes to section 1903(w) of the Act to add a new clause
detailing when a tax would not be considered generally redistributive,
along with accompanying definitions, and the new clause closely mirrors
the text of the proposed regulations and definitions from the proposed
rule. The revised section 1903(w) of the Act and the proposed
regulation had limited organizational differences, and the statute does
not include the examples listed in the proposed regulation. Therefore,
in borrowing the language of the proposed rule to draft the WFTC
legislation, Congress affirmed that CMS' proposed changes to Sec.
433.68(e) are necessary to better implement the statutory mandate in
section 1903(w)(3)(E) of the Act that taxes must be generally
distributive for a waiver to be approved. This final rule addresses the
concerns CMS described in the proposed rule, and, at the same time,
codifies in regulation the new statutory requirements.
CMS acknowledges that the statutory requirement the proposed rule
would address (that is, health care-related taxes for which a waiver of
the broad-based and/or uniform requirements is approved must be
generally redistributive in nature) has been amended by the WFTC
legislation since the proposed rule. However, as the changes required
by statute are substantively identical to the contents of the proposed
rule, we do not believe a further round of notice and comment is
necessary to proceed with finalizing the proposal, which implements the
new statutory requirements. Under section 553(b)(B) of the
Administrative Procedure Act (APA), an exception from the generally
applicable notice and comment requirement is available where it would
be unnecessary, as is the case here despite the change in underlying
statutory authority, since the proposed rule in a potential second
cycle of notice and comment would merely re-propose the same revisions
to the regulation that CMS proposed initially, as would be required to
implement the statute. We further note that a large number of comments
were received after the enactment of the
[[Page 4801]]
WFTC legislation and made reference to it.
II. Provisions of the Regulations and Analysis of and Responses to
Public Comments
We proposed that if any provision of this rule is determined to be
invalid or unenforceable by its terms, or as applied to any person or
circumstance, or stayed pending further action, it shall be severable
from the remainder of the final rule, and from rules and regulations
currently in effect, and not affect the remainder thereof or the
application of the provision to other persons not similarly situated or
to other, dissimilar circumstances. If any provision is held to be
invalid or unenforceable, the remaining provisions which could function
independently should take effect and be given the maximum effect
permitted by law. In this rule, we finalize several provisions that are
intended to and will operate independently of each other, even if each
serves the same general purpose or policy goal. Where a provision is
necessarily dependent on another, the context generally makes that
clear.
We received approximately 257 timely pieces of correspondence,
which included comments from individuals, State government agencies,
non-profit health care organizations, advocacy groups, and hospital
associations.
We thank and appreciate the commenters for their consideration of
the proposed requirements for addressing this loophole and ensuring the
fiscal integrity of the Medicaid program. In this section, arranged by
subject area, we summarize the proposed provisions, the public comments
received, and our responses. For a complete and full description of the
proposed requirements, see the 2025 proposed rule. We also received
several out-of-scope comments that are not addressed in this final
rule.
The following is a summary of the public comments we received on
the proposed rule and our responses.
Comment: Several commenters raised concerns that the proposed rule
is not aligned with the recent statutory changes in the WFTC
legislation since the proposed rule was drafted to ensure compliance
with the statutory language in place prior to enactment of the WFTC
legislation. These commenters urged CMS to revise or withdraw the
proposed rule to better reflect the variations included in the WFTC
legislation. A few commenters raised that the proposed rule does not
align with Congressional intent to allow for this type of provider tax
financing and a certain degree of non-uniformity in health care-related
taxes in that it afforded the opportunity to have the broad based and/
or uniformity requirements waived. Several other commenters recommended
that CMS not finalize the proposed rule and maintain the existing
regulatory structure and requirements governing health care-related
taxes. Another commenter requested that CMS extend the comment period
for the proposed rule to afford commenters time to analyze the impact
of the WFTC legislation. A few commenters requested an additional 60
days, while another suggested an extension of 30 days should be
considered.
Response: We disagree with the commenters regarding the alignment
of the proposed rule with the new provisions of the WFTC legislation.
This final rule and the WFTC legislation are aligned in that they both
provide more explicit direction regarding the generally redistributive
requirement for health care-related taxes. The proposed rule and final
rule's regulatory language is consistent and aligns with the language
and purpose of section 71117 of the WFTC legislation. In addition, the
examples we provide in regulation text that are not included in the
statutory language reflect a level of detail more typical for
implementing regulations and generally are not expected to be found in
statute. Therefore, we do not find it inconsistent that there is
additional language in the regulations and, given the alignment of the
proposed rule's provisions to the amendments made by section 71117 of
the WFTC legislation, we do not believe it is necessary to provide a
comment period extension. As always, CMS is available to work with
States expeditiously as they make any necessary changes to comply with
the statute and this rule.
Comment: Most commenters were opposed to the proposed rule.
Commenters expressed general opposition to the rule on the basis that
it would impact services and beneficiary access to care by harming
supplemental payments or other payment mechanisms funded by taxes that
will be impermissible. Specifically, several commenters stated concerns
regarding the impact this rule will have on access to care and the
quality of care received by Medicaid beneficiaries, particularly
children, seniors, and individuals with disabilities. Other commenters
stated that with decreased funding available to support Medicaid
payments, covered Medicaid services and benefits would be reduced, and
States may limit coverage of optional Medicaid eligibility groups.
Commenters were concerned about the impact the proposed rule would have
on State budgets and processes, including impacts to non-Medicaid
spending and non-health State spending as a result of having to
reconfigure State general funds to cover funding gaps. Many commenters
stated that the proposed rule likely would require States to undertake
significant administrative efforts, including development of new
legislation, revising rate methodologies and related State plan
amendments, and conducting extensive actuarial modeling.
Numerous commenters expressed concerns that reductions in health
care-related tax revenues would lead to lower Medicaid payment for
providers. They stated that this impact would be most acute in rural
communities, where individuals rely on a limited number of local
facilities for both primary and specialty care and that provider
participation in Medicaid would be impacted due to the unsustainable
financial margins. The commenters specifically mentioned pediatric care
at children's hospitals, specialty care for people with developmental
disabilities, pregnancy and post-partum care, Federally Qualified
Health Center (FQHC) services, and mental health care. Another
commenter expressed concern that reductions in health care-related tax
revenues may also impact Medicaid Graduate Medical Education
investments (which are not a distinct Federally matchable Medicaid
expenditure type but with respect to which some States make Medicaid
supplemental payments in connection with services furnished) designed
to address physician workforce shortages, which some States use health
care-related tax revenues to fund.
Numerous commenters stated that the impact of the rule will be
realized by all providers, but noting specifically hospitals, nursing
facilities and long-term care facilities. The commenters further
elaborated that without tax-funded payments to offset uncompensated
care costs, such providers will bear increasing costs, further
straining their financial sustainability. Further, the financial strain
may result in providers closing, resulting in an impact on unemployment
and local communities.
Response: We acknowledge the commenters' concerns. The goal of this
final rule is not to cause disruption in access to any health care
services for Medicaid beneficiaries or to jeopardize the financial
stability of health care providers or health systems. The purpose of
this final rule is to ensure compliance with section 1903(w) of the Act
as discussed in the proposed rule, and, since the amendments made by
the
[[Page 4802]]
WFTC legislation, to implement new statutory requirements. This final
rule promotes the sustainability of the Medicaid program for all States
by reducing wasteful and abusive financing practices perpetuated by a
subset of States that have been able to use as non-Federal share
revenue from health care-related taxes that are not generally
redistributive as required by statute. States may still utilize health
care-related taxes to support their share of Medicaid program costs,
provided that they meet all statutory and regulatory requirements,
including being generally redistributive. Nothing about this final rule
changes the ability of a State to collect health care-related tax
revenue and to use such revenue from permissible taxes as the non-
Federal share of Medicaid expenditures, or to make Medicaid payments at
existing levels. This change ensures that State Medicaid programs are
financed by permissible sources, while preventing impermissible cost
shifting to the Federal government by certain States.
Comment: Several commenters urged CMS to monitor access to services
to avoid unintended consequences for care delivery, and to develop
tools to assess outcomes for Medicaid beneficiaries. Another commenter
recommended that CMS consult with interested parties to understand the
scope of the proposed rule's impact, particularly with respect to
section 1902(a)(30)(A) of the Act.
Response: As with all changes, we intend to monitor the impact of
this final rule and provide necessary technical assistance to States
for them to meet its requirements, as well as all applicable statutory
and regulatory requirements. We have existing requirements for
analyzing access through the review of State plan amendments, managed
care contract requirements, section 1915 waivers, and section 1115
demonstrations, as applicable. Our goal is to assist States in
designing and operating their Medicaid programs in a manner that
ensures access to high quality care for Medicaid beneficiaries. Based
upon our review of existing State programs and our discussions with
several of the impacted States, we have a significant understanding of
both provider and State concerns regarding the impact of this final
rule. However, this final rule is not designed to reduce funding in the
Medicaid program, but rather to ensure Medicaid funds are financed by
permissible sources, while preventing inappropriate cost shifting to
the Federal government by certain States.
Comment: We received some comments in support of the proposed rule
overall. These comments cited concerns shared by CMS, such as the
inequity between States created by those exploiting the loophole, and
the harm to the fiscal integrity of the Medicaid program that results
from overburdening the Federal government. A commenter stated their
concern that States' use of provider taxes inflates a State's Federal
funding beyond what is authorized under statute through the FMAP
formula. Other commenters supported the proposed rule as necessary to
encourage healthy competition across States in development of models to
finance their Medicaid programs. The commenters stated that the
proposed rule would ensure equal treatment of States as some did not
exploit the loophole. A few commenters supported the proposed rule on
the basis that it fulfills the original intent of the generally
redistributive requirement and promotes and maintains the financial
stability of Medicaid programs and Medicaid provider networks. Several
commenters stated these changes are necessary to protect Federal tax
dollars and American taxpayers by preventing States from shifting their
share of Medicaid program expenditures to the Federal government.
Another commenter stated that the existing statistical test permits
non-uniform taxes on MCOs to seem compliant with the statutory
generally redistributive requirement while designed specifically to
disproportionately impact Medicaid providers.
Response: We thank commenters for their support of our proposals,
which we generally are finalizing as proposed in this rule with minor
wording modifications, and adjustment to the transition period. We
agree that taxing models that exploit the loophole distort the Federal-
State fiscal partnership with respect to Medicaid and improperly shift
costs to the Federal government.
Comment: A commenter expressed concern that the proposed rule could
undermine ``legitimate'' tax arrangements. Another similarly expressed
concern that the proposed rule would unintentionally impact States that
were not previously identified as having problematic tax structures and
requested that CMS add language to ensure the rule does not negatively
affect those States. A commenter was concerned that, because of slow
State legislative processes, ensuring State compliance with the
proposed rule will take several years.
Response: We drafted the proposed rule to focus on preventing
States from adopting tax structures that are impermissible based on the
statute. To the extent a health care-related tax on a permissible class
satisfies recently amended statutory requirements regarding what is
considered ``generally redistributive'' and complies with all other
Federal requirements, including that it does not involve a hold
harmless arrangement, it is likely to be permissible; we are available
to provide technical assistance to States to discuss individual health
care-related tax programs to ensure compliance with all applicable
Federal requirements. Regardless, all States are responsible for
ensuring compliance with all applicable Federal statutes and
regulations. Even if the State has not affirmatively identified an
impermissible health care-related taxing structure, it still bears the
ultimate responsibility of ensuring compliance with all Federal
statutory and regulatory requirements governing health care-related
taxes, including those newly enacted in the WFTC legislation and
implemented in this final rule.
We are confident that all affected States with loophole taxes are
aware of CMS' concerns with the tax loophole and our intent to address
it through communications with us, this proposed rule, and recent
Congressional action, but we expect some States may need to convene
special legislative sessions to address this final rule and the WFTC
legislation (and may need to regardless of other WFTC legislation
provisions). Most States with health care-related taxes that exploit
the loophole received formal notice with their most recent waiver
approval that we were concerned the tax was not generally
redistributive within the meaning of the statute, which we discuss more
in section II.D. For those States that were not formally notified, we
believe they are aware due to significant press attention on this topic
but nevertheless are providing transition periods.
Comment: A commenter stated that the flexibility of current
provider tax structures fosters innovation in care delivery and that
restricting the availability would stifle innovation, hinder States'
ability to develop and sustain effective care models and limit access
to care. Another commenter stressed the importance of health care-
related taxes to a State's Medicaid program and requested that CMS
provide a list of permissible funding sources if the funding sources
that States had been using are now deemed impermissible.
Response: There is nothing in this final rule that should result in
the stifling of State innovation. Rather, this final rule is intended
to strengthen the Medicaid program by enhancing the financial stability
of the program by ensuring dollars are available to support
[[Page 4803]]
services, as well as help ensure that Medicaid dollars are spent
appropriately and for the benefit of Medicaid beneficiaries through the
availability of Medicaid services without placing disproportionate
burden of financing onto the Federal government. While some States or
entities may have realized certain benefits from tax structures that
exploit the loophole, those tax structures do not align with the
generally redistributive requirement in the statute (before the
amendments made by the WFTC legislation, and certainly after).
Health care-related taxes remain a permissible source of funding.
Nothing in this rule would affect the ability of States to establish
health care-related taxes and use them as the source of non-Federal
share, provided they meet all Federal requirements. Therefore, there is
not a need to provide a list of permissible funding sources, because
they are unchanged by this rule. This rule (and the related amendments
made by the WFTC legislation) merely provide that certain tax
structures will not satisfy the generally redistributive requirement,
without changing the principle that health care-related taxes that
require a waiver but that are generally redistributive and meet all
other applicable Federal requirements will continue to be permissible.
Comment: Several commenters indicated that the WFTC legislation or
the proposed rule will lead to decreased Medicaid benefits and lower
payment rates. A few commenters also pointed to Medicaid eligibility
changes and work requirements contained in the WFTC legislation and
stated that the proposed rule should not be finalized due to the
cumulative effect. They also stated CMS should guarantee that primary
care payment rates will not fall below current levels due to the
proposed rule. A few commenters recommended that CMS provide
implementation funding to States for both this final rule as well as
the WFTC legislation.
Response: We acknowledge these concerns and as always are available
to provide technical assistance to States aiming to avoid service
disruption and to develop innovative care delivery models to ensure
access to care for Medicaid beneficiaries. We also acknowledge that the
cumulative effect of changes established by the WFTC legislation may
have varying impacts on States; however, the WFTC legislation codified
the requirements we proposed in statute, and thus as such, it would be
counter to section 1903(w) of the Act to not finalize the proposed
rule. Specific authority for funding to States under the WFTC
legislation was not provided or authorized with respect to the
amendments made by section 71117 of the WFTC legislation. However, FFP
is available for certain State Medicaid administrative expenditures
that meet statutory and regulatory requirements. Finally, we emphasize
again that we maintain our commitment to States through our review of
State program proposals to ensure that all statutory requirements are
met, including access to care requirements.
Comment: Some commenters suggested that CMS postpone finalization
to allow CMS time to gather additional information on how States are
using provider taxes and to conduct further analysis of the impact of
the rule on providers. A commenter was concerned that certain States
will not have sufficient time to update their managed care preprints
and submit to CMS for approval, and that where managed care State
directed payments are supported by health care-related taxes they will
no longer be permissible under the provisions of this proposed rule.
Response: Most States with health care-related tax waivers that
exploit the loophole have received formal notice regarding the
structure of such programs, but in general States have been aware for
years that we intended to take action on this topic. We have advised
States of our concerns, often in writing, and, as discussed later in
this final rule, a transition period has been established. Finally, we
note that as of the effective date of this final rule, States will have
had nearly a year since the proposed rule, and more than 6 months since
the enactment of the WFTC legislation, to consider and make appropriate
adjustments to sources of non-Federal share.
Comment: A commenter recommended that CMS require States to report
detailed information on how they raise the State share of Medicaid
funding. They further stated that linking provider-level data would
allow CMS to assess whether provider taxes are, in practice, generally
redistributive, and if providers are being held harmless.
Response: We agree about the importance of transparency in how
States finance their share of Medicaid program costs. Through our
analysis of health care-related taxes, we have identified distortions
of health care-related taxes that shift the burden to the Medicaid
program. We review health care-related taxes both when a State applies
for a waiver, and when a State submits a preprint or SPA regarding a
payment funded by a health care-related tax. This final rule allows us
to take necessary action for taxes that are not generally
redistributive that we were able to identify through existing oversight
but did not have the regulatory authority to disapprove until now due
to the statistical loophole in the regulation. We will continue to
explore all available avenues to improve transparency, further protect
Medicaid program dollars and ensure that Federal taxpayer dollars are
being spent appropriately.
Comment: A few commenters indicated that the proposed rule could
benefit from clarifications. Some requested that language be added to
clarify which tax structures remain compliant, notwithstanding the
proposed requirements. One specifically requested that language be
added to clarify that tax structures not subject to a waiver are
presumed compliant. Another commenter stated that nursing home tiers
(that is, taxing nursing facilities with different characteristics such
as number of beds, rural or non-State government at different rates)
may be used for tax purposes that are not to exploit the loophole and
requested that CMS clarify that these tiering structures are not those
tiering practices referenced in this rule. These commenters stated that
absent these clarifications, the proposed rule could have a negative
impact on the use of compliant tax structures to support Medicaid
financing, particularly for rural and safety net providers, including
nursing homes.
We received other similar comments expressing this same concern
about nursing facility taxes. Commenters stated that nursing homes, due
to their high proportion of residents for whom Medicaid is the payer,
face unique challenges in meeting ``generally redistributive''
requirements. They stated that longstanding, compliant tiered tax
structures could now face undue scrutiny, and that excluding Medicare
revenues from the tax base, as currently allowed, should continue. A
commenter requested that CMS preserve established and permissible
provider assessment practices, emphasizing that these allow States the
flexibility to design Medicaid programs that best meet the needs of
their populations. Several commenters requested that nursing homes be
excluded from the regulation entirely. A commenter requested that we
exclude children's hospitals from the regulation entirely due to the
critical services they provide. A commenter requested that all
hospitals be exempted from the regulation. A commenter requested that
nursing homes be given the same flexibilities as hospitals in the
regulation.
[[Page 4804]]
Response: Regardless of whether a health care-related tax waiver is
necessary, State tax programs must meet all Federal statutory and
regulatory requirements. Although the statute and regulations do not
require a demonstration that a health care-related tax is generally
redistributive in nature when the State is not seeking a waiver of the
broad-based and/or uniformity requirements, the absence of a need for a
health care-related tax waiver does not presume that the tax meets all
other Federal requirements related to permissible class and hold
harmless requirements. States must evaluate their individual tax
programs and work with CMS to review for allowability. The final rule
clearly describes what it means for a health care-related tax to be
considered generally redistributive, which test under the final rule
and the amendments made by section 71117 of the WFTC legislation now
ensures will not result in disproportionate burden on Medicaid.
The WFTC legislation provision that closes the loophole does not
specify exemptions from the new generally redistributive requirements
based on provider type or tax class, nor did we propose such
exemptions. We also want to affirm that, while we will examine all tax
rate groups and tiering tax structures on all non-uniform taxes, we are
aware that there are many appropriate and permissible tax rate
practices that involve the use of tiers and groups. We note that of the
many nursing facility taxes, we are only aware of two that appear to
utilize the loophole. As such, we disagree that there is a need for
special consideration for nursing facilities, since many States have
developed permissible health care-related taxes on nursing facility
services without exploiting the loophole and inappropriately cost
shifting to the Federal government. This final rule does not limit the
flexibility of States to develop tax programs that meet Federal program
requirements. Nothing in the current rule, this final rule, or the WFTC
legislation would prohibit or preclude States from excluding Medicare
revenue from taxation. In addition, due to the interests of ensuring
consistency of administration, fiscal stewardship over the Medicaid
program, and the statute as amended by section 71117 of the WFTC
legislation, we decline to adopt the commenters' suggestion of
excluding specific providers or permissible classes of services from
the requirements of this final rule. We agree with the commenter that
every permissible class should be treated and evaluated similarly in
the new regulation, including the services of nursing facilities.
Comment: Several commenters urged CMS to incorporate special
considerations and exemptions into the proposed rule, emphasizing the
need for targeted flexibility, clear guidance, and recognition of
unique provider circumstances to ensure fair and workable provider tax
policies. A few commenters recommended that CMS establish a safe harbor
for taxes with modest non-uniformity, stating this would respect
Congressional intent and established practices that allow reasonable
variation in provider taxes. A commenter highlighted how current
regulations allow exemptions for certain hospitals (that is, rural
hospitals, sole community hospitals, financially distressed hospitals
and psychiatric hospitals), but not for nursing homes, and urged CMS to
extend similar exemptions to nursing homes facing financial and
demographic pressures. A commenter called for CMS to clarify the
requirements for when provider taxes will be considered generally
redistributive and permissible, to avoid confusion and ensure
compliance.
Response: We disagree that special exemptions should be included in
this final rule. Providing safe harbors or exemptions for taxes that do
not meet statutory and regulatory requirements jeopardizes the fiscal
integrity of the Medicaid program. Exemptions such as these do not
support using Federal taxpayer dollars appropriately. Finally, we note
that the WFTC legislation did not include exceptions, and we are
finalizing without exceptions both for the fiscal integrity reasons
stated and to implement for alignment with the updated statutory
requirements.
Comment: A few commenters requested that specific types of
organizations such as governmental and non-profit emergency medical
services agencies be exempted from the proposed rule.
Response: We appreciate the commenters' concerns and understand the
desire to exempt certain provider types, such as governmental and non-
profit emergency medical services agencies, from the provisions of the
proposed rule. However, in the interest of consistent fiscal policy, it
is not feasible to exempt specific categories of providers from the
rule's requirements. Uniform application of the rule ensures that all
health care-related taxes are administered fairly and without
preferential treatment. In addition, the WFTC legislation does not
authorize exceptions for specific provider types. As a Federal agency,
we are obligated to implement regulations to effectuate applicable
laws.
Comment: A commenter expressed concern regarding the rule's
application to licensure programs. Specifically, the commenter was
concerned that the proposed rule could inadvertently make Medicaid
certification fees impermissible. This commenter requested that CMS
clarify that State licensure and certification program fees are exempt
from the requirements of the proposed rule.
Response: We disagree with the commenter's recommendation. A
certification fee solely based on Medicaid participation would not be
permissible as it would not meet the existing regulatory requirements
at Sec. 433.56(a)(19). For a licensing or certification fee to be
permissible, it must meet the provisions of Sec. 433.56(a)(19)(i)-
(iii). There were no proposed revisions to this language. These types
of fees must still be broad based and uniform (or the State must
receive a waiver of these requirements), the payer of the fee cannot be
held harmless, and the amount of the fee cannot exceed the cost of
operating the licensing or certification program.
Comment: A few commenters stated that the proposed rule would
eliminate or severely restrict the flexibility Congress intended for
States to design non-uniform provider taxes, undermining statutory
intent and established practice. A few commenters stressed Congress's
expressed intent for flexibility, with a commenter stating that it runs
contrary to statutory intent and violates the APA. A commenter
emphasized how the vast majority of State provider taxes are not
designed to exploit the loophole identified in this proposed rule,
stating that this structural overhaul and additional threshold is not
necessary.
Response: The proposed rule and our response to public comments
received reflect the APA process. We agree that there are health care-
related taxes that meet statutory and regulatory requirements,
including as amended by section 71117 of the WFTC legislation and under
the requirements of this final rule. However, as we discuss throughout
this rule, there are some health care-related taxes that take advantage
of an inadvertent loophole in a regulatory statistical test which has
allowed States to circumvent the statutory requirement for a health
care-related tax to be generally redistributive. As Congress stated
through the plain language of section 1903(w)(3)(E) of the Act, the
Secretary shall approve a health care-related tax waiver for the broad-
based and/or uniformity requirements if the
[[Page 4805]]
net impact of the tax and associated expenditures is ``generally
redistributive'' in nature and the amount of the tax is not directly
correlated to Medicaid payments for items and services with respect to
which the tax is imposed. The health care-related taxes taking
advantage of the inadvertent loophole circumvent the statutory
requirement for health care-related taxes seeking to be approved via a
waiver to be generally redistributive. The circumvention of the
statutory requirement results in shifting the burden of financing the
Medicaid program to Medicaid providers and ultimately to the Federal
government. The statutory intent was further reinforced by section
71117 of the WFTC legislation, which requires by statute the very
changes we proposed under the preexisting authority of section
1903(w)(3)(E) of the Act.
Comment: Several commenters stated that States' ability to tax is
essential to their sovereignty, and that provider taxes are a legally
permissible and essential way to raise revenue to pay for the State
share of Medicaid payments. These commenters indicated the proposed
rule creates Federalism concerns and infringes on State sovereignty by
limiting State taxing authority. Some commenters believed that CMS'
suggestion that the proposed rule did not raise Federalism or
preemption concerns was based on the agency's narrow view of the
benefits provider tax programs provide to the Federal government. A few
commenters pointed to Department of Revenue of Ore. v. ACF Industries,
Inc., 510 U.S. 332, 345 (1994) to support their position that State
taxing authority is ``central to State sovereignty'' and should not be
limited beyond the ``evident scope'' of any Federal law that limits
that authority.
Response: We do not disagree that the ability to levy taxes is
within a State's sovereign power. Nothing in the Medicaid statute
restricts a State's ability to impose taxes and collect tax revenue,
although the statute does place certain limitations on which tax
revenues may be used to draw down Federal Medicaid matching funds. In
this regard, we agree that States have the ability and authority to
impose health care-related taxes without the Medicaid expenditure
reduction in statute at section 1903(w)(1)(a)(2) of the Act and Sec.
433.70(b) as long as they meet the applicable requirements of Federal
law. This final rule is not changing that fact. However, Federal
statute and regulation, and further reinforced most recently by the
WFTC legislation, have established parameters to ensure that Medicaid
providers and the Medicaid program are not unduly harmed by such taxes.
This final rule is not limiting States' ability to utilize health care-
related taxes; rather, it provides necessary parameters to ensure the
statutory provisions are maintained and met.
Comment: Numerous commenters requested that CMS provide clear
guidance and technical assistance to States and providers, in
particular to those States that will need to restructure their health
care-related taxes. They stated that this is necessary to allow States
to phase out impermissible taxing structures with minimal disruption to
their Medicaid program. Commenters suggested CMS provide examples and
templates of acceptable tax structures, have a centralized team to
support tax waiver redesign and modeling, and work with impacted States
to identify alternate funding sources.
Response: We have staff assigned to review health care-related
taxes, including waiver requests, and provide technical assistance to
States on non-Federal share sources. We again assure the commenters
that we are available to provide technical assistance. We also remind
States that FFP is available for certain State Medicaid administrative
costs that meet statutory and regulatory requirements.
Comment: A few commenters disagreed with the language from the
background section of the proposed rule regarding the purpose and value
of health care-related taxes. These commenters stated that health care-
related taxes do in fact support stable funding for the Medicaid
program. Some of these commenters discussed specifics about their
State's Medicaid program financing structure, how taxes supplement
rather than supplant Medicaid funding, and the healthcare this funding
supports. One other commenter noted that even though almost every State
imposes some type of health care-related taxes, CMS does not have
precise data on how much State funding is derived from provider taxes
due to opaque financial reporting. This lack of clear data makes it
challenging for CMS to evaluate how much providers are actually paid,
net of taxes, and how much of the State's share is effectively shifted
back to the Federal government.
Response: This rule does nothing to stifle the use of permissible
health care-related taxes; it merely ends an abusive practice that
threatens the fiscal integrity of the Medicaid program at large. It is
both the States' and CMS' responsibility to ensure that Medicaid
dollars are spent appropriately and in compliance with Federal
requirements, including the statutory requirement that taxes for which
a waiver is approved be generally redistributive in nature. This final
rule addresses health care-related taxes that run counter to statutory
requirements intended to ensure the Medicaid program is not unduly
burdened. This is necessary to protect Federal taxpayers, and to
protect Medicaid providers from bearing the cost of financing the
Medicaid program or other programs within a State that utilize the
health care-related tax revenues. Although this final rule is not
focused specifically on transparency, and therefore comments about
additional financial reporting are beyond the scope of the provisions
of this final rule, it does mirror the new statutory requirements
enacted in the WFTC legislation, and will enable us to provide better
oversight and ensure the fiscal integrity of the Medicaid program.
Comment: A few commenters disagreed with CMS referring to the
provider tax structure addressed in the proposed rule as a
``loophole.'' Some commenters stated that health care-related taxes are
legal mechanisms structured within strict parameters and approved by
the Federal government. These commenters expressed frustration with
CMS' depiction of health care-related taxes when, in the past, CMS had
acknowledged health care-related taxes being a critical source of
Medicaid program funding. A commenter suggested that CMS put guardrails
in place to ensure Medicaid tax revenue is used properly, rather than
broadly disallowing certain taxes. Some commenters mentioned State
accountability policies that ensure health care-related tax revenue is
spent on relevant areas of Medicaid and health care, promoting quality
care and a better joint Federal and State partnership in administering
the Medicaid program.
Response: The purpose of this final rule is to provide necessary
oversight of health care-related tax waivers to align with applicable
Federal statutory provisions. This final rule contains necessary
guardrails--now required by statute--to ensure that health care-related
tax revenue is generated in a permissible manner without circumventing
the purpose of the statutory ``generally redistributive'' requirement
to not overly burden Medicaid providers. The previous regulations
addressed this same issue through the statistical test that we are
maintaining, but unfortunately that test was vulnerable to exploitation
by certain States seeking to increase revenue from the Federal
government. This vulnerability has allowed a tax
[[Page 4806]]
program to place a much higher tax burden on Medicaid activities
compared to commercial activities, which allowed a State to effectively
shift a disproportionate burden of the tax onto the Medicaid program.
As previously stated, this was the very outcome that the statistical
test--as well as the statute, even before the amendments made by
section 71117 of the WFTC legislation--were intended to prevent States'
circumventing the intent of the test in this manner is fairly
characterized as a ``loophole,'' which is defined by Merriam's
Dictionary as ``a means to escape, especially an ambiguity or omission
in the text through which the intent of a statute, contract or
obligation may be evaded.''
Comment: Without referencing specific provisions in the proposed
rule, many commenters expressed concern regarding general ambiguity and
subjectivity of generally redistributive requirements and proxy
language provisions. A commenter stated the language of the provision
is vague and creates uncertainty. A few commenters stressed the need
for CMS to provide clear, objective, and consistent standards to guide
States in demonstrating that a tax is generally redistributive. A
commenter recommended that CMS work with Medicaid agencies to develop a
new statistical test or other objective measure. A commenter
recommended that CMS establish a framework with clear, quantitative
benchmarks and reproducible thresholds to guide States in demonstrating
that taxes are generally redistributive. A commenter stated that the
rule should allow reasonable and clearly defined uses of Medicaid
statistics to set non-uniform tax rates, as long as safeguards are in
place to prevent unfair tax burdens and gaming.
Response: We disagree with the commenters that the rule is
ambiguous, subjective, or unclear. First, Sec. 433.68(e)(3)(i)
prohibits States from imposing a higher tax rate on any taxpayer or tax
rate group based on a provider's Medicaid taxable units than the tax
rate imposed on any taxpayer or tax rate group based on a provider's
non-Medicaid taxable units except for excluding Medicare revenue or
payments as described at Sec. 433.68(d). Whether one tax rate is
higher than another is a straightforward comparison that requires
comparing two tax rates to determine which rate is higher. Second,
Sec. 433.68(e)(3)(ii) prohibits States from taxing any taxpayer or tax
rate group defined by its relatively higher level of Medicaid
utilization compared to any other taxpayer or tax rate group defined by
its relatively lower level of Medicaid utilization. The example
provided demonstrates how this is also a straightforward comparison:
one tax rate group is for facilities with $200 million or more in
Medicaid revenue while the other tax rate group is for facilities with
less than $200 million in Medicaid revenue. These groups, clearly
defined based on Medicaid utilization, have vastly disparate tax rates
of $250 and $20 per bed day, respectively, which is again a
straightforward comparison. In addition, the preamble of this rule
provides several additional examples to illustrate for commenters how
these standards work.
While Sec. 433.68(e)(3)(iii) may appear less straightforward than
the first two provisions, it is essentially the same as the first two,
just without explicitly naming Medicaid. We believe this provision is
crucial to stop efforts to circumvent the first two provisions by not
explicitly stating the term ``Medicaid'' (or the State-specific name
for the program). This provision has been narrowly tailored to achieve
this result and is now required by statute. Additionally, for all three
of these provisions, we encourage States to approach us for technical
assistance as early as possible to help them ascertain whether their
particular provision could possibly run afoul of any of these
provisions.
We discussed in the proposed rule and elsewhere in this final rule
why we did not choose to establish a new statistical test: our desire
not to be disruptive, the fact that the B1/B2 test generally works well
for most health care-related tax waiver requests, and the fact that a
new statistical test could mean a new loophole. A State may use
Medicaid statistics as part of the development of a non-uniform tax
rate, as long as the tax rates are not disparate based on Medicaid
utilization, with the higher burden placed on Medicaid business. For
example, we discuss later in response to a comment where it may be
appropriate to use Medicaid data as an available data source, provided
the effect is not impermissible. A State may not use Medicaid
statistics to have non-uniform rates that tax Medicaid providers more
heavily, as that use would be counter to the letter and intent of the
final rule, the longstanding statutory generally redistributive
requirement, and the amendments made by section 71117 of the WFTC
legislation.
Comment: Several commenters recommended that CMS limit the proposed
rule to just MCO taxes, as they account for the majority of the tax
burden targeted by the proposed rule. In addition, commenters
recommended that since taxes on hospitals are not as burdensome on
average to the Medicaid program as taxes on MCOs, hospital taxes should
not be included.
Response: We disagree that it is appropriate to only limit this
policy to taxes on MCOs. While it is true that most of the loophole
taxes we are aware of are taxes on the services of MCOs, the
permissible class defined at Sec. 433.56(a)(8), we have also
identified taxes on other permissible classes, including inpatient
hospital services and nursing facility services, that pose similar
risks to the Medicaid program. One of our guiding principles for
addressing the loophole was to close it entirely. To exclude certain
permissible classes from this policy would not achieve that goal. We
believe it is more appropriate and effective to address the issue
comprehensively rather than partially. Limiting the rule to MCO taxes
could leave other problematic tax arrangements unaddressed and
potentially allow similar issues to spread in non-MCO permissible
classes. As a result, we want to prevent future issues by addressing
the situation proactively and comprehensively. Additionally, the WFTC
legislation does not limit the requirements to MCO taxes only, nor was
the longstanding statutory ``generally redistributive'' requirement
limited to MCO taxes before the amendments made by the WFTC
legislation. Therefore, we also decline to adopt the commenters'
suggestion for consistency with Federal statute as well. However, in
recognition that MCO loophole taxes impose a greater burden on the
Medicaid program, we have provided, through the authority under the
WFTC legislation, a longer transition period for non-MCO taxes that
violate the loophole. This is detailed with greater specificity in
section II.D.
Comment: A commenter noted that the proliferation of Medicaid
managed care plans has made it difficult for physicians to focus on
patient care due to differing requirements. This commenter also stated
that there needs to be increased oversight on Medicaid managed care.
Response: We agree with the commenter that effective and efficient
oversight of Medicaid managed care is a laudable goal. However, the
relationship between the proliferation of managed care plans and the
ability of physicians to provide adequate patient care is outside the
scope of this rule.
Comment: A commenter pointed out that existing regulations at Sec.
433.68(e)(2)(iii)(B) permit States to develop less redistributive taxes
if the tax entirely excludes or reduces the tax burden on specified
entities. They
[[Page 4807]]
suggested that essential hospitals be added as one of the providers
listed for this lower threshold.
Response: The proposed rule did not propose any changes or
additions to the existing types of providers that can be excluded from
a State's tax program and still be deemed as generally redistributive
in nature with a lower statistical test threshold. Therefore, this
comment is out of scope of the proposed rule. We also did not propose
any changes to the language in Sec. 433.68(d). The option for health
care-related tax programs to permissibly exclude Medicare revenues is
still maintained in regulation. However, it is important to note that
any State health care-related tax program must meet all applicable
statutory and regulatory requirements.
Upon review of comments, and consistent with the WFTC legislation,
we are finalizing the rule as proposed, with a couple minor wording
changes and adjustments to the transition period, which are noted in
the respective provision sections.
A. General Definitions (Sec. 433.52)
We proposed adding new definitions at Sec. 433.52. We proposed to
add and define ``Medicaid taxable unit'' to mean ``a unit that is being
taxed within a health care-related tax that is applicable to the
Medicaid program.'' This includes units that are used as the basis for
Medicaid payment, such as Medicaid bed days, Medicaid revenue, costs
associated with the Medicaid program such as Medicaid charges, or other
units associated with the Medicaid program. Although we had previously
established the use of ``taxable unit'' in preamble of prior
rulemaking,\19\ we stated our belief in the proposed rule that
formalizing a definition in regulation will allow us to better specify
the inclusion of factors in our consideration of whether a tax is
generally redistributive, which we discuss in section II.B.
---------------------------------------------------------------------------
\19\ See 57 FR at 55128 (``By the term ``Medicaid Statistic,['']
we mean the number of the provider's taxable units applicable to the
Medicaid program.'').
---------------------------------------------------------------------------
We proposed to add and define ``non-Medicaid taxable unit'' to mean
``a unit that is being taxed within a health care-related tax that is
not applicable to the Medicaid program.'' This includes units that are
the basis for payment by non-Medicaid payers, such as non-Medicaid bed
days, non-Medicaid revenue, costs that are not associated with the
Medicaid program, or other units not associated with the Medicaid
program.
We proposed to add and define ``tax rate group'' to mean ``a group
of entities contained within a permissible class of a health care-
related tax that are taxed at the same rate.'' Our work on the
subsequent provisions of Sec. 433.68(e)(3)(i), (ii), and (iii) led to
the development of this term to illustrate this concept succinctly, and
we therefore decided it would be beneficial to define it formally in
regulations as well. These provisions referred to groups of providers
or health care items and services taxed at the same rate. For the sake
of clarity and simplicity, we believed it was easiest to use a single
term to refer to these types of groupings.
We invited comments on the inclusion of these terms, the
definitions we proposed, and if there are any other terms used in the
proposed rule that should be included in the regulatory definitions as
well.
The following is a summary of the public comments on our proposed
definitions, and our responses.
Comment: We received several comments that expressed concern that
the proposed definitions were too vague, lacked clarity, or were
subjective. Some commenters stated that this was very concerning with
the use of the term ``could include'' in the definitions of Medicaid
taxable unit and non-Medicaid taxable unit. They commented that the use
of this phrasing would be extremely difficult to implement.
Response: The intent of the definitions was not to be limited by
the use of the phrase ``could include.'' The phrasing was merely
intended to reflect that the list of examples was not exhaustive.
However, since that meaning can be conveyed by simply stating
``include,'' we are amending the regulation to remove the word
``could'' for clarity. Furthermore, the WFTC legislation section 71117
included these definitions, and did not include the phrasing ``could
include,'' so this update creates precise alignment with the current
statutory language.
Comment: A few commenters commended CMS for developing clear
definitions in Sec. 433.52 and for the examples of permissible tax
groupings.
Response: We appreciate the commenters' feedback regarding the
clarity of the definitions provided in Sec. 433.52. We agree that
clear definitions are essential to support understanding and compliance
with the final rule.
Following review of public comments, we are finalizing the
definitions as proposed with the modification to remove the word
``could'' in the definitions of Medicaid taxable unit and Non-Medicaid
taxable unit.
B. Permissible Health Care-Related Taxes--Generally Redistributive
(Sec. 433.68(e))
Section 1903(w)(3)(E)(ii)(I) of the Act provides that the Secretary
shall approve a State's application for a waiver of the broad-based
and/or uniformity requirements for a health care-related tax, if the
State demonstrates to the Secretary's satisfaction that the tax meets
specified criteria, including that the net impact of the health care-
related tax and associated Medicaid expenditures as proposed by the
State is generally redistributive in nature.
In section II.C., we discuss new regulatory language in Sec.
433.68(e)(3) we are finalizing to better implement the statutory
mandate that a tax be generally redistributive, and the changes made by
the WFTC legislation. The new regulatory language necessitates
conforming changes to the preceding regulatory language, that is, Sec.
433.68(e)(1) and (2), to reflect the new requirement at Sec.
433.68(e)(3). Accordingly, we proposed to amend Sec. 433.68(e) to
provide that a proposed tax must satisfy new paragraph (e)(3), in
addition to, as applicable, paragraph (e)(1) or (2) of that section.
The addition of paragraph (e)(3) is discussed in section II.C. of this
rule.
We further proposed to amend paragraphs (e)(1)(ii) through (iv) and
(e)(2)(ii) and (iii) to add that the waiver must satisfy the
requirements of paragraph (e)(3) and (f), in addition to existing
requirements, for the waiver request to be approvable. Paragraph (f)
refers to the current regulatory implementation of limitations on hold
harmless arrangements in connection with health care-related taxes,
which we did not propose to modify in the proposed rule. The addition
of this reference to paragraph (f) in various places in paragraph (e)
is intended to enhance clarity, but not to make any substantive change
concerning hold harmless limitations. We note that paragraph
(e)(1)(iii) references taxes enacted prior to August 13, 1993. Although
a new waiver submission for a tax in effect prior to August 13, 1993,
would be unlikely, it is still possible, (for example, if a State makes
a non-uniform change to its longstanding tax and needs a waiver), and
this proposal accounts for that possibility.
We sought comment on our proposed amendments to Sec. 433.68(e),
(e)(1)(ii) through (iv), and (e)(2)(ii) through (iv) and on any
additional conforming regulatory edits that may be needed to reflect
that paragraph (e)(3) is a requirement for a waiver of the broad-
[[Page 4808]]
based and/or the uniformity requirement to be approved.
The following is a summary of the public comments on the proposed
changes to Sec. 433.68(e), (e)(1)(ii) through (iv), (e)(2)(ii) and
(iii), and our responses:
Comment: Some commenters were concerned regarding the varying usage
of the phrase ``is approvable'' and ``will be approved'' in the changes
proposed to Sec. 433.68(e)(1) and (2). They requested that CMS clarify
the intent of the differing languages, with one stressing the
importance of clear standards for States and providers.
Response: The language referenced by the commenters refers to
places where CMS changed existing regulatory language and where we did
not. In the regulatory text for both Sec. 433.68(e)(1)(ii) and
(e)(2)(ii), we use the phrase ``the tax waiver is approvable'' where we
were replacing text that previously stated CMS ``will automatically
approve.'' Conversely, in Sec. 433.68(e)(1)(iii), (iv), and
(e)(2)(iii), the phrase ``will be approved'' appears where it did in
the previous regulations, because here we were not changing that, but
instead adding the language ``in addition to satisfying the requirement
at paragraphs (e)(3) and (f).'' We believe that the phrases ``is
approved'' and ``will be approved'' convey the same meaning as ``is
approvable'' that we are finalizing in this regulation. We are
finalizing these changes as proposed.
Comment: A few commenters supported the rule's efforts to curb
``gaming'' and exploitation of the loophole in provider tax structures.
A few commenters stressed their support for changes to the B1/B2 test
to prevent gaming. A few commenters urged CMS to take additional steps
such as applying the additional requirements to demonstrate a tax is
generally redistributive, which the commenter called a requirement not
to unduly burden the Medicaid program, to both the B1/B2 and P1/P2
tests to limit future gaming.
Response: We thank the commenters for their support. With the
enactment of the WFTC legislation, we have determined that the final
rule's provisions are sufficient at this time, and it currently is not
necessary to propose changes to the application of the B1/B2 and P1/P2
tests. Under this final rule, the requirements we are establishing are
not based on an undue burden on Medicaid but rather ensure proper
application of the statute. However, we note that the change to
paragraph (e)(1)(ii) and (iii) ensure the requirements of paragraph
(e)(3) are met when a State is only seeking a broad-based requirement
waiver using the P1/P2 test, as well as when a State is seeking a
uniform requirement waiver using the B1/B2 test. This is consistent
with the amendments made by section 71117 of the WFTC legislation.
Comment: A commenter supported the proposed changes to Sec.
433.68(e) as necessary clarifying and technical edits to account for
the new requirements.
Response: We thank the commenters for their support.
After reviewing the comments, we are finalizing the changes to
Sec. 433.68(e)(1)(ii) through (iv) and (e)(2)(ii) and (iii), as
proposed.
C. Permissible Health Care-Related Taxes--Additional Requirement To
Demonstrate a Tax Is Generally Redistributive (Sec. 433.68(e)(3))
CMS sought to address health care-related taxes that do not have
the effect of being generally redistributive despite being able to pass
the P1/P2 or B1/B2 test, as applicable, as previously discussed. In the
proposed rule, we explained our belief that, in large part, the B1/B2
test has served its function as a straightforward mathematical
implementation of the statutory requirement under section
1903(w)(3)(E)(ii)(I) of the Act that to be granted a waiver a tax must
be generally redistributive. Although the linear regression used in the
B1/B2 analysis is vulnerable to certain kinds of manipulation by
States, as discussed in section I.D. of this final rule, CMS'
experience has shown that the B1/B2 test usually works as intended. In
the proposed rule, we aimed to eliminate the possibility these
vulnerabilities will be exploited. As a result, we proposed to retain
the B1/B2 test based on the long-term reliance of many States on the
test and its overall utility in accomplishing its purpose of ensuring
that taxes for which waivers are requested are generally
redistributive. However, as demonstrated by the problematic taxes
discussed earlier that are designed to target Medicaid with increased
tax rates compared to other taxpayers, it is necessary to take our
analysis a step beyond the mathematical result of the B1/B2 test to
ensure we uphold the statutory mandate that a tax for which a waiver is
approved be generally redistributive, which we proposed to do through
the addition of the requirements in paragraph (e)(3). In addition, as
specified in existing statute and by cross reference in regulation at
section 1903(w)(1)(A)(iii) of the Act and Sec. 433.70(b),
respectively, even if a tax passes the applicable statistical test, it
is still considered impermissible if it contains a hold harmless
arrangement prohibited by section 1903(w)(4) of the Act and Sec.
433.68(f). Therefore, we proposed to add cross-references to Sec.
433.68(f) in regulatory language we proposed to update in Sec.
433.68(e)(1)(ii), (1)(iv), (2)(ii), and (2)(iii) regarding the
approvability of a tax waiver proposal.
As previously discussed, Sec. 433.68(e) specifies the applicable
statistical test for evaluating whether a proposed tax is generally
redistributive: if the State is seeking only a waiver of the broad-
based requirement, paragraph (e)(1) specifies that a State must meet
the test referred to as ``P1/P2'' described in section I.C. of this
rule, while a State seeking a waiver of the uniformity requirement or
both the broad-based and uniformity requirements must meet the test
specified in paragraph (e)(2), referred to as ``B1/B2,'' also described
in section I.C. of this final rule.
We proposed adding a new paragraph, Sec. 433.68(e)(3), to ensure
that a health care-related tax is generally redistributive by
preventing taxes that impose higher tax rates on providers that
primarily serve Medicaid beneficiaries than on other providers that
serve a relatively smaller number of such beneficiaries. Specifically,
in paragraph (e)(3), we proposed that the new requirements would apply
on a per class basis. We also proposed that regardless of whether a tax
meets the standards in paragraphs (e)(1) and (2), the tax would not be
``generally redistributive'' if it has certain described attributes
that are contrary to the tax program being generally redistributive in
nature.
The provisions of this final rule specify the attributes of a tax
that would violate the generally redistributive requirement in
paragraphs Sec. 433.68(e)(3)(i), (ii) and (iii). The applicability of
these provisions, and the associated analysis of whether a tax violates
the generally redistributive requirement, would differ based on whether
the tax or waiver indicates Medicaid explicitly. We discuss each of
these in turn. We note that this policy will not interfere with a
State's ability to implement otherwise permissible State and locality
taxes (that is, taxes imposed by units of local government such as
counties).
The following is a summary of comments received about the
additional ``generally redistributive'' requirement, in general, and
our responses.
Comment: A few commenters recommended that CMS adopt a presumption
in favor of provider taxes being generally redistributive, with the
burden placed on CMS to demonstrate noncompliance only if specific
regulatory requirements are not met. A
[[Page 4809]]
commenter stated that applying both the B1/B2 and P1/P2 tests would
better prevent future gaming of provider tax rules.
Response: The Social Security Act clearly places the obligation on
States to operate their Medicaid program in compliance with Federal
requirements. The final rule's regulatory provisions describe what is
necessary for a health care-related tax to be considered generally
redistributive. In developing the proposed rule and considering the
enactment of the WFTC legislation with its amendments to section
1903(w) of the Act, we have determined that the final rule's provisions
are sufficient at this time and there currently is not a need for
changes to the application of the B1/B2 and P1/P2 tests. The effect of
requiring all waivers to meet both the B1/B2 and the P1/P2 tests would
be to eliminate the statistical loophole. However, it would also be
more restrictive than the option of adding requirements in Sec.
433.68(e)(3)(i) through (iii) that we proposed and would affect more
States with more taxes. In addition, it would encompass some taxes
where there is no evidence that they are out of compliance with Federal
requirements. Because of the comparatively greater burden that would be
involved in addressing a wider variety of States and taxes, which
generally do not merit increased concern, CMS did not believe that this
option would be desirable. For this reason, we did not choose it.
Rather the requirements finalized in this rule, particularly in section
Sec. 433.68(e)(3), provide the tools necessary for us to effectively
evaluate health care-related tax waiver proposals and determining
whether they are in fact generally redistributive. A health care-
related tax cannot be presumed to be generally redistributive if it has
not been established that all requirements in statute and regulation
are met. This work requires analysis of the State's tax program and
proposal. Finally, we note that the suggestion of the commenters would
not align with the requirements under the WFTC legislation, which we
have endeavored to align with.
Comment: A commenter highlighted an example of a relevant State
proposition directing tax revenue generated from MCO-based taxes to
fund designated services benefiting all State Medicaid beneficiaries.
The commenter suggested that CMS should amend the rule to enable States
to impose non-uniform taxes if they use the funds to supplement
reimbursements or enhancing services for Medicaid beneficiaries. A few
commenters urged CMS to introduce mechanisms to determine whether the
revenue was being used in a supplemental manner rather than just
supplanting other State general fund obligations in determining whether
to approve a waiver for a particular tax structure.
Response: We appreciate the commenter's recognition of how health
care-related taxes, including those on MCOs, can be used to fund
Medicaid services. We acknowledge that many States rely on such taxes
to support a wide range of Medicaid payments. Nothing in this final
rule prohibits States from continuing to impose health care-related
taxes on services of MCOs. This rule is not intended to prevent States
from making new investments in their Medicaid programs through any
permissible means of financing allowed under statute and regulation.
However, taxes designed to exploit the loophole are not generally
redistributive in nature as required by statute, and they place an
undue financial burden on the Medicaid program and the Federal
government beyond what is contemplated by statute and regulation. After
the finalization of the additional generally redistributive
requirement, and with the statutory changes made by section 71117 of
the WFTC legislation, States with currently non-compliant MCO taxes may
redesign their health care-related taxes to ensure compliance with
Federal requirements. Additionally, States have the option to finance
these services from sources other than health care-related taxes on
services of MCOs.
Comment: A commenter recommended CMS publish clear guidance on the
process for evaluating proposed tax waivers. A commenter recommended
CMS maintain the B1/B2 test due to the subjectivity of the proposed
rule's provisions and the States' longstanding reliance on the test. A
commenter stated that these provisions were too broad in scope because
they would capture and implicate a wider variety of taxes than is
necessary.
Response: The provisions of the proposed rule provide clear
standards for tax waivers. If a State taxes a taxpayer or tax rate
group more heavily based on its Medicaid taxable units or utilization
than its non-Medicaid taxable units or utilization and expressly
identifies the taxpayer or tax rate group by reference to ``Medicaid''
or an equivalent name, that will implicate Sec. 433.68(e)(3)(i) or
(ii). If a State does the same thing, but to circumvent the additional
generally redistributive requirement under this final rule (and as
required by the amendments made by section 71117 of the WFTC
legislation) does not use the word ``Medicaid'' or an equivalent name,
but instead identifies the taxpayer or tax rate group differently to
achieve the same result, that would implicate Sec. 433.68(e)(3)(iii).
Nothing about the way the B1/B2 currently works will change; for
waivers of the uniformity requirement, States will still need to pass
the B1/B2 test. To address the statistical loophole, we are
supplementing the existing B1/B2 test with a new additional generally
redistributive requirement, as proposed and as required under the
statutory amendments made by section 71117 of the WFTC legislation. By
employing these two methods together (that is, the existing B1/B2 test
and the new generally redistributive requirement), the analysis of
proposed tax waivers will help ensure that we only approve tax waivers
that are generally redistributive because they tend to use non-Medicaid
revenue to pay for Medicaid payments, as required by statute. Likewise,
we disagree that the new provisions do not provide clear guidance.
Section 433.68(e)(3)(i) and (ii) fundamentally rely on straightforward
measures of whether one amount is greater or less than another amount.
Section 433.68(e)(3)(iii) does involve a consideration of a wider
variety of factors that are not strictly speaking statistical or
numeric, but that only forms the first step of the proxy analysis,
which then concludes with whether the tax has the same effect as
described in paragraph (e)(3)(i) and (ii). Despite the wider variety of
factors that are under consideration, our analysis at this stage will
remain objective since the proxy is only limited to capturing States
that are attempting to circumvent the requirements in Sec.
433.68(e)(3)(i) and (ii) through using alternative language and not
other situations.
Section 433.68(e)(3)(iii) is necessary to prohibit States from
attempting to circumvent the additional ``generally redistributive''
requirement by not using the word ``Medicaid'' or an equivalent name.
While we have considered relying solely on a new statistical test, we
declined to propose doing so at this time because the alternative tests
we considered would have caused unnecessary disruption for States with
existing approved tax waivers that are functioning appropriately. In
addition, we disagree with the commenter that the regulation is too
broad in scope. The regulation is narrowly tailored to accomplish its
purpose of ensuring that tax programs are generally redistributive,
while still retaining State flexibility in designing their tax
programs. We have repeatedly
[[Page 4810]]
emphasized these policies only affect a small number of known loophole
taxes. As a result, we decline to adopt the commenters' suggestions.
Finally, we note that the WFTC legislation enacted these provisions,
substantially as we proposed, with limited organizational differences
between the regulation and statute and without including the examples
listed in the proposed regulation. Therefore, apart from the fact that
we determined the policies we finalized are the most effective, least
disruptive, pathway to close the statistical loophole, we also
determined it is appropriate to finalize as proposed to align with the
amendments made by the WFTC legislation.
Comment: A few commenters provided specific examples of their
State's tax arrangements and sought clarity on whether or not they
would be deemed permissible.
Response: As with many new regulations, we understand that States
may require technical assistance in interpreting how the regulation
applies to their unique circumstances. While the notice and comment
rulemaking is not the appropriate venue to discuss the specifics of
each State's particular situation, we encourage States to contact us
directly if they have any questions or concerns regarding how the
regulation might affect them. We also intend to communicate directly
with the small number of likely impacted States regarding the status of
their tax waiver(s) and the new requirements under this final rule and
the amendments made by section 71117 of the WFTC legislation. We are
committed to supporting States and providing technical assistance as
needed. Furthermore, we recommend States contact us as early as
possible if they have questions or are concerned about whether their
health care-related taxes may conflict with the new Federal
requirements.
Comment: A few commenters suggested edits to the proposed rule in
areas of the proposed rule's provisions that commenters indicated were
ambiguous or with which the commenters otherwise disagreed. These
included removing the examples from the regulatory text, applying the
policy only to MCO taxes, and to limit the applicability of Sec.
433.68(e)(3)(i), (ii), and (iii) to States that have received companion
letters from CMS informing them that their tax may be problematic.
Finally, a commenter suggested that the ``legitimate public policy
goal'' apply to all of Sec. 433.68(e)(3)(i), (ii), and (iii).
Response: We are not making any edits based on these suggestions.
We discussed in earlier responses why it would not be appropriate to
limit the scope of this rule to MCO taxes. We also believe the examples
in regulatory text demonstrate the agency's commitment to the
interpretation of the regulations that we described in preamble to the
proposed rule, and we have made it clear these examples are not
exhaustive. We are also not limiting the applicability to States that
have received companion letters, because then there would still be
loophole taxes. We have addressed the issue of whether a State has
received a companion letter through the different transition periods,
where all States that did not receive a formal companion letter have at
least a full State fiscal year to come into compliance under this final
rule. We decline to adopt the suggested edit that the legitimate public
policy language applies to all the additional requirement regulations,
as this is only a consideration for Sec. 433.68(e)(3)(iii), borne out
of the fact that Medicaid is not being named explicitly. This
difference requires a greater examination of intent, to ensure
inadvertent associations are not inappropriately penalized. Finally, as
we have stated, we are finalizing all changes to Sec. 433.68(e)(3) as
proposed, with one wording change to paragraph (e)(3)(iii) noted in the
relevant section for consistency with section 71117 of the WFTC
legislation.
Comment: A few commenters in support of the proposed rule pointed
to how MCO taxes that exploit the loophole in particular
disproportionately impact Medicaid tax burden.
Response: We appreciate the commenters' support and agree that
taxes on services of MCOs, as described at Sec. 433.56(a)(8), that
also exploit the loophole, present the most egregious examples of this
problem. We believe that the provisions of the proposed rule would
effectively address these taxes so as to prohibit this issue from
recurring.
After consideration of the public comments overall on the
establishment of an additional requirement to demonstrate a tax is
generally redistributive, and consistent with section 71117 of the WFTC
legislation, we are finalizing all changes to Sec. 433.68(e)(3) as
proposed, with one wording change to paragraph (e)(3)(iii) noted in the
relevant section.
1. Taxes That Refer to Medicaid Explicitly
In Sec. 433.68(e)(3)(i), we proposed that if, within the
permissible class, the tax rate imposed on any taxpayer or tax rate
group based upon its Medicaid taxable units is higher than the tax rate
imposed on any taxpayer or tax rate group based upon its non-Medicaid
taxable units (except as a result of excluding from taxation Medicare
or Medicaid revenue or payments as described in paragraph (d) of this
section) the tax would not be generally redistributive. We also
proposed to specify an example of a tax that would violate this
provision, although the example is not the only example of how a tax
might be structured to violate this requirement. The example we
proposed in regulations text specifies that an MCO tax where Medicaid
member months are taxed $200 per member month whereas the non-Medicaid
member months are taxed $20 per member month would violate this
requirement. Medicaid would, in this context, also include descriptions
of where a State uses its proper name of its State-specific Medicaid
program.
In Sec. 433.68(e)(3)(ii), we proposed that if within a permissible
class, the tax rate imposed on any taxpayer or tax rate group
explicitly defined by its relatively lower volume or percentage of
Medicaid taxable units is lower than the tax rate imposed on any other
taxpayer or tax rate group defined by its relatively higher volume or
percentage of Medicaid taxable units, it would not be generally
redistributive. We also proposed to specify two examples of taxes that
would violate this provision, although the examples were not intended
to be the only examples of how a tax might be structured to violate
this requirement. The first example specifies that a tax on nursing
facilities with more than 40 Medicaid-paid bed days of $200 per bed day
while nursing facilities with 40 or fewer Medicaid-paid bed days are
taxed $20 per bed day would violate this requirement. The second
example describes a tax on hospitals with less than 5 percent Medicaid
utilization at 2 percent of net patient service revenue for inpatient
hospital services, while all other hospitals are taxed at 4 percent of
net patient service revenue for inpatient hospital services; this tax
structure also would violate this requirement.
Health care-related taxes with the attributes described in the
examples in Sec. 433.68(e)(3)(i) and (ii) are designed to generate
less tax revenue from non-Medicaid sources and more tax revenue from
Medicaid sources for the same amount of taxable services or revenue,
which is inconsistent with a generally redistributive tax. This is
contrary to the Congressional intent and statutory direction that non-
broad based and non-uniform taxes that are granted a waiver must be
generally redistributive. Based on our analysis, existing State taxes
that
[[Page 4811]]
use the B1/B2 loophole described previously would all fail the
requirement in the proposed Sec. 433.68(e)(3)(i). One of these
existing State taxes that uses the loophole would also fail the
requirement in Sec. 433.68(e)(3)(ii).
These scenarios illustrate examples of taxes that target Medicaid
taxable units with higher tax rates when compared with non-Medicaid
taxable units. As a result of this targeting, the tax ensures that
taxed entities that serve no, or relatively low percentages, of
Medicaid beneficiaries are not financially harmed as a result of the
tax. This is important because providers with low Medicaid utilization
would be less able to be made whole by additional Medicaid payments. As
a result, these providers are not burdened by any, or more than a de
minimis, tax liability. Because of this tax structure, the State, its
localities, and taxpayers do not appear to shoulder a significantly
reduced net non-Federal share. As a result, the Federal government is
the only net payer or a substantially higher net payer than
contemplated by statute in its specification of the applicable Federal
matching percentage. In addition to this being counter to the statutory
framework, as described above, the scenarios presented by the rule are
illustrative of taxes that present a significant fiscal integrity risk
to the Medicaid program without any benefit to the Federal taxpayer.
When non-Federal entities do not incur a net non-Federal share cost (or
incurring a reduced non-Federal share cost), there is a reduced
incentive for States to propose payment methods that are efficient,
economic, and consistent with other applicable Federal requirements.
The following is a summary of the public comments on the provisions
when a waiver explicitly names Medicaid under Sec. 433.68(e)(3)(i),
and our responses:
Comment: A commenter urged CMS to omit the examples included in
this section, both because they are non-exhaustive (and according to
the commenter, therefore cause uncertainty), and because they overlook
situation-specific nuances. The commenter challenged the example that a
higher tax rate on nursing facilities with more than 40 Medicaid-paid
bed days than the tax rate on nursing facilities with 40 or fewer bed
days would be considered not generally redistributive, asserting that a
State may use Medicaid-paid bed days as a proxy for total bed days,
because Medicaid data is timely and less volatile over time, rather
than increase the share of tax burden on Medicaid taxable units.
Response: We are maintaining the examples in the regulation text.
The inclusion of these examples allows readers of the regulations to
have clear insight into the meaning of the regulations. This also
provides examples on which a State can reasonably rely, as these have
been codified in regulation. We believe it is clear that these examples
are not exhaustive, and maintain that that they are valuable reference
points for States as they interpret and implement the regulation.
We acknowledge the commenter's point that the examples do not
capture the nuances of each specific situation, and we are available to
provide technical assistance on different circumstances. With respect
to the example in the comment, to provide the data necessary to pass
the B1/B2 test initially, States must already be collecting data on
Medicaid units as distinct from total taxable units. A State would be
unable to calculate the B1/B2 test if the only data they had was
Medicaid bed days. As a result, we do not believe that the situation
suggested by the comment would be possible, given how States must
calculate the B1/B2 test. States often use lagged data from a few years
prior in their health care-related tax waiver requests. We expect this
practice to continue. Nothing in the final rule would preclude States
from continuing to do this. We continue to encourage States to provide
the best, most accurate, most recent data they have for health care-
related tax waiver submissions to us.
Comment: A commenter stated that the language of this provision was
too vague and creates uncertainty. Another commenter requested that CMS
provide guidance to States, given that their intentions for the tax and
rate may need to be considered.
Response: We respectfully disagree with the commenter's assertion
that the language of Sec. 433.68(e)(3)(i) is vague or creates
uncertainty. As discussed in response to general comments that
indicated the same, Sec. 433.68(e)(3)(i) prohibits States from
imposing a tax rate on any taxpayer or tax rate group based on Medicaid
taxable units higher than the tax rate on any taxpayer or tax rate
group based on a provider's non-Medicaid taxable units (except for
excluding Medicare revenue or payments as described at Sec.
433.68(d)). It is readily apparent if one tax rate is larger than
another tax rate. Then, to aid States further, we provided multiple
examples of potential violations, and we encourage States to seek
technical assistance early in the design of their tax programs. We
appreciate the commenter's request for additional guidance and is
available to engage with States individually to address any concerns
related to Sec. 433.68(e)(3)(i).
The following is a summary of the public comments on proposed Sec.
433.68(e)(3)(ii), and our responses:
Comment: A commenter recommended that CMS allow tiered assessment
models that use lower tax rates on small Medicaid providers or high-
volume Medicaid providers, when the model supports access and meets
Federal requirements.
Response: Nothing in this rule would prohibit States from
establishing lower tax rates for small Medicaid providers or high-
volume Medicaid providers. In fact, a tax that provides lower tax rates
for providers with higher Medicaid taxable units or utilization aligns
with the ``generally redistributive'' concept. The regulation would
permit this while not allowing lower tax rates for providers with lower
Medicaid taxable units or utilization. Providers defined by
comparatively higher Medicaid business cannot be taxed more than
providers defined by their comparatively low Medicaid business. We
would likely need to examine the details of the commenter's particular
situation to make a definitive judgement on permissibility under
Federal requirements.
Comment: A commenter cautioned that taxes on nursing homes in many
States use tiers, and that some States impose health care-related taxes
by referencing providers that serve multiple levels of care as
``definitions'' for tax rate tiers, though these ``definitions'' are
not codified in State statute or regulation. The concern the commenter
has is that these practices will be viewed as impermissible proxies.
Responses: For the purposes of Sec. 433.68(e)(3)(iii), CMS will
not decide based on one sole factor, such as how the ``definitions''
are codified in State statute or regulation. We will initially review
how the State describes the tax to CMS, and then also consider
surrounding circumstances and information about the tax. When States
submit health care-related tax waiver requests to CMS, they must submit
a letter describing, among other things, the structure of the tax, and
the tax rates. CMS refers to this as the health care-related tax
request letter. In its health care-related tax request letter, if the
State uses the word ``Medicaid'' or its State-specific equivalent,
Sec. 433.68(e)(3)(i) or (ii) may come into effect. If not, Sec.
433.68(e)(3)(iii) may still apply. CMS would need to look at the
example in question in greater detail, as
[[Page 4812]]
we will be making these assessments on a case-by-case basis.
Comment: A few commenters claimed that Sec. 433.68(e)(3)(i) and
(ii) would make it difficult for States to impose multiple tax rates.
One such commenter stated that this could occur because CMS is
considering the tax portion only and is not considering payments
supported by the tax.
Response: We respectfully disagree with the commenters assertion
that Sec. 433.68(e)(3)(i) or (ii) will make it difficult for States to
impose multiple tax rates. The additional analysis to determine whether
a tax is generally redistributive finalized in this rule will only
occur when a State is proposing multiple tax rates and therefore is not
a uniform tax. However, these policies do not prohibit non-uniform
taxes. These specific provisions only apply if the State uses
``Medicaid'' in their description of the tax to us and then would only
further trigger these provisions if the Medicaid-associated tax rate is
higher.
Additionally, we agree with the commenter that the regulation is
focused mainly on the structure of a tax program as opposed to the
methodology used to make Medicaid payments; however, this is not
because we do not consider the associated payments. Section
1903(w)(3)(E)(ii)(I) of the Act specifies that whether a tax is
generally redistributive in nature considers the net impact of the tax
and associated expenditures; as such, the generally redistributive
analysis must necessarily consider the payments that the tax will fund,
including whether they are not being used for Medicaid payments.
However, our policies have historically focused on the tax structure
because we expect and have found that health care-related taxes are
generally used to fund Medicaid payments, and we ensure our policies
reflect that likelihood.
We further note that no part of assessing the permissibility of
taxes exists in a vacuum. Our analyses of provider taxes also consider
payments supported by these taxes; for example, the analysis we conduct
to determine whether a hold harmless arrangement is in place. As such,
although the changes we are finalizing at Sec. 433.68(e) focus mainly
on the structure of the tax itself, this is through the knowledge that
the tax is likely used for Medicaid payments, and in conjunction with a
closer examination of the payments for the hold harmless analysis.
After consideration of the public comments, and consistent with
section 71117(a)(1) of the WFTC legislation, which added the proposed
language as section 1903(w)(3)(E)(iii)(I) and (II) of the Act, we are
finalizing Sec. 433.68(e)(3)(i) and (ii) as proposed. However, we note
that the WFTC legislation reversed the order of the two provisions from
what we proposed. We are maintaining the order as proposed, as we view
this difference as immaterial and want to prevent any confusion from
the proposed rule and the way the information was organized at the
greater level of detail contained in rulemaking.
2. Waivers That Do Not Refer to Medicaid Explicitly
In Sec. 433.68(e)(3)(iii), we proposed to prohibit a State from
imposing a tax that excludes or imposes a lower tax rate on a taxpayer
or tax rate group defined by or based on any characteristic that
results in the same effect as described in paragraph (e)(3)(i) or (ii).
In other words, there does not need to be an explicit reference to
Medicaid in the State's tax program if the State is using a substitute
definition, measure, attribute, or the like as a proxy for Medicaid to
accomplish the same effect. By ``the same effect,'' we mean imposing a
higher tax rate on Medicaid taxable units than on non-Medicaid taxable
units, even if this is accomplished with less mathematical precision
under an approach that does not explicitly reference Medicaid than
would be possible under an approach that violates proposed paragraph
(e)(3)(i) or (ii).
The proposed rule specified two examples of taxes that would
violate this provision but does not provide an exhaustive list of ways
a tax might be structured to violate it. The first example involves the
use of terminology to establish a tax rate group based on Medicaid
without explicitly mentioning ``Medicaid'' (or the State-specific name
of the Medicaid program) to accomplish the same effect as described in
paragraph (e)(3)(i) or (ii). This example specifies that a tax on
inpatient hospital service discharges that imposes a $10 rate per
discharge associated with beneficiaries covered by a joint Federal and
State health care program and a $5 rate per discharge associated with
individuals not covered by a joint Federal and State health care
program would violate this requirement, because joint Federal and State
health care program describes Medicaid, and a higher tax rate is
imposed on Medicaid taxable units. The second example concerns the use
of terminology that creates a tax rate group that closely approximates
Medicaid, to the same effect as described in paragraph (3)(i) or (ii).
This example specifies that a tax on hospitals located in counties with
an average income less than 230 percent of the Federal poverty level of
$10 per inpatient hospital discharge, while hospitals in all other
counties are taxed at $5 per inpatient hospital discharge, would
violate this requirement, because the distinction being drawn between
tax rate groups is associated with a Medicaid eligibility criterion
(income) with a higher tax rate imposed on the tax rate group that is
likely to involve more Medicaid taxable units.
The intent of the proposed provision in paragraph (e)(3)(iii) is to
address potential efforts by States or local units of government to
mask a health care-related tax that falls more heavily on Medicaid
taxable units using some other terminology or defining factor to
circumvent the requirements in paragraph (e)(3)(i) and (ii) by avoiding
explicitly targeting Medicaid taxable units with higher tax rates. For
the same reasons described previously regarding taxes that would
violate paragraph (e)(3)(i) or (ii), such taxes would not meet the
statutory generally redistributive requirement and would have a
substantially negative impact on the fiscal integrity of the Medicaid
program. Absent this provision, we explained our concern that if we
only finalized the requirements in Sec. 433.68(e)(3)(i) and (ii),
States might choose to pursue taxes that would otherwise be prohibited
under Sec. 433.68(e)(3)(i) and (ii) through the use of a proxy for
Medicaid. Following the enactment of the WFTC legislation, we are also
finalizing paragraph (e)(3)(iii) for consistency with the new statutory
language.
We proposed to codify this regulatory language with this level of
detail directly in response to feedback we received to a similar
proposal in the November 2019 proposed rule. Although we remain
committed to addressing the statistical loophole, as we were in the
November 2019 proposed rule, we acknowledge that the level of detail in
the November 2019 proposed rule might not have provided enough context
to give commenters an accurate picture of our intent. Under the
analogous provision of the 2019 proposed rule, we would have determined
a tax program not to be generally redistributive if it imposed an
``undue burden'' on the Medicaid program because the tax ``excludes or
imposes a lower tax rate on a taxpayer group defined based on any
commonality that, considering the totality of the circumstances, CMS
reasonably determines to be used as a proxy for the tax rate group
having no Medicaid activity or relatively lower Medicaid activity than
any other tax rate group.'' (84 FR 63778). The 2019 proposed rule may
not have presented
[[Page 4813]]
a clear idea of how we would apply the requirement to avoid imposing an
undue burden on the Medicaid program. In the proposed rule, we added
language to Sec. 433.68(e)(3) to provide reassurance to interested
parties that these current proposals are intended only to shut down the
loophole to better effectuate the statutory directive that health care-
related taxes for which the broad-based and/or uniform requirement is
waived must be generally redistributive, and not impact permissible
State health care-related tax programs unrelated to this goal. For
example, in section II.A., we proposed to define ``Medicaid taxable
unit'' to narrow the scope from ``Medicaid activity'' as used in the
November 2019 proposed rule. We also chose, in all of paragraph (e)(3),
to propose specific illustrative examples that demonstrate our
commitment to a clear, specific, and predictable application of our
regulations. We believe that the illustrative examples will provide the
public with a better understanding of what these provisions do and how
we will apply it in practice when evaluating State tax waiver
proposals, compared to the November 2019 proposed rule.
We invited comments on other examples we could provide, whether in
the final rule preamble or in regulation text, that could make even
clearer how we will implement the proposed policies. We address
comments received on the examples we proposed at the end of this
section with other comments and responses pertaining to waivers that do
not refer to Medicaid explicitly.
Since the scenarios described in Sec. 433.68(e)(3)(iii) would not
name Medicaid explicitly, we explained that CMS would need to assess
whether Medicaid is nevertheless implicated, and then whether the tax
results in the same effect as described in paragraph (3)(i) or (ii).
Under this assessment, we would examine the tax and waiver submission,
including the characteristics of each tax rate group description, the
entities in the tax rate group, and the Medicaid taxable units and non-
Medicaid taxable units associated with each tax rate group and entities
in each tax rate group. No single factor would result in an automatic
determination by CMS that the tax rate groups have been designed to
target Medicaid when it is not explicitly named. However, a series of
overlapping descriptions or characteristics that appear to point toward
Medicaid utilization, without using the word Medicaid, would probably
lead to a heightened level of scrutiny. For example, we explained that,
if CMS analyzes a Medicaid utilization table in a tax waiver submission
(which lists providers, their tax rates, and their Medicaid
utilization) and observes that a certain group of excluded providers
described as ``Provider Group A'' has little to no Medicaid
utilization, we would further scrutinize ``Provider Group A'' to
ascertain whether it is a proxy for lack of Medicaid utilization, as
discussed further later in this rule.
Accordingly, we proposed that CMS may examine whether the tax or
waiver uses terminology that describes Medicaid implicitly without
using the term itself, such as the ``joint Federal and State health
care program,'' used in our example in the proposed rule.\20\ We would
also examine if the tax rate group is defined based on criteria that
mirror Medicaid eligibility or other defining characteristics, such as
a data point that is associated with Medicaid or a Medicaid eligibility
criterion like income (such as percentages of low-income individuals in
a geographic area), or a particular provider type that is associated
with high Medicaid utilization (such as State or other public
facilities and university/teaching hospitals).
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\20\ 90 FR 20587.
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This analysis would fit into our regular review work and
interactions with States. When CMS reviews a tax waiver submission, we
assess the waiver for compliance with all applicable statutes and
regulations. This assessment is not necessarily limited to the waiver
submission itself, or to the materials as first submitted by the State.
Upon review, we generally tailor a set of questions for the State to
obtain any additional information necessary to adjudicate the waiver
request or request revisions necessary for the submission to meet
Federal requirements. For example, we might ask for clarification based
on something we did not understand, that we want to confirm, or that
may be in error. We regularly have additional discussions with the
State, which may include technical assistance phone calls, and review
of State submission of updated or additional health care-related tax
waiver request materials. The process is both collaborative and
iterative, to allow States to vary their taxes in ways appropriate for
their individual circumstances as supported by statute and regulations,
and to allow CMS to arrive at an appropriate approvability decision
based on Federal requirements.
We explained that an assessment of whether or not a State is
utilizing a proxy in violation of proposed paragraph (e)(3)(iii) would
be conducted under this same process. If we analyze a Medicaid
utilization table and observe a disparate set of rates for higher and
lower Medicaid utilization tax rate groups despite the tax passing B1/
B2, and we cannot readily determine how the tax rate groups have been
constructed, we will ask the State for additional information as is
part of our standard practice. Consistent with our existing practice,
this allows the State to identify for CMS any necessary clarifications
or explanations that informed the development of the tax rate groups.
The additional information we obtain from the State could allow us to
determine that the tax rate groups were not constructed to target
taxation to higher Medicaid utilization tax rate groups or away from
lower Medicaid utilization tax rate groups, but instead for a
legitimate public policy purpose not directed at manipulating relative
tax burden.
Section 433.68(e)(3)(iii) is not intended to prevent States from
designing tax rate groups to achieve legitimate public policy goals,
when these do not prevent the tax from being generally
redistributive.\21\ In this context, by ``legitimate,'' we mean any
public policy goal that the State may lawfully pursue, which is the
State's actual purpose and not a spurious or fictive purpose offered to
conceal or negate a true purpose of directing higher relative tax
burden to the Medicaid program. This type of assessment is already
historically reflected in the consideration CMS gives to certain non-
uniform taxes under Sec. 433.68(e)(2)(iii)(B), where CMS permits a
lower threshold to pass the B1/B2 test for taxes that provide more
favorable tax treatment only for specified types of entities, including
sole community hospitals as defined in Sec. 412.92. A ``sole community
hospital'' (SCH) generally is a hospital that is the only hospital in
its geographic area and therefore serves as the sole source of
inpatient hospital services for the vulnerable population in the area.
Because these hospitals play vital roles in providing access to care to
beneficiaries, they were included in the statutory and regulatory
flexibilities built into the statistical test in recognition of their
importance to recipient access to services (57 FR 55118 through 55129).
---------------------------------------------------------------------------
\21\ See reference in proposed rule at 93 FR 20588.
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For example, a State establishing a nursing facility tax program,
within which a tax rate group for a provider type such as continuing
care retirement communities (CCRCs) is subject to a lower tax rate for
public policy reasons, would not, in and of itself, violate
[[Page 4814]]
paragraph (e)(3)(iii), even if the CCRC tax rate group happens to have
lower Medicaid utilization than other tax rate groups in the tax
program. In this case, we would consider that the designation of CCRC
exists outside of the health care-related tax domain, and, for taxation
purposes within the CCRC designation, the tax rate is not
differentiated between Medicaid and non-Medicaid taxable units. CCRCs
are licensed by the States in which they are located. They are not a
classification or designation that the State created for the purposes
of establishing health care-related tax provider groups or otherwise to
minimize the impact on non-Medicaid providers or taxable units.
As another example, a State might seek to exclude providers located
in rural areas from taxation. States often afford special consideration
for rural providers as a means of helping preserve beneficiary access
to services in rural areas that otherwise might not have a sufficient
number of qualified providers to serve the needs of Medicaid
beneficiaries. Like sole community hospitals, the existing regulations
in Sec. 433.68(e)(2)(iii)(B) currently provide additional flexibility
for States in designing non-uniform tax waivers that favor rural
hospitals. A tax structure that excluded rural providers without any
explicit reference to Medicaid would likely not fall within the proxy
provision. Generally, because the provider group would be defined by a
pre-existing classification that exists for various public policy
purposes apart from taxation (rural location) and because the tax
treatment within the classification of rural providers would not vary
between Medicaid and non-Medicaid taxable units, there would not appear
to be an indication that the State is using the taxpayer rate group to
direct tax burden to the Medicaid program or away from providers with
relatively lower Medicaid utilization.
When, by chance, a State's effort to design a tax program in
support of a public policy purpose like promoting health care access
results in a tax rate group that happens to have lower Medicaid
utilization ending up with a tax break, some States may balance this
with a corresponding break for higher Medicaid utilization providers.
Nothing in the proxy provision would prevent States from being able to
balance tax rate groups in this way as they have in the past. Other
possible examples of tax rate groups that States may wish to give a tax
break to for policy reasons not related to directing higher relative
tax burden to the Medicaid program include psychiatric hospitals and
rural hospitals, among others. These instances would be permissible
under proposed paragraph (e)(3)(iii)(B) because the State has a
legitimate public policy reason not related to directing relative tax
burden toward the Medicaid program for giving preferential tax
treatment to the tax rate group for the type of provider in question.
As noted, the groupings discussed in the previous paragraphs exist
for policy reasons outside of the context of taxation, indicating they
were not created solely for the purpose of the tax and waiver under
review. Conversely, a possible signal that a State is trying to exploit
the loophole for a reason that is not tied to legitimate public policy
would be the State's use of groupings that do not appear to have a
connection to a reasonable policy purpose. This would indicate to CMS
that we need to investigate further to determine if the State's
proposal would lack a legitimate policy purpose and would impose
disproportionate burden on Medicaid. Examples of groupings that could
have a legitimate policy purpose include grouping providers within a
permissible class by number of bed days for an inpatient hospital
services tax and member months for managed care plan services tax. In
these instances, the grouping uses health care-associated
quantification measures. We note that this would not be the sole factor
to determine whether a State has a legitimate public policy interest
when establishing tax groupings; groupings like this would simply not
raise the same red flags as groupings unrelated to health or tax
policy.
An example of a grouping that does not appear to have a connection
to a legitimate policy purpose (and that would prompt further inquiry)
could include a feature of the physical plant of facility in question.
For example, if a State was targeting a specific hospital with very
high Medicaid utilization, and that hospital was unique in having two
separate exterior entrances to the emergency department, the State
might construct inpatient hospital tax rate groups based on the number
of exterior entrances to the emergency department. CMS might see this
on review of a waiver submission, and it would prompt additional
questions to the State as part of our typical practice of assessing
waiver submissions to understand the rationale for assigning tax rates
in this manner, because it is not evident how incentivizing hospital
emergency departments through taxation to have (or not to have) a
particular number of separate exterior entrances to the emergency
department would advance a legitimate State public policy goal.
As stated, CMS does not intend for Sec. 433.68(e)(3) to target any
taxes other than those that utilize the loophole in the B1/B2 test. We
explained in the proposed rule that we would apply this proposed
provision narrowly, to reach only those situations where, based on
considerations not related to a legitimate public policy goal as
discussed previously, CMS determines that a State is attempting to mask
that it is seeking to apply a higher tax rate based on a taxpayer's or
tax rate group's Medicaid taxable units in a manner that, if it had
been done explicitly, would violate Sec. 433.68(e)(3)(i) or (ii).
The following is a summary of the public comments on the proxy
provisions located at Sec. 433.68(e)(3)(iii), and our responses.
Comment: Many commenters expressed concern regarding a perceived
lack of clarity in the proxy criteria for terminology equivalent to
Medicaid. Several commenters expressed concern with a lack of standards
for how CMS will determine the ``same effect as Medicaid'' or what the
agency will consider as constituting a proxy for Medicaid. Several
commenters recommended CMS define explicit standards, outside of
illustrative examples, for the proxy classification criteria in the
final rule. These commenters sometimes noted that these standards would
provide additional clarity on the provision. Several commenters stated
that the vague standard for the proxy provisions would make State
revenue sources less predictable since they would not know if CMS would
consider their descriptions a proxy or not. In addition, a commenter
stated that because of the lack of clarity for the proxy provision
States may not develop tax programs because their taxes could be
disapproved retroactively. A commenter described the proxy as overly
complex. Finally, some commenters stated that the ambiguity of the
proxy provision will cause CMS to expend additional resources to
determine if a tax rate group uses a proxy or not.
Response: We respectfully disagree with the commenters that Sec.
433.68(e)(3)(iii) and its associated preamble language lacks clarity.
While we acknowledge that we did not provide a comprehensive list of
every possible way that States could design proxy language, which would
not be a feasible task, we believe that the overall purpose and intent
of the provision is clear. The regulation is intended to prevent States
from circumventing the new, additional requirement to demonstrate that
a tax is generally redistributive by creating provider
[[Page 4815]]
group designations intended to be able to tax the Medicaid program
more. This is not a baseless concern. There have been instances in the
past where States have appeared to interpret Federal requirements in
ways that, while not explicitly stated, may have had the effect of
circumventing clear Federal statutes and regulations. For example, the
permissible classes upon which States may impose health care-related
taxes are listed at section 1903(w)(7) of the Act and Sec. 433.56.
States may not impose a health care-related tax upon health care items
and services other than those listed in those places without
experiencing a penalty spelled out in statute at section
1903(w)(1)(a)(2) of the Act and Sec. 433.70(b). A health care-related
tax, as defined by section 1903(w)(3)(a) of the Act and Sec. 433.55,
in part, is a tax where at least 85 percent of the burden falls on
health care providers, or under which the treatment of individuals or
entities providing or paying for health care items or services is
different than the tax treatment provided to other individuals or
entities. In the past, there have been instances where States have
structured broad taxes in ways that included health care items or
services (as well as non-health care items and services, and non-health
care providers) which, when the health care items and services included
in the tax are considered independently, did not meet the criteria for
a permissible tax class under Federal requirements. After identifying
such arrangements, we issued a letter to all States reminding them of
statutory and regulatory requirements, outlining future compliance
expectations, and issued a disallowance to one State to enforce
compliance that continued non-compliance even after the all-State
letter.\22\ Without the proxy provision we are finalizing at Sec.
433.68(e)(3)(iii), States may likewise attempt to circumvent Federal
requirements on health care-related taxes by describing Medicaid
without using the word Medicaid for the purpose of evading the
additional requirements to demonstrate a tax is generally
redistributive. We use the word ``defined by'' in Sec. 433.68(e)(3)(i)
and (ii) to encompass only those situations where the State uses the
word Medicaid or its State-branded equivalent (that is, the proper name
of the State's Medicaid program and/or State Medicaid agency). We do
not wish to leave the door open to this kind of manipulation.
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\22\ SHO #14-001, ``Health Care-Related Taxes,'' issued on July
25, 2014, available at https://www.medicaid.gov/federal-policy-guidance/downloads/sho-14-001.pdf.
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Regarding the request to provide ``explicit standards'' outside of
illustrative examples, as noted, such a list would be impossible to
create. The proxy provision precludes States from adopting synonyms for
Medicaid without using the word Medicaid to evade the additional
requirement to demonstrate a tax is generally redistributive. There may
be innumerable ways someone could describe something without using the
proper name of the thing itself, but achieve the same effect. Any
attempt to produce a definitive list would be inherently incomplete. We
disagree that States would have uncertainty or confusion about whether
a tax violates the proxy provision or not. States that develop a proxy
for Medicaid would do so to circumvent the additional requirement to
demonstrate a tax is generally redistributive. Because of this, these
States would, necessarily, be aware that the proxy provision could
apply to their tax rate group. By contrast, if a State begins with a
legitimate public policy purpose (as discussed earlier in this
preamble) in mind when designing its tax program, we expect that that
purpose will be evident on the face of the State's waiver request or
will be elaborated during our collaborative waiver review process, such
that the State need not be concerned that its tax program design would
be regarded inaccurately as a proxy for targeting disproportionate tax
burden to Medicaid. If States have additional questions about how the
proxy provision may affect them, we encourage States to request
technical assistance from us.
While we appreciate the commenter's concern for the time and
resources that our staff will spend implementing the new proxy
provision, the addition of the provision will not substantially
increase the workload that we already have when processing waiver
requests. We currently engage with States on a wide variety of issues
related to their health care-related tax waiver submissions, and as
stated, the information we would gather to make our assessment is part
of this standard work.
Comment: A few commenters expressed concern that the proposed
provision would create confusion for States looking to modify existing
or design new provider taxes and would allow the agency to alter what
it would consider to be a proxy. A few commenters noted this rule moves
away from the reliance on statistical tests to determine broad-based
and uniform waiver compliance. Some commenters expressed specific
concern that the rule is directly in contrast to the agency's original
implementation of the B1/B2 and P1/P2 tests. A commenter urged CMS to
base proxy determinations solely on data rather than subjectivity. A
commenter expressed concern that the proposed rule would prohibit a
long-standing Medicaid proxy terminology in the State's health care-
related tax program even though the tax program's goal is to align
Medicaid financing with delivery system needs. Another commenter urged
CMS to allow States to demonstrate their compliance with this rule by
using a comprehensive review process. A commenter believed the lack of
objective standards may lead to an arbitrary application of this rule.
Response: We respectfully disagree with commenters who assert that
the proposed provision would create confusion for States looking to
modify existing or design new provider taxes. If a taxpayer group is
defined using proxy for Medicaid and has the same effect as Sec.
433.68(e)(3)(i) and (ii), avoiding the word ``Medicaid'' in an attempt
to evade the additional requirement to demonstrate a tax is generally
redistributive, this would violate Sec. 433.68(e)(3)(iii). Conversely,
if it does not use a proxy in this manner (or have the same effect as
Sec. 433.68(e)(3)(i) and (ii)), it would not. We concede that the
determination of what does and does not constitute a proxy under this
provision necessarily lies with the agency. However, we have an
obligation, in this and all requirements, to apply standards
consistently. Therefore, we have attempted to provide as many examples
and as much logic as possible to help States understand the standards
we will apply.
We respectfully disagree with commenters that the rule, as a whole,
moved away from statistical tests. States are still required to pass
the P1/P2 or B1/B2 test as applicable. The regulations finalized in
this rule are additive. Section 433.68(e)(3)(i) and (ii) rely on
straightforward comparisons.
Section 433.68(e)(3)(iii) is not a statistical test because the
novel element that paragraph (e)(3)(iii) introduces beyond the
straightforward comparison is an assessment of language. There is no
statistical test to determine whether an alternative description is
being used to circumvent the additional requirement to demonstrate a
tax is generally redistributive. However, although we anticipate many
cases will be clear, this does not make the assessment somewhat
subjective. As a result, we believe that the proposed approach offers
flexibility to States
[[Page 4816]]
while preserving the fiscal integrity of the Medicaid program.
We do not agree with the commenter that simply because the State
has had ``Medicaid proxy terminology'' in place for a long time, that
we should provide for some sort of waiver for this arrangement. First,
while we are not currently aware of any States that exploit the
loophole using proxy terminology to do so, States have not needed to
use proxy terminology as the current regulations permit direct use of
Medicaid terminology so long as the waiver passes the statistical test.
Next, States will have adequate periods of transition outlined in the
transition period of this final rule. In addition to the transition
period, we also issued a letter discussing the transition periods after
the enactment of the WFTC legislation. These transition periods are
described in greater detail in section II.D. We also believe that the
commenter may be misunderstanding what constitutes a prohibited proxy
methodology under Sec. 433.68(e)(3)(iii). The rule does not prohibit
States from adopting lower tax rates for provider groups that happen to
have lower Medicaid utilization--provided there is a legitimate public
policy reason unrelated to directing tax burden to Medicaid. For
example, many States exclude nursing facilities services provided by
CCRCs from nursing facility taxes based on non-Medicaid policy
considerations. If the commenter wishes to receive a definitive
assessment of their State's particular methodology, we will need to
review the specific arrangement in detail.
We agree with the commenter that States and CMS should look at the
entire tax program comprehensively when determining if a proxy is
present as defined by Sec. 433.68(e)(3)(iii). We believe that our rule
as proposed does this. We disagree with the commenter that there is a
``lack of standards'' or that this will lead to arbitrary applications.
While there does not, and cannot, exist a definitive set of elements
that need to be present for the proxy provision to apply, we believe
that the examples we have provided and the legitimate public policy
purpose standard we have laid out in the proposed rule gives States an
understanding of the rules that apply under this final rule and the
amendments made by section 71117 of the WFTC legislation. Finally, we
strive to consistently maintain equal treatment for all States, and we
generally take into consideration past precedents in determining future
action. We believe this approach provides a sound framework to prevent
arbitrary application of Federal legal requirements while preserving
necessary flexibility.
Comment: A few commenters urged CMS not to codify examples in
regulation text, in particular examples of impermissible taxes, as it
may lead to uncertainty or confusion.
Response: The aim of the examples provided in the proposed rule at
Sec. 433.68(e)(3)(iii) was not to provide a list of taxes that would
definitively be either permissible or impermissible. In general, we
would need to examine the specific tax in question to make a definitive
determination. Rather, these examples were intended to be illustrative
of the types of taxes that may serve as proxies versus those that may
not. We agree with the commenters that providing an exhaustive list of
such proxies would not be possible. For this reason, we have declined
to do so in this rule.
Comment: A commenter requested that CMS align the proposed rule
with the WFTC legislation, specifically by replacing ``any
characteristic that results in the same effect'' with ``any description
that results in the same effect.'' The commenter believed a
``characteristic'' of a tax design may be distinct from a
``description'' used within a tax design.
Response: We agree with the commenter's suggestion to align the
regulatory language with the language in the WFTC legislation that uses
the term ``description'' and not ``characteristic,'' and we are
finalizing that change. However, we do not believe that there is a
substantive difference between the word ``description'' as used in the
WFTC legislation and the word ``characteristic'' as used in the
proposed rule. In the health care-related tax waiver narrative letters
that States submit to us, they must describe to us the characteristics
of their various tax rate groups for CMS to make appropriate
determinations, so in practice these terms are functionally the same.
However, we wish to clarify that the word ``description'' does not only
include the words that the State uses in the letter but can also
include any supporting information or documentation that it provides to
us during our consideration of the health care-related tax in question.
As a result, whether the regulation contains the word
``characterization'' or the word ``description,'' the same result is
achieved. States may not circumvent the additional requirement to
demonstrate a tax is generally redistributive by using alternative
language to achieve the same prohibited result as explicitly
referencing Medicaid or its State-specific equivalent. To conform with
the language of the statute, we are finalizing the language of Sec.
433.68(e)(3)(iii) with a revision that replaces ``characterization''
with ``description.''
Comment: A commenter expressed concern that CMS identified teaching
hospitals for scrutiny as a tax rate group because they are defined
based on criteria that mirror Medicaid eligibility or other defining
characteristics.
Response: Section 433.68(e)(3)(iii) does not create a blanket
prohibition on States establishing separate tax rates for ``a
particular provider type that is associated with high Medicaid
utilization (such as State or other public facilities and university/
teaching hospitals.). It also does not suggest that these facilities
will be subject to any special scrutiny in and of themselves. The
``teaching hospital'' example in question would only be potentially
problematic if a State places a higher rate on these facilities than on
other facilities with relatively lower Medicaid utilization rates. This
is because one could conceive how ``teaching hospitals'' would
constitute a legitimate public policy purpose. States may continue to
impose relatively lower tax rates on these providers (with relatively
higher Medicaid utilization) or tax them at the same rate as other
providers. Additionally, we remind commenters that there may not be a
singular factor that will be dispositive of the existence of a proxy
for Medicaid. Rather, we will analyze all available information,
considering the overall design of the tax, provider classifications,
and the practical effect of the tax across provider types. The goal is
to ensure compliance with statutory and regulatory requirements--not to
penalize providers or States for permissible rate structures that
accomplish legitimate policy goals. We would likely need to examine the
commenter's State's specific situation before making definitive
determinations on the permissibility or impermissibility of any
specific arrangement related to a health care-related tax.
Comment: A commenter expressed support regarding the interpretive
leeway afforded to States and CMS' permission of certain instances of
proxy terminology discussed in the proposed rule's preamble.
Response: We appreciate the commenter's support. We agree that
these provisions afford States and CMS sufficient flexibility to
address the application of the provisions to specific situations.
Comment: A commenter indicated there is room for interpretation in
the provision and commended CMS for allowing this interpretive space
for nursing home provider taxes.
[[Page 4817]]
Response: We thank the commenters for their supportive feedback and
agree that this standard provides States with some flexibility.
Comment: Many commenters expressed concern regarding the lack of
clarity on the criteria used to determine legitimate public policies.
Several commenters urged CMS to provide additional information about
the process and criteria for defining legitimate public policy. Several
commenters recommended CMS allow greater flexibility in defining
legitimate public policy due to unintended ramifications the rule may
have on legitimate public policies that may not meet CMS' standards. A
commenter requested that CMS confirm that the definition of
``legitimate'' does not prescribe the nature, subject matter, or
rationale of a public policy for the purposes of Sec.
433.68(e)(3)(iii). Another commenter recommended that CMS revise the
rule to define a tax as generally redistributive if it serves a
legitimate public policy goal and suggested the specific factors CMS
described for considering this determination should be codified in
regulation.
Response: The term ``legitimate public policy purpose'' does not
appear in the regulatory text of Sec. 433.68(e)(3)(iii). Instead, we
introduced this concept in the proposed rule preamble to provide
helpful guidance to States in assessing when the provision may apply
because we have determined that the State is using a proxy methodology
to single out Medicaid. As a reminder, Sec. 433.68(e)(3)(iii) only
comes into play when two conditions are met. First, the State must
create taxpayer groups defined without explicitly referencing
``Medicaid'' in the description of the taxpayer groups but using a
proxy that nevertheless singles out Medicaid. Second, the State must
impose a tax on a taxpayer group that has the same effect as Sec.
433.68(e)(3)(i) or (ii). That is, there must be a higher tax rate on a
taxpayer group that serves a generally higher level of beneficiaries in
the Medicaid program. Acknowledging that inadvertent associations may
result from permissible tax structures requires the analysis to
determine whether the State is using a proxy methodology to single out
Medicaid. This provision was designed to strike the appropriate balance
between fiscal oversight and State flexibility. We provided several
illustrative examples of proxy descriptions that we believed may fall
within the scope of this provision. We stated, ``[o]ther possible
examples of tax rate groups that States may wish to give a tax break to
for policy reasons not related to directing higher relative tax burden
to the Medicaid program include psychiatric hospitals and rural
hospitals, among others.'' (90 FR 20589). We noted that States may want
to give breaks to these types of facilities for what we called a
``legitimate public policy purpose.'' We contrasted that with,
``grouping that does not appear to have a connection to a legitimate
policy purpose.''
Our intent is not to restrict States from offering any tax breaks
or exclusions to providers with relatively low Medicaid utilization, as
long as those decisions are based upon legitimate public policy
considerations; where they are, we anticipate that we would not
determine that the State is using a proxy in the manner prohibited by
Sec. 433.68(e)(3)(iii). However, if a State creates a tax rate group
that does not have a legitimate public policy justification and that
was created solely for the purpose of designing a health care-related
tax that exploits the Medicaid program, we may consider such a grouping
a proxy for Medicaid taxable units or utilization.
We do not believe that it would be possible to provide a
comprehensive list of ``legitimate public policy purposes'' as
suggested by the commenters. States may have a wide variety of
legitimate policy purposes in mind that relate to different State
circumstances. These factors could relate to differences in public
health priorities, State fiscal administration, or the health insurance
marketplaces in respective States. For example, some States may have
more tribal health considerations, others may have more rural health
concerns, others may have more urban health concerns. We have
frequently encountered differences among States regarding how they
spend money on their Medicaid programs, which programs they choose to
fund, in what amounts, and using what methodologies. We believe that it
would be overly prescriptive and not sufficiently respectful of States'
prerogatives and the principles of cooperative Federalism to provide
States with a list of such principles. Additionally, we generally defer
to States when judging the legitimate nature of their public policy
purposes unless we have specific reasons to question them. If a State's
justification is rational and does not appear to be designed to avoid
complying with a Federal requirement, we are likely to accept it. Our
goal is to ensure that health care-related taxes for which a waiver is
approved are generally redistributive in nature, as required by
statute. Within that framework we are committed to providing States
with as much flexibility as possible.
The use of the word ``legitimate'' is not meant to be a value
judgement on the sagacity of a State's choices in its public health and
other public policy priorities. We are aware that States have many,
often competing priorities within the State when it comes to their
Medicaid programs and serving their Medicaid beneficiaries. As the
entity that is generally more familiar with the local concerns, the
State has invaluable insight in determining its public health and other
public policy priorities. As a result, States are free to balance these
interests against one another and make decisions that are in the best
interests for their populations, provided that they stay within the
confines of Federal law and regulations. The term is intended to
contrast with a tax rate group created for the purpose of enabling the
State to circumvent the requirement to demonstrate a tax is generally
redistributive located at Sec. 433.68(e)(3)(i) and (ii).
We do not believe that ``legitimate'' requires a specified
definition in this context separate from its plain language meaning, as
we are using it descriptively rather than as a term of art. It is an
actual, real, not fictional, group that a State has a public policy or
public health reason to treat in a certain way. It is not something
contrived or spurious that has been concocted or fabricated for the
purpose of evading the requirements to be generally redistributive. We
also believe the preamble is the appropriate place for this discussion
and decline to adopt the commenter's suggestion to add the legitimate
public policy considerations to the regulation. We do not want to be
overly restrictive to States by adopting a special definition of what
``legitimate'' is. If CMS defined the term in regulation, this would
constrain States more than necessary. In order to preserve State policy
flexibility, we have decided to not include such a definition in the
regulatory text.
Comment: When considering if something is a ``legitimate public
policy'' purpose, a commenter suggested that CMS should focus on
allowing States to determine that a given provider tax structure
supports access, continuity of care, and Medicaid providers in
underserved areas. Another commenter suggested that States be allowed
to tailor tax rate groups specific to their State.
Response: We agree with the commenter that access to care is a
critical consideration for the future of the Medicaid program. In
addition, we agree with the commenter that, in certain instances,
access to care may be
[[Page 4818]]
a ``legitimate public policy purpose'' that the State uses to define
its tax rate groups. For that reason, we gave several examples of
providers that are critical in maintaining access to care in the
proposed rule, such as sole community hospitals and psychiatric
hospitals. In addition to access to care, States may have other
purposes such as quality of care and efficiency of care. These are just
a few of several legitimate public policy purposes that States could
point to in this situation. What matters is not what order the State
places for its healthcare or other public policy priorities, but that
the purpose itself is legitimate and not contrived for the purpose of
evading the requirement to demonstrate a tax waiver is generally
redistributive. Finally, we agree with the commenter that States often
may tailor tax rate groups in line with legitimate public policy
priorities specific to their State, provided they do not violate any
Federal requirements. States have considerable leeway in this matter as
long as they do not violate Federal statute and regulations.
Comment: A few commenters recommended CMS allow States to
demonstrate policies aligning with public policy goals and promoting
objectives of the Medicaid program.
Response: We appreciate the commenters' recommendation, which
aligns with our standard review practices. In cases where we have
questions or concerns about the tax rate for a specific tax rate group,
we would generally follow the approach suggested by the commenters and
provide States the opportunity to explain the rationale behind their
tax structure. If a State can demonstrate that its policy supports
legitimate public policy goals, certainly including Medicaid program
goals, and presents a clear and reasonable rationale, we will consider
this explanation when making its determination. Additionally, we note
again that there may be no one dispositive factor, but a combination of
multiple factors taken as a whole that are likely to guide our
determination on the applicability of Sec. 433.68(e)(3)(iii) to a
specific tax rate group. We encourage States to provide us with
detailed and relevant information that supports their position, while
avoiding unnecessary or excessive documentation that may not aid in the
evaluation.
Comment: Many commenters agreed with preamble language regarding
tax structures relevant to skilled nursing facilities, community
hospitals, intermediate care facilities, and rural hospitals that may
be permissible when designed to advance a legitimate public policy
purpose.
Response: We appreciate the commenters' positive feedback and
support. We attempted to provide a list of illustrative examples of
legitimate public policy purposes in the proposed rule. We are glad
that commenters found the examples helpful. Our goal was to clarify
that we do not intend to interfere with a State's efforts to promote
important policy objectives--such as supporting access to care in rural
areas or for populations with specialized needs--so long as those
efforts are not designed to circumvent Federal requirements. We will
continue to consider such legitimate policy goals when evaluating the
permissibility of health care-related tax structures.
Comment: Many commenters requested similar consideration for tax
structures relevant to a variety of facility and care types, including
safety-net hospitals, teaching hospitals, essential hospitals,
community health centers, emergency medical services, behavioral health
facilities, and children's hospitals. A commenter suggested that CMS
place these provider types in the text of the proposed rule as opposed
to the preamble only, which we presume meant placing the provider types
in regulation text as opposed to the preamble only.
Response: As we noted in the proposed rule, the examples provided
were intended to be illustrative only. They do not represent a
comprehensive or exhaustive list of permissible groupings. We remain
committed to work directly with States to evaluate their specific tax
structures. We encourage States to seek technical assistance early in
the process if they are unsure whether their proposed tax structure
could be affected by Sec. 433.68(e)(3)(iii). While the rule includes
illustrative examples of provider tax rate groupings, these were not
intended to represent a definitive list of ``permissible tax
groupings.'' Rather, the examples reflect groupings that we have
observed in the past and that, based on prior experience, generally
have not raised concerns under the standard described in Sec.
433.68(e)(3)(iii)--specifically, the prohibition on using tax rate
group descriptions as a proxy for low or high Medicaid taxable units or
utilization to circumvent the additional requirement to demonstrate a
tax is generally redistributive. In addition, the main focus of the
provision is not to provide examples of groupings that would be
permissible, but to provide a list of groupings that would likely be
impermissible if used as a proxy for Medicaid utilization. As a result,
we decline to include specific types of ``legitimate'' provider
groupings in the text of the regulation as suggested by the commenter.
Comment: A few commenters recommended CMS leverage their proposed
definitions to conduct a 1-year, data-driven analysis of current health
care-related tax revenue allocation. The commenters pointed out that
there is often a disconnect between the sources of non-Federal share,
including health care-related taxes, on the one hand and the programs
that the payment actually funds on the other. The commenter stated that
further study is needed in this area.
Response: We conduct oversight to trace the flow of funds from
health care-related taxes to the actual payment mechanisms that they
fund when reviewing State payment proposals. These include asking
States to tie their taxes to specific State plan amendments and State-
directed payments that are funded by the tax. In addition, we have
asked States to provide dollar amounts paid to providers funded by the
health care-related tax for which they are requesting a health care-
related tax waiver. However, while we support enhanced data collection
and payment transparency, the goal of the commenter to tie the sources
of funding more directly to the sources of non-Federal share is beyond
the scope of the present rule. We remain committed to close
collaboration with States and other interested parties to ensure
compliance with the regulation and to support transparency in how
health care-related taxes are designed and implemented.
As a result of the public comments, and based on section
71117(a)(1) of the WFTC legislation, which added the proposed language
of the regulation with limited changes as section
1903(w)(3)(E)(iii)(III) of the Act, we are finalizing Sec.
433.68(e)(iii) as proposed with the minor modification of substituting
``description'' for ``characterization.''
D. Permissible Health Care-Related Taxes--Transition Period (Sec.
433.68(e)(4))
We made every effort to ensure the impact of the proposed rule
would be limited to those health care-related taxes that exploit the
statistical loophole. Moreover, we understand that the updated
requirements proposed in previous sections of the proposed rule and now
finalized in this rule will require those States with such taxes to
modify or end them to prevent a reduction in medical assistance
expenditures eligible for FFP. Our aim is to close the loophole as soon
as possible, while acknowledging State
[[Page 4819]]
circumstances. Therefore, we proposed to provide a transition period
only for those States with currently approved tax waivers that exploit
the loophole that would be out of compliance with Sec. 433.68(e)(3)
that have not received the most recent approval within the past 2
years. We had also sought comment on various alternatives (discussed in
more detail later in this section), including whether to provide
different transition periods based on permissible class, or a
transition period that is longer than 1 year for taxes that qualify for
a transition period, or no transition period for all tax waivers that
exploit the loophole. We are finalizing alternatives to the proposed
transition periods to distinguish MCO taxes that exploit the loophole
from other permissible classes and to provide additional time, given
the relatively recent release of guidance, discussed in the next
paragraph.
On November 14, 2025, CMS released a ``Dear Colleague'' letter \23\
providing guidance to States on the provider tax provisions in the WFTC
legislation, including the transition periods for section 71117 the
Secretary was permitting, as authorized under the WFTC legislation.
This letter stated that tax waivers in the MCO permissible class would
have at least until the end of the State fiscal year that ends in 2026
to comply with the new requirements added by the WFTC legislation.
Taxes within all other permissible classes would have until the end of
the State's fiscal year that ends in 2028. We are finalizing policies
that in all instances provide as much, and sometimes more, time than
the transition parameters in the ``Dear Colleague'' letter. Table 1
sets forth the compliance dates (that is, the timeframe by which a tax
must comply), based on transition periods finalized under this final
rule:
---------------------------------------------------------------------------
\23\ Available at https://www.medicaid.gov/medicaid/downloads/providertax_dcl_11142025.pdf.
[GRAPHIC] [TIFF OMITTED] TR02FE26.001
Consistent with the other policies finalized in this rule, this
will not affect any non-loophole taxes. The transition period length
will be the length of time between the effective date of this final
rule and when the State's health care-related tax waiver that no longer
conforms to regulatory requirements would have to be modified or
discontinued to avoid a reduction in medical assistance expenditures.
The compliance date, in turn, represents the time after the transition
period, when a State must be in compliance. We proposed to determine
eligibility for a transition period based on the most recent approval
date of the waiver in which the State utilizes the loophole.
We invited comment on the length of time since a waiver was most
recently approved and the time of the transition period applicable to
those lengths of time, including whether the transition periods should
be shorter or longer, and specifically whether the lengths of the
transition periods should be adjusted to account for States that have a
2-year legislative cycle (see related discussion later in this
section). We also solicited comments on whether the final rule should
instead include transition period lengths for each category of State
waivers by permissible class, such as different lengths of time for
inpatient hospital taxes versus MCO taxes.
We also invited comments on whether different permissible classes
would be more or less burdensome to rectify a tax waiver that utilized
the loophole. We did not receive any comments on this request for
feedback. While we did not distinguish between MCO and non-MCO taxes in
the proposed rule, we did discuss as an alternative policy under
consideration whether different transition period lengths should be
given for MCO taxes and taxes on other permissible classes (90 FR
20591). Due to how interrelated many of the comments on this section
were, we respond to all comments received on the transition periods and
proposed alternatives at the end of this section.
First, we specifically proposed that States with health care-
related tax waivers that do not meet the requirements of paragraph
(e)(3), where the date of the most recent approval of the waiver that
violates paragraph (e)(3) occurred 2 years or less before April 3,
2026, would not be eligible for a transition period. Any collections
made under that waiver following April 3, 2026 could have been subject
to deduction from medical assistance expenditures as described in Sec.
433.70(b). For example, if a State's most recent approval for a tax
loophole waiver was received on December 10, 2024, under our proposal,
regardless of permissible class, the State's waiver would no longer be
valid on April 3, 2026 under this policy, because the effective date is
less than 2 years after December 10, 2024.
We did not propose a transition period for waivers with the most
recent approval date 2 years or less before the effective date of the
final rule for several reasons. States that fall into this category
obtained their most recent approval knowing that CMS intended to
undertake rulemaking in this area, as was communicated in a companion
letter with their approval. We recommended that impacted States
carefully consider how to mitigate or avoid possible challenges that
could result from rulemaking. Although this circumstance could be
administratively burdensome for States to address, an affected State
would have risked that burden by requesting the exploitative waiver,
and by not taking corrective action sooner, and with no guarantee of
any type of transition period. Under the policies finalized in this
rule, these taxes will now have a transition period that ends December
31, 2026. In other words, the tax would need to comply with the new
requirements by January 1, 2027. Disallowances for taxes that remain
noncompliant with the requirements of this final rule may have
associated revenues deducted from expenditures eligible for FFP,
starting with revenues collected on the first day
[[Page 4820]]
after the end of the transition period. As noted, for this first
transition period, that date will be January 1, 2027. As discussed
previously in this final rule, the transition periods finalized in this
rule, in all instances, either maintain or add to the transition
parameters in the ``Dear Colleague'' letter. This is also more generous
than the proposed rule, which proposed no transition period for these
taxes with recently approved waivers.
Second, we proposed that States with health care-related tax
waivers that do not meet the requirements of paragraph (e)(3), where
the date of the most recent approval of the waiver that violates
paragraph (e)(3) occurred more than 2 years before April 3, 2026, must
either submit a health care-related tax waiver proposal that complies
with paragraph (e)(3) with an effective date no later than the start of
the first State fiscal year beginning at least 1 year from April 3,
2026, or otherwise modify the health care-related tax to comply with
this rule and all other applicable Federal requirements with an
effective date not later than the start of the first State fiscal year
beginning at least 1 year from April 3, 2026.
Under this final rule, MCO taxes that exploit the loophole with
approvals more than 2 years before the effective date of the final rule
will still have until their first State fiscal year beginning at least
1 year from April 3, 2026, as proposed. For example, if a State's last
waiver approval for an MCO tax was more than 2 years prior to April 3,
2026, and the State's fiscal year begins April 1, 2026, the final day
of that State's transition period is March 31, 2027, and that State
would need to submit a compliant health care-related tax waiver, or
otherwise address the tax waiver's noncompliance, with an effective
date no later than April 1, 2027. The regulatory language we are
finalizing now reflects that this transition period is specific to MCO
taxes approved more than 2 years before the effective date of the final
rule.
We believe providing at least 1 full State fiscal year for MCO
taxes with a most recent approval of more than 2 years before the
effective date of the final rule is an appropriate timeframe for
several reasons. As discussed in the proposed rule, we considered that
past rulemaking that involved transition periods often had longer
transition times in consideration of States that might have biennial
legislative sessions. Out of all the affected States (that is, States
that have currently approved tax waivers that take advantage of the
statistical loophole and do not comply with paragraph (e)(3)), all
States have annual legislative sessions, which should give them
sufficient time for their respective legislatures to enact any
necessary changes. There is one State that has a biennial budget cycle,
and this State will receive a transition period of at least a full
State fiscal year. Also, we noted that Sec. 433.72(c)(2) specifies
that a waiver will be effective for tax programs commencing on or after
August 13, 1993, on the first day of the calendar quarter in which the
waiver is received by CMS. For instance, in the event of an April 1,
2026, effective date for the final rule, a State with a 1-year
transition period and a State fiscal year that begins July 1 would have
until September 30, 2027, to submit a waiver package with an effective
date of July 1, 2027. In this case, the State has nearly 3 extra months
to submit a compliant waiver. Depending on when a State's fiscal year
begins relative to this rule's effective date, a State eligible for the
transition period may have approximately 2 years to remedy a
noncompliant tax waiver under our policy.
We are modifying this final rule from the proposed to generally
align with (and in some cases, add to) the transition parameters in the
``Dear Colleague'' letter, consistent with alternative transition
policies discussed in the proposed rule. As reflected in Table 1, the
last category of taxes affected by this rule, non-MCO taxes, will have
until the end of the State fiscal year that ends in calendar year 2028
to bring their taxes into conformity with the new Federal requirements.
This maximum allowable time is different than the proposed rule and
consistent with what was communicated in the ``Dear Colleague'' letter.
Following the enactment of section 71117 of the WFTC legislation, when
deciding whether and in what capacity to grant a transition period
under the section 71117(c) authority, we determined it was appropriate
to provide additional transition period time for non-MCO tax waivers
that exploit the loophole. In our work with States to identify and
understand the taxes that exploit the statistical loophole, we have
found that the most egregious examples of shifting the burden of
financing Medicaid to the Federal government exist in MCO taxes. As
just one example, one approved MCO tax waiver that exploits the
loophole imposes a rate on Medicaid taxable units that is 117 times
higher than comparable commercial business. Conversely, a hospital tax
that exploits the loophole taxes Medicaid 3.5 times higher than
comparable commercial business. As such, CMS oversight prioritized
quickly identifying MCO taxes that appear to exploit the loophole, and
we have expressed concerns to States with such taxes, in most cases
before State implementation of the loophole tax. Consistent with CMS'
findings that MCO taxes are the permissible class of tax that most
commonly implicates the loophole, we believe that shorter transition
period for such taxes is necessary to allow States and CMS to remedy
the most egregious MCO-taxes.
We also stated in the proposed rule that States with new tax
loophole waiver proposals pending before CMS as of the effective date
of this final rule would not be eligible for a transition period. This
remains true in the final rule and is consistent with the transition
period policy discussed in the ``Dear Colleague'' letter. Additionally,
we note that after the July 4, 2025, enactment date of the WFTC
legislation, CMS does not have authority to approve taxes that use the
loophole closed by section 71117 of the WFTC legislation, and this
final rule. In the time since the proposed rule, we have received
another tax waiver request that proposes a tax that exploits the
loophole. We noted in the proposed rule that in the event that
additional States submit waivers that exploit the loophole, and these
waivers were approved prior to the effective date of this final rule,
CMS would issue a companion letter with their tax waiver approval
letter, and the State would not receive a transition period for its
tax. This recently received loophole tax waiver request is still
pending. As just noted, due to the passage of the WFTC legislation, CMS
is unable to approve the waiver. The waiver is also not eligible for
the transition periods that are being implemented via this final rule
or that are discussed in the ``Dear Colleague'' letter.
We previously signaled in the November 2019 proposed rule that this
is a policy area we wanted to address. As part of our standard health
care-related tax waiver approval letters of the broad-based and/or
uniformity requirements, CMS informs States that ``any changes to the
Federal requirements concerning health care-related taxes may require
the State to come into compliance by modifying its tax structure.''
Given that CMS has signaled it intended to address the loophole in the
November 2019 proposed rule, health-care related tax waiver approval
letters, and the proposed rule, we believe that States should be
sufficiently aware of our intent to make changes in this area and their
responsibility to adjust accordingly.
[[Page 4821]]
Furthermore, of the seven States with existing loophole waivers
that we have identified as of the date of the proposed rule, four have
been issued companion letters with their most recently approved tax
waiver letters, and all four waivers have approval dates within 2 years
of this final rule's effective date. These companion letters were
intended to formally notify these States that we viewed their tax
structures as problematic and intended to address the issue through
notice and comment rulemaking soon.
There are three States that have not been issued companion letters
that we expect to be affected by this final rule. Given CMS' actions
described previously in this final rule, we believe that they should
still be sufficiently informed through previous actions that signaled
our intent to address the loophole issue; moreover, we have
communicated with these States directly, as part of our standard
practice of offering technical assistance to States. These States also
will all be eligible for longer transition periods under the policies
finalized in this rule, with none receiving the shortest transition
period. Likewise, we are offering technical assistance to all States
that we anticipate might be impacted by this rule to ensure all are
aware of the requirements and timeframes and will be well positioned to
meet them.
Regardless of the length of transition period a State will receive
for its waiver, we will consider a tax waiver proposal to be in
compliance with the requirements in this rule if (and when) the tax in
question is generally redistributive as described in section
1903(w)(3)(E)(ii)(I) of the Act and Sec. 433.68(e). We note that the
proposal would also need to meet all other requirements for tax waiver
proposals and health care-related taxes in general, which still
includes the P1/P2 test and B1/B2 test, where applicable, in addition
to the new requirements in paragraph (e)(3). It does not mean CMS will
automatically approve a waiver renewal or amendment request. CMS will
still closely examine any renewals or amendments associated with taxes
that exploit the loophole for any other violations of statutory and
regulatory requirements, including hold harmless. CMS routinely
provides technical assistance to States prior to the formal submission
of a tax waiver proposal and would provide similar assistance to
affected States upon request.
Rather than ending health care-related tax waivers that do not meet
the requirements of this final rule and section 71117 of the WFTC
legislation, States are also permitted to adjust the taxes in question
in such a way as to be compliant with Federal requirements without
needing to submit a new tax waiver proposal. Specifically, States are
permitted to make the structure of a tax uniform, which would then not
require the submission of a new tax waiver (on the basis of uniformity;
a tax that is not broad based would still require a waiver). For
example, a State may wish to adjust its tax to be imposed on all non-
Federal, non-public entities, items, and services within a permissible
class and to be applied consistently in amount/rate across all taxable
units. The tax would also need to comply with the hold harmless
provisions specified at Sec. 433.68(f), but we would consider such a
tax to be broad-based and uniform, and it would not require a waiver at
all. CMS intends to monitor the individual circumstances of States that
would be affected by this rule to ensure that affected taxes have been
amended if we do not receive a new tax waiver request for review and
approval. As another example, a State could make a uniform change to a
tax, while still not making the tax uniform overall, without requesting
a new waiver. A uniform change might be a change to a tax that reflects
the same percentage tax rate change for every tax rate group of
providers. However, we note that based on the scale of the difference
in rates in loophole taxes, it may not remedy the loophole issue to
change the tax uniformly.
As stated, this rule is not intended to be disruptive to States'
health care-related tax programs. We acknowledge that this rule will
require some States to make changes, with different applicable
timeframes. However, we believe the rule will likely have a minimal
impact on the total amount of tax revenue States could collect because
a State's ability to collect taxes will remain unchanged. In other
words, affected States would have the opportunity to modify their
existing taxes to come into compliance with all requirements and
maintain the same or similar level of revenue collection, if that is
the State's policy choice. Further, it is possible that tax waivers
that exploit the loophole that are modified to comply with the proposed
rule would result in increased financial benefit to taxpayers that
serve relatively high percentages of Medicaid beneficiaries because
those taxpayers would no longer bear a disproportionate tax burden in
relation to taxpayers that serve relatively lower percentages of
Medicaid beneficiaries.
Finally, we proposed that, once the transition period for a tax
waiver that qualifies under paragraph (e)(4) has expired, CMS may
deduct from a State's medical assistance expenditures revenues from
health care-related taxes that do not meet the requirements of
paragraph (e)(3) as specified by section 1903(w)(1)(A)(iii) of the Act
and Sec. 433.70(b). Under Sec. 433.70(b), CMS can deduct from a
State's medical assistance expenditures, before calculating FFP,
revenues from health care-related taxes that do not meet the
requirements of Sec. 433.68. However, we assured States that payments
made with revenue collected during the transition period in accordance
with an approved existing tax waiver that exploits the loophole would
not be subject to disallowance on the basis of these new regulatory
requirements.
We proposed multiple alternatives to the transition period policies
proposed in this section. First, we proposed, alternatively, that
waivers that do not comply with proposed Sec. 433.68(e)(3) approved
within the past 3 years before the effective date of the final rule
would not receive a transition period. As compared to the proposed
policy, this 3-year period would include an additional, currently
approved tax waiver that exploits the loophole, for a total of five
loophole tax waivers that would not receive a transition period,
instead of four waivers. We did send a companion letter with the most
recent approval for this additional loophole tax waiver, so under this
alternative transition period, all States with loophole tax waivers
that would not receive a transition period still would have received a
companion letter expressly notifying the State of our concerns about
its tax structure with the most recent waiver approval. We further
proposed, alternatively, to extend this either 2 or 3-year timeframe
since the last approval as may be needed in the final rule to capture
the four most recently approved loophole tax waivers (if we finalized a
2-year transition period) or five most recently approved such waivers
(if we finalized a 3-year transition period), to ensure that these
specific waivers (with which most recent approval we sent the State a
companion letter) do not receive a transition period. Finally, we
considered an alternative to our proposal of no transition period for
more recently approved loophole tax waivers and a 1-year transition
period for loophole tax waivers with longer-standing most recent
approvals. Specifically, we alternatively proposed to offer no
transition period for any loophole waiver, regardless of the time since
the most recent approval of the waiver. Next, we alternatively proposed
that loophole waivers approved in the 2
[[Page 4822]]
years (or 3 years) before the effective date of the final rule would
receive a 1-year transition period instead of no transition period, and
the longer-standing most recent waiver approvals (more than 2 or 3
years before the effective date of the final rule) would receive a 2-
year transition period. We discussed previously the transition periods
outlined in the ``Dear Colleague'' letter, as well as the modified
transition timeframes provided to States for their waivers to come into
compliance with the new Federal requirements under this final rule.
We invited comments on the transition periods, including whether
any of the proposed cutoff timeframes and/or transition period lengths
should be shorter or longer. We also invited comments on whether any of
the policies in the proposed rule would be disruptive to existing State
tax waivers that do not exploit the statistical loophole. The following
is a summary of the public comments on the proposed transition periods
and our responses:
Comment: Almost all those who commented on the transition period
section did so to indicate that the transition periods were
insufficient. Many of these commenters also disagreed generally with
the proposed bifurcation of transition periods. Several commenters
stated that the proposed transition periods seem arbitrary and do not
provide adequate time for States to transition. A few commenters stated
the transition period must minimize harm to providers and Medicaid
beneficiaries. Several commenters recommended a transition period that
provides States with a reasonable or adequate amount of time to comply
with the proposed requirements. Many commenters that requested CMS
provide longer transition periods, such as the 3 years authorized in
the WFTC legislation, pointed to prior transition periods CMS had
afforded to States. A few commenters pointed to the DRA of 2005 and
suggested CMS adopt a similar 48-month compliance period. A few
commenters stated that CMS had historically incorporated longer
transition periods such as a 10-year phase out of pass-through payments
from 2016 through 2027. A few commenters stated that CMS had provided
3-year transition periods in last year's Medicaid managed care final
rule regarding State-directed payments. A few commenters stated that
when CMS changed its method of calculating upper payment limits in
2001, CMS provided transition periods of 3, 5, and 8 years depending on
the length of time a State had its approved amendments in place. A few
commenters suggested varying lengths of time such as a 5-year
transition period. A commenter recommended a 10-year transition period
and a commenter recommended a 3- or 4-year transition period.
Many of these commenters stated that without longer transition
periods, States would be unable to revise their provider tax
structures, resulting in reduced provider services and reduced access
to care for beneficiaries. Several commenters stated that the financial
stability of hospitals and hospital services would be impacted, and a
few commenters specified that safety net hospitals would be
particularly affected by the proposed rule. Commenters stated that the
financial pressure would lead States to implement changes that
adversely impact Medicaid beneficiaries and providers, such as
restricting Medicaid coverage, and cutting services and programs. Some
commenters that expressed concern about how this would affect hospitals
and nursing homes stated it would be particularly felt in rural areas.
Response: We understand the concern about the length of time
affected States will have to remedy their tax structure to no longer
exploit the loophole. However, as we described in the proposed rule, we
want to emphasize again here that impact of this rule is on a narrow
subset of taxes that collect revenue via a structure that is not
generally redistributive. The circumstance with this policy is distinct
from other transition periods referenced by commenters, which were
implemented as the result of large programmatic changes. In contrast,
with this final rule, we are amending the statute to align with the
text and intent of section 1903(w)(3)(E)(ii)(I) of the Act rather than
implementing a significant change to Medicaid. The tax waivers that
exploit the loophole and do not comply with the provisions of this
final rule were inconsistent with the statute requiring taxes for which
waivers are approved be generally redistributive in nature both before
the amendments made by section 71117 of the WFTC legislation, and
explicitly so after.
We also note there was nothing preventing a State from undertaking
the necessary steps to change its tax. If a State chooses to reduce
payments or services in response to this rule, then that State is
making that choice knowingly in the face of other options. Nothing
about this rule changes the ability of a State to collect revenue;
rather, the rule ensures that a State's tax meets the statutory
definition of ``generally redistributive'' as provided in section
1903(w)(3)(E)(ii)(I) of the Act. However, as discussed previously in
this rule, we are finalizing transition periods that provide States
additional time from what was proposed. We note that we do not have
statutory authority, under section 71117 of the WFTC legislation, to
provide for any transition period over 3 fiscal years in duration, as
was suggested by some commenters.
Comment: A few commenters recommended extending the transition
period to 3 fiscal years to ensure adequate time is given to phase out
non-compliant taxes without jeopardizing the stability of the Medicaid
program, continuity of care and affordability of commercial coverage.
The commenters stated that when adjusting tax programs to be compliant,
States will have to increase tax rates for commercial health plans,
which will increase premiums for individual market coverage. One such
commenter stated that these increased tax assessments could result in
insufficient premium rates that could place financial strain on health
insurers and reduced health plan availability. The commenters opined
that by allowing 3 years, States will be able to align changes to
commercial plan taxation with individual and employer market rate
cycles and avoid market disruption. The commenters stated that without
sufficient transition, 2026 premium rates could be insufficient and
lead to reduced health plan availability, with a commenter noting that
insurers and State regulators are now finalizing 2026 premium rates in
various markets. A few commenters suggested more generally that a
transition period should be adequate to accommodate rate setting cycles
and avoid disruptions to consumers in insurance markets in affected
States.
Response: We appreciate the important and constructive feedback of
the commenters who shared their concerns and experiences with us. We
want to emphasize the assurance we provided in the proposed rule that
this rule is narrowly tailored to affect only those State taxes that
exploit this loophole and thus harm the stability of the Medicaid
program. We further want to emphasize that all States impacted by this
rule have engaged in this practice knowing it was not aligned with the
intent of the Medicaid program and with awareness that we intended to
remedy the situation, either due to the issue arising in prior
rulemaking, or because we communicated with them directly about this
during the most recent waiver approvals.
While we understand that the amendments in this final rule may not
be ideal from the perspective of some interested parties, the
``generally
[[Page 4823]]
redistributive'' requirement is written in statute, and taxes that
exploit the loophole discussed in the proposed and this final rule fail
to meet this requirement. Furthermore, the many States and taxes that
do not exploit the loophole serve as evidence that exploiting the
loophole is not necessary to run a Medicaid program. As the Federal
steward of Medicaid, we must ensure that all health care-related taxes
comply with the Medicaid statute. In recognition of the changes that
certain States will need to make to their taxes and the potential time
required to implement those changes, we are finalizing transition
policies that are more generous than those described in the proposed
rule. Otherwise, we are finalizing the policies proposed, apart from
minor wording changes, in order to protect the fiscal stability of
Medicaid.
Comment: We received numerous comments regarding the authority for
the Secretary to grant a transition period of up to 3 years in section
71117(c) of the WFTC legislation. Several commenters stated that
allowing a transition period for States with waivers approved 2 years
or less before the final rule's effective date was aligned with
Congressional intent and specifically stated the WFTC legislation.
Several commenters stated that anything other than alignment with the
WFTC legislation for State transition periods would cause confusion and
distress for hospitals, providers, and beneficiaries. A commenter added
that the WFTC legislation did not contemplate the immediate termination
of currently approved taxes. Many commenters requested that CMS use its
authority under the WFTC legislation to afford all States with a
transition period. A few of these commenters stated that aligning the
transition period in the proposed rule with the transition period
described in the WFTC legislation would provide States with a clear and
consistent transition period, ensure complete compliance, and avoid
serious budget impacts to those States with more recent waiver
approvals.
Response: When the WFTC legislation was enacted on July 4, it was
after the proposed rule had been published on May 15. The nearly exact
overlap in language between the proposed regulations and the bill text
demonstrates the legislative intent for the bill to align with what we
had proposed. As such, we want to draw commenter attention to the
specific language of section 71117(c) of the WFTC legislation, which
states ``subject to any applicable transition period'' (emphasis
added). This language is not a requirement to establish a particular
transition period, but merely the authority to do so. Section 71117(c)
of the WFTC legislation goes on to state that the transition period is
``not to exceed 3 fiscal years,'' rather than stating that the
transition period must be 3 years. If we were required to provide 3
years, the plain text of section 71117(c) of the WFTC legislation would
have reflected this intent. Instead, Congress granted the Secretary
discretion to determine an appropriate transition period to be afforded
to States.
As previously discussed, on [DATE], we circulated a letter to our
State colleagues describing the transition period the Secretary was
granting under the authority in the WFTC legislation, of at least
through the end of the State's fiscal year that ends in 2026, and more
in some instances. Our intent with the letter was to provide prompt
notice to States about the minimum transition period the Secretary
would offer under the WFTC legislation, while allowing us to finalize
the transition period via the rulemaking process. There still remains
the urgent need to make sure tax waivers no longer exploit the
loophole. Therefore, we are finalizing that all affected health care-
related taxes that exploit the loophole with waivers approved before
July 4, 2025, will receive a transition period, and the length of that
period will depend on the permissible class taxed and the length of
time since the most recent waiver approval for that tax.
Comment: A few commenters stated that more time was needed so that
States could obtain detailed technical assistance and guidance from CMS
on the interaction between the proposed rule and the WFTC legislation.
These commenters pointed out a potential conflict in which the proposed
rule allows States to modify their provider taxes, but the moratorium
in section 71115 of the WFTC legislation may prevent States from
modifying their existing provider taxes. A commenter stated a longer
transition period would allow States to obtain more guidance from CMS
about what is permissible under the proposed rule.
Response: States with loophole taxes that need to modify their tax
will be able to do so without violating section 71115 of the WFTC
legislation, provided that the tax meets all Federal statutory and
regulatory requirements. Section 71115 of the WFTC legislation
generally prevents new or increased provider taxes that would cause tax
collection for a permissible class in a State to exceed the new
indirect hold harmless threshold, but it does not prevent
modifications. Moving forward, States will be able to adjust their
taxes so long as they do not exceed the relevant tax collection limits.
Therefore, we do not currently see a need for technical guidance on the
interaction between these provisions, as they are not strictly in
conflict.
Comment: Many commenters who recommended the need for a longer
transition period cited the insufficiency of notice to affected States
as a basis for this need. A few commenters stated that the companion
letters sent with recent waiver approvals to States were insufficient
notice for the proposed rule's provisions. Some of those commenters
went on to say the letter indicated only an intent to develop new
regulatory requirements but that those requirements were not specified.
Other commenters stated that the companion letters were inconsistent
with principles of fair notice and regulatory consistency. In their
view, all States are informed at the time of approval that future
Federal law changes may require prospective revision. Also, in their
opinion, these documents did not provide the minimum necessary
information States needed to make informed decisions, such as the
possibility that CMS would not honor the already approved waiver
timeframe, allow a transition period, or explain what States would have
to do to bring the taxes into compliance if Federal legal requirements
changed. Furthermore, some of these commenters added that setting these
issues aside, those letters were not broadly disseminated to the
public, so interested parties were not provided notice or an
opportunity to comment.
A few commenters stated that the 2019 proposed rule is also
inadequate notice to States that CMS intended to propose this rule due
to the eventual withdrawal of the 2019 proposed rule and the amount of
time that has passed since its publication. A few commenters stated
that States could not have known when and exactly how CMS would update
its statistical tests and the related regulatory criteria to assess
provider tax waiver requests. A commenter stated that pointing to a
proposed rule from years earlier that was not finalized is not adequate
or appropriate regulatory guidance.
Some commenters offered suggestions for how to mitigate the issue
of notice to States. A commenter recommended waivers already in place,
approved with or without companion letters, should remain active
through the end of the transition period. A commenter stated that at a
minimum, CMS should honor already approved waivers. A commenter also
recommended CMS inform States if
[[Page 4824]]
they have tax structures out of compliance after the finalization of
this rule.
Response: We disagree with the commenters that noted that States
have not had sufficient notice as to how we would address the loophole.
As described previously in this final rule, we have communicated to
States that we have intended to address the loophole, and we are
finalizing this policy through notice and comment rulemaking. Between
the proposed rule, the comment process, and the subsequent publication
and delayed effective date of the final rule, we have met our
obligations for notice and comment rulemaking. However, we do
acknowledge that there are times we have delayed implementation, and
often this is to mitigate administrative burden on States needing to
make changes. For example, in the 2024 Ensuring Access to Medicaid
Services final rule, we delayed implementation on many provisions, at
different times, in recognition of the number of new requirements
States would need to address and develop processes to implement in a
rule of that scale. That is not the case in this final rule.
This rule finalizes a policy that reflects the conceptual basis
that a tax must be generally redistributive. We emphasize again that
this rule only affects a few States and their taxes. We also believe
that the 2019 proposed rule, although not finalized or identical to
this rule, provides a clear signal of our intent and our view that a
tax is problematic if it is not generally redistributive within the
meaning of the statute, even if it passes the B1/B2 test. It is not new
information that we are announcing in this rule that those practices
are not aligned with statutory intent, which has been made even plainer
by the amendments made by section 71117 of the WFTC legislation.
Apart from issuing the companion letters to the States with the
most recent approvals, we also discussed with them prior to the
issuance of the approval that the tax exploited the loophole. We
further note that, when the shortest transition periods granted in this
final rule expires, States will have had almost a year or more than a
year since the proposed rule, and nearly 9 months since the passage of
the WFTC legislation.
In response to commenter concern, we want to assure that currently
approved waivers for loophole taxes will remain in force and effect
until the expiration of the applicable transition period. However, we
want to further clarify that some tax waivers themselves do not
currently have a specified expiration date that we would otherwise
honor. We further note that we cannot honor an approved waiver, despite
the fact that the waiver does not by its own terms specify an
expiration date, if the waiver becomes inconsistent with Federal law
due to subsequent statutory and regulatory changes. We also want to
confirm that we intend to affirmatively notify (or more accurately, re-
notify) affected States, and work closely with them to ensure timely
compliance.
Comment: A few commenters agreed with CMS and stressed that States
have had adequate notice and time to prepare for compliance. One such
commenter went further to say no States should have a transition
period. The commenter also stated that any delay in finalizing the
proposed rule would allow further loophole utilization and qualify more
States for the transition period than currently estimated. A few
commenters expressed general support for having no transition period
and immediately implementing the rule. A commenter stated their belief
that no transition period would benefit the most vulnerable Medicaid
populations.
Response: We appreciate the support of commenters. While we believe
it may have been possible and appropriate not to offer a transition
period, and proposed this as an alternative, we determined it would be
most beneficial for all involved to focus on the most recent and most
egregious tax waivers first. Although the passage of WFTC legislation
addressed the concern about delays expressed by the commenter, we do
note that in the proposed rule we addressed and accounted for no
transition period for additional waiver submissions.
Comment: Several commenters appeared to share the same
misunderstanding that CMS intended to apply these new policies
retroactively. Several stated that it is common practice for tax
``collections'' to occur months (if not years) after a provider owes
the tax. Thus, these commenters stated that the rule would penalize
these States for not complying with requirements that were not in place
at the time their waivers were approved, and it would effectively apply
new regulatory requirements retroactively. A few commenters stated that
CMS lacks the statutory authority to impose the proposed requirements
retroactively, as section 71117(c) of the WFTC legislation requires CMS
to apply them prospectively. In addition, a few commenters stated that
the retroactive application they perceived in our proposed rule was not
legally permissible under the APA, that it would be arbitrary and
capricious under 5 U.S.C. 706(2)(A), and that it would compromise
principles of fair notice, regulatory consistency, and good-faith
reliance. In addition, a few commenters stated that while the US
Supreme Court upheld a retroactive tax statute in United States v.
Carlton, 512 U.S. 26 (1994), CMS cannot retroactively apply the
proposed requirements as they fail both prongs of the Carlton test. A
commenter stated that disallowing FFP for uncollected taxes would
invalidate actuarial certifications. A commenter requested that
financial penalties only apply to collections for taxes incurred after
the effective date of the final rule, not retroactively. The commenter
requested that CMS consider language that would limit the application
of the penalty to collections of taxes incurred for those periods that
occur after the effective date of the final rule.
Response: We want to clarify that the policies described in this
rule will not be applied retroactively, nor did we propose that they
would. The penalties will be imposed for revenues collected after the
date by which a State needed to have its tax in compliance, which would
be no earlier than the first day after the State fiscal year that ends
in 2026. Even if the collection itself occurs later under the State's
usual tax revenue collection processes, if the collection was made in
accordance with a tax that was permissible with respect to the time
period for which the revenue is being collected, it would not violate
this requirement. Therefore, we would not penalize that collection. For
example, if a State collects tax revenue from providers in July 2026,
after the effective date of the final rule, and the revenue collected
is for taxable activity that occurred during the State's FY 2025, this
would be permissible, as the tax was permissible at that time, before
the effective date of this final rule.
We are concerned that several, discrete comments had the same
incorrect interpretation that we intended to apply these requirements
retroactively. We intend to work closely with affected States to
determine if and why they believe a penalty, if applied, is
retroactive, to clarify the effect of the final rule, as may be needed.
Although we did not propose nor intend to apply these policies
retroactively, we do not have full knowledge of all State revenue
collection practices, and we welcome any additional information or
requests for assistance.
Comment: A number of commenters opposed to the proposed transition
periods referenced the specific need for State legislatures to have
more time to act. Per these commenters, a truncated transition period
fails to recognize the significant operational, regulatory, and
[[Page 4825]]
legislative challenges States face in modifying complex tax and
financing structures. These commenters added that changing these tax
structures requires legislative action and time for the State
legislatures to act. However, because the effective date of the rule is
tied to the date when CMS finalizes the rule, these States may or may
not qualify for a transition period depending on if/how quickly CMS
finalizes the rule. Furthermore, they add, even if a State does qualify
for the transition period, the effective date could fall in the middle
or very close to the end of their fiscal year cycles when their
legislatures are not in session. Therefore, some State legislatures may
not have time to adjust to avoid the financial shortfall or find
adequate alternative funding streams. Some commenters stated that this
is particularly concerning for States with limited legislative
calendars whose legislatures meet biannually.
Similarly, several commenters stated that the transition periods in
the proposed rule would not be sufficient to allow time for States to
work with CMS, their respective legislatures, and interested parties to
gain support and approval of revised funding mechanisms. Several
commenters believed that longer transition periods were needed for
States to navigate the complex fiscal and operational challenges
involved in revising their provider taxes. A commenter stated that a
voter referendum may be needed to require and implement the use of
provider taxes. A commenter believed that the variation in State budget
cycles underscored the need for an adequate transition period. Other
commenters added that State agencies may also need to change their
regulations, which will require engagement with interested parties, and
time for drafting and commenting.
Response: We note that nearly every State affected by this rule has
a legislature with an annual legislative cycle. We have also seen many
cases where State legislatures convene special sessions to address
urgent and pressing matters. Although we do not believe this situation
will require States to convene special sessions, as States have been
aware of the issue and could plan for this outcome, we realize that
some States may end up in this position by choosing not to bring their
loophole taxes into compliance with the new Federal requirements by the
end of the applicable transition period under this final rule. We do
not believe it is appropriate to continue this drain on the fiscal
integrity of the Medicaid program by allowing ongoing cash windfalls to
States so they can address this during a more relaxed schedule. We
believe that the transition periods afforded in this final rule should
provide sufficient time for States to adjust their health care-related
taxes as needed.
Comment: Many of the general comments regarding the transition
period section disagreed with treating certain States differently on
the basis of how recently their waivers were approved, and stated that
there should be transition periods for all affected taxes. Many
commenters opined that the proposal to deny a transition period to some
States was disproportionately burdensome for the affected States.
Several commenters stated that CMS should provide all States with a
transition period because treating States differently based on the date
of approved waivers would be arbitrary, capricious, and unfair, with
one saying it penalized those States unfairly for a policy that was not
yet in place. Another commenter stated that it would be equitable for
CMS to provide all States the same transition period. A few commenters
stated that denying a transition period to some States lacked a
rational basis grounded in program design or policy impact. A few
commenters stated that States acted in good faith when they received
CMS approval for tax waivers and current policy structures allowing
their provider tax structures. These commenters believe the relevant
States should not be penalized with no transition period.
Response: The States that are receiving the shortest transition
periods are not situated the same as those that are receiving more
time. The States with shorter transitions have all received companion
letters with their most recent approvals, and we engaged directly with
these States during the waiver approval process about the loophole
issue. These companion letters were intended to document formal notice
to these States that we viewed their tax structures as problematic and
intended to address the issue through future notice and comment
rulemaking. However, as mentioned, before the issuance of the most
recent approvals and the accompanying companion letters, we were
communicating directly with those States about our concerns. Those
States nevertheless made the decision not to modify or withdraw the tax
waivers to ensure the ongoing cash windfall from the Federal
government. Moreover, the most recent approvals have had the current
revenue levels in place the least amount of time, and some are the
result of new taxes or massive increases that greatly magnified the
negative impacts of these loophole taxes and fundamentally altered the
revenue a State would anticipate receiving. At no point in time have
these States operated under the impression that the current funding
levels were permissible or protected against imminent CMS action. It is
for that reason we did not propose a transition period for the most
recent waiver approvals. However, while we still stand by this
reasoning, we have amended the transition periods in this final rule by
giving a short transition period to those tax waivers that would have
received none under the policy described in the proposed rule, to align
with the ``Dear Colleague'' letter, which served to give a measure of
certainty regarding the transition periods to States while CMS
completed this rulemaking process. We believe that aligning the
duration of the transition periods in this final rule with those of the
periods described in the ``Dear Colleague'' letter serves the best
interests of the Medicaid program because alignment will help prevent
potential confusion.
Comment: Many commenters expressed a need for more time
specifically for those States that would not receive a transition. They
cited reasons such as the length of time required to unwind or revisit
existing tax structures and provider payment policies. These commenters
stated that to develop provider tax or financing alternatives, it would
take time to engage in interested parties' negotiations and obtain
legislative approval as well as approval from CMS. A few commenters
stated that not allowing a transition period would negatively impact
non-Medicaid interested parties, too. A commenter stated that affected
States may make hasty and suboptimal tax changes to ameliorate the lost
funding, and that these changes could lead to higher commercial
insurance premiums for individuals and employers. Another commenter
stated that due to the reductions in Medicaid reimbursement rates, some
providers may offset the financial losses by increasing the payment
rates they charge to commercial plans and Medicare.
A few commenters stated that the proposal to deny a transition
period to States with waivers approved 2 years or less before the final
rule's effective date was particularly arbitrary considering that
States do not know if or when CMS will finalize the rule. In their
opinion, this would require States to preemptively dismantle, or
redesign approved programs when the final contours of Federal policy
are unknown. Some commenters similarly stated that
[[Page 4826]]
it is unreasonable for CMS to expect that States should have already
redesigned their tax programs to comply with requirements that are not
yet defined.
A few commenters stated that not allowing a transition period
unjustly puts these States in an extremely precarious financial
position, as they would experience sharp budget shortfalls with serious
and immediate impacts on their Medicaid programs and State budgets.
They added that these States are at a major disadvantage because their
waivers would be immediately out of compliance and the corresponding
funding subject to deductions until they make the necessary changes.
Response: As we stated in the proposed rule, it has been incumbent
upon States to assess the risk of having a waiver deemed prospectively
impermissible when determining whether to submit or proceed with a
waiver request that exploits the loophole. The companion letters also
made clear that we intended to act, but did not indicate there would be
any type of transition period, so there was no reason a State should
have chosen to maintain its exploitative tax structure on the belief of
time to transition. The time to transition has already been occurring.
To the extent this change results in a budget shortfall for a State, it
will be the result of that State's budget being reliant on an
inequitable funding stream from the Federal government, inconsistent
with the statutory purpose and design. However, we also note that under
the ``Dear Colleague'' letter and the transition periods adopted into
this final rule affected States will have a transition period of a
duration that is at least until the end of their respective State
fiscal year that ends in calendar year 2026 whereas, under the proposed
rule, we proposed that certain States would receive no transition
period.
Comment: Many commenters stated that provider taxes are a critical
source of funding for States. Additionally, because some affected
States use or planned to use funds associated with tax waivers that
exploit the loophole to increase payment rates for some providers/
services, future provider reimbursement would likely be lowered. They
stated this would be detrimental for the affected providers not only
due to the loss of future funds, but also because they relied on the
current or anticipated rate increases and have already made long-term
decisions on staffing, equipment, and service capacity. Per these
commenters, taken together, the cascading effect of an inadequate
transition time would lead to State changes that introduce significant
uncertainty and operational disruptions into Medicaid programs, and
that will hinder access to care for Medicaid beneficiaries. In the case
of a 1-year transition period, commenters expressed similar concerns,
but also noted that payments are already unsustainably low, and this
change would reduce them even further.
Several commenters stated that it was justifiable for States to
rely on CMS honoring the waiver approval timeframe, and that States
made meaningful budgetary and programmatic decisions accordingly. These
commenters stated that these States' reliance on CMS' approval is no
less valid simply because their waivers were approved more recently.
Response: We acknowledge that in many cases, the revenue generated
from a tax and bolstered by the increased burden on the Federal
government's share of Medicaid is used to fund additional payments to
providers. However, it is the responsibility of the individual States
to come into conformity with new Federal requirements under this final
rule and the amendments made by the WFTC legislation, in a manner that
is the least disruptive to their individual circumstances. Finally, we
note again as discussed in a previous response that some waivers do not
have an approval timeframe. They are open-ended approvals, where a new
waiver is only required if a State wants to make a non-uniform change
to the tax or if necessary to conform the tax to newly applicable
Federal legal requirements. Therefore, in these cases there is not a
waiver approval timeframe for us to honor. Any promises or assurances
as to the timeframes for payment rates would be from States to
providers.
Comment: A commenter suggested that if CMS decided to include a
longer phase-out period for those States that did not receive separate
companion letters, but whose waivers were approved in the last 3 years,
that these States should immediately stop using funds for ``FFP.'' This
commenter also recommended a 1-year transition period for provider
taxes approved more than 3 years ago.
Response: We appreciate the suggestion. As we understand it, the
commenter was suggesting the transition period apply only with respect
to the requirement to change the tax structure, such as by submitting a
new waiver, but the State would not be permitted to use the tax revenue
as its non-Federal share in the interim. Although we would support the
goal to end the burden on the Federal government caused by the tax
waiver that exploits the loophole as soon as possible, we believe it
would add a layer of administrative complexity and furthermore, we did
not propose or otherwise contemplate this approach in the proposed
rule. Therefore, we are not adopting this change.
Following review of public comments, we are finalizing the
transition periods with modifications described.
III. Collection of Information Requirements
Under the Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3501 et
seq.), we are required to provide 60-day notice in the Federal Register
and solicit public comment before a ``collection of information,'' as
defined under 5 CFR 1320.3(c) of the PRA's implementing regulations, is
submitted to the Office of Management and Budget (OMB) for review and
approval. To fairly evaluate whether an information collection should
be approved by OMB, section 3506(c)(2)(A) of the PRA requires that we
solicit comment on the following issues:
The need for the information collection and its usefulness
in carrying out the proper functions of our agency.
The accuracy of our estimate of the information collection
burden.
The quality, utility, and clarity of the information to be
collected.
Recommendations to minimize the information collection
burden on the affected public, including automated collection
techniques.
In the proposed rule, we solicited public comment on each of the
aforementioned issues for the following sections of the rule that
contained collection of information requirements. We did not receive
such comments, and therefore, are finalizing the burdens in this rule
as proposed, with minor modifications to account for additional
waivers.
A. Wage Estimates
To derive average costs, we used data from the US Bureau of Labor
Statistics' (BLS') May 2024 National Occupational Employment and Wage
Statistics for all salary estimates (https://www.bls.gov/oes/tables.htm). In this regard, Table 2 presents BLS' mean hourly wage,
our estimated cost of fringe benefits and other indirect costs
(calculated at 100 percent of salary), and our adjusted hourly wage.
[[Page 4827]]
[GRAPHIC] [TIFF OMITTED] TR02FE26.002
As indicated, we adjusted our employee hourly wage estimates by a
factor of 100 percent. This is necessarily a rough adjustment, both
because fringe benefits and other indirect costs vary significantly
from employer to employer, and because methods of estimating these
costs vary widely from study to study. Nonetheless, we believe that
doubling the hourly wage to estimate total cost is a reasonably
accurate estimation method.
B. Collection of Information Requirements
The following sections of this rule contain collection of
information requirements (or ``ICRs'') that are or may be subject to
OMB review and approval under the authority of the PRA. Our analysis of
the requirements and burden follow. For this rule's full burden
implications, please see the Regulatory Impact Analysis under section
IV. of this preamble.
1. ICRs Regarding General Definitions (Sec. 433.52)
We do not anticipate that any of the definition changes (adding and
defining ``Medicaid taxable unit,'' ``non-Medicaid taxable unit,'' and
``tax rate group'') will result in the need for States to amend
existing or create new State Plan or policy documents. Consequently,
such changes are not subject to the requirements of the PRA.
2. ICRs Regarding Tax Waiver Submissions (Sec. 433.68)
The following changes will be submitted to OMB for approval under
control number 0938-0618 (CMS-R-148).
Under the current regulations, States may submit a waiver to CMS
for the broad-based requirements (all providers within a defined class
must be taxed) and/or the uniformity requirements (all providers within
a defined class must be taxed at the same rate) for any health care-
related tax program which does not conform to the broad based or
uniformity requirements under Sec. 433.68. For a waiver to be approved
and a determination that the hold harmless provision (for example,
guaranteeing to repay taxpayers the cost of the tax) is not violated,
States must submit written documentation to CMS which satisfies the
quarterly reporting and recordkeeping requirements under Sec.
433.74(a) through (d). Without this information, the amount of FFP
payable to a State cannot be correctly determined.
Uniformity Requirements Waiver: A State must demonstrate that its
tax plan is generally redistributive by calculating the ratio of the
slopes of two linear regressions, generally resulting in a value of 1.0
or higher. Under the changes in this final rule, States will still need
to demonstrate this calculation, and the waiver proposal must reflect a
tax that is generally redistributive under the requirements in new
paragraph Sec. 433.68(e)(3) (entitled, ``Additional requirement to
demonstrate a tax is generally redistributive'').
This rule addresses an inadvertent regulatory loophole related to
the current statistical test to ensure that taxes passing the test are
generally redistributive. The loophole essentially allows States to
shift the cost of financing the Medicaid program to the Federal
government. As indicated in section II of this preamble, this rule
finalizes our proposed policy to close the loophole in the statistical
test by:
Prohibiting States from explicitly taxing Medicaid units
at higher tax rates than units of other payors.
Prohibiting State gaming through ``proxy'' terminology.
Including a transition period for States with existing
loophole taxes.
We anticipated in the proposed rule that the provisions of this
final rule may require seven States to submit a total of eight new
waiver proposals (within 2 years of the effective date of this final
rule) that demonstrate compliance with the updated requirements. This
number is based on the number of States that had tax waivers that
exploit the loophole as of the publication of the proposed rule and
reflects that one State has two waivers.
We have since learned of one additional loophole tax for a total of
nine waivers in the same seven States. Although the submission of a new
waiver is not the only way to address the requirements of this final
rule, for purposes of scoring the impact of this rule we assume all
seven States will go this route, as we believe it is the most likely
and we have no reliable way of knowing how each State may choose to
proceed. However, we also recognize that some States may choose to
restructure their taxes in a manner that does not require them to
submit a new waiver request. Existing tax waivers that do not exploit
the statistical loophole are not affected and, therefore, have no added
requirements and burden.
Consistent with our active (or currently approved) estimates under
the aforementioned OMB control number, we continue to estimate that it
would take 80 hours at $46.88/hr for a healthcare support worker to
prepare and submit the waiver request. In aggregate, we estimate a one-
time burden of 720 hours (9 waivers x 80 hr/waiver) at a cost of
$33,754 (720 hr x $46.88/hr). When taking into account the Federal
administrative match of 50 percent, we estimate a one-time State cost
of $16,877 ($33,754 * 0.5).
Consistent with our active collection of information request, this
final rule does not provide States with a waiver form or template.
Instead, instruction for preparing and submitting the waiver is
provided in the aforementioned rules and what is codified in Sec. Sec.
433.68 and 433.72.
Outside of the revised waiver, we do not anticipate that the
finalized changes will result in the need for States to amend existing
or create new State Plan or policy documents. Consequently, we are not
setting out such burden.
Broad-Based Requirements Waiver: Please note that this rule's
finalized policies will also apply to waivers of the requirement for
taxes to be broad-based; however, because this rule affects existing
waivers that exploit the loophole, we are only considering the
uniformity requirements waiver in this PRA/COI section.
C. Summary of Burden Estimates
[[Page 4828]]
[GRAPHIC] [TIFF OMITTED] TR02FE26.003
IV. Regulatory Impact Analysis
A. Statement of Need
The final rule will eliminate an inadvertent loophole in existing
health care-related tax waiver regulations and strengthen CMS' ability
to enforce section 1903(w)(3)(E) of the Act. These changes are
necessary to address taxes that align with existing regulations but do
not meet the requirement of the statute due to a statistical loophole
that exists in the regulations. These provisions of the final rule are
narrowly tailored to address this problem and enable CMS to enforce its
new requirements with care to ensure that existing tax waivers that do
not exploit the statistical loophole are not affected. All other
changes are conforming or technical changes and related to this primary
objective of closing the loophole.
As reflected further in this section, the financial impact on the
Federal government of the existing problem is large, and the potential
for this problem to proliferate further demands swift action.
B. Overall Impact
We have examined the impacts of this rule as required by Executive
Order 12866, ``Regulatory Planning and Review,'' Executive Order 13132,
``Federalism,'' Executive Order 13563, ``Improving Regulation and
Regulatory Review,'' Executive Order 14192, ``Unleashing Prosperity
Through Deregulation,'' the Regulatory Flexibility Act (RFA) (Pub. L.
96354), section 1102(b) of the Social Security Act, section 202 of the
Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4), and the
Congressional Review Act (5 U.S.C. 804(2)). Pursuant to Subtitle E of
the Small Business Regulatory Enforcement Fairness Act of 1996 (also
known as the Congressional Review Act, 5 U.S.C. 801 et seq.), OMB's
Office of Information and Regulatory Affairs has determined that this
final rule does meet the criteria set forth in 5 U.S.C. 804(2).
Executive Orders 12866 and 13563 direct agencies to assess all
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select those regulatory approaches that
maximize net benefits (including potential economic, environmental,
public health and safety, and other advantages; and distributive
impacts;). Section 3(f) of Executive Order 12866 defines a
``significant regulatory action'' as any regulatory action that is
likely to result in a rule that may: (1) have an annual effect on the
economy of $100 million or more or adversely affect in a material way
the economy, a sector of the economy, productivity, competition, jobs,
the environment, public health or safety, or State, local, or tribal
governments or communities; (2) create a serious inconsistency or
otherwise interfere with an action taken or planned by another agency;
(3) materially alter the budgetary impact of entitlements, grants, user
fees, or loan programs or the rights and obligations of recipients
thereof; or (4) raise novel legal or policy issues arising out of legal
mandates, or the President's priorities.
A regulatory impact analysis (RIA) must be prepared for regulatory
action as defined by section 3(f)(1) of Executive Order 12866. For the
proposed rule, we prepared our estimates using a ``no action''
baseline, which OMB's Office of Information and Regulatory Affairs
determined was significant per section 3(f)(1). For this final rule,
and in light of the passage of the WFTC legislation, we are maintaining
the same analysis but noting that it is now a ``pre-statute'' baseline.
Accordingly, we have prepared an RIA that to the best of our ability
presents the costs, benefits, and transfers of the rulemaking.
Therefore, OMB has reviewed these regulations, and the Departments have
provided the following assessment of their impact.
Executive Order 14192, titled ``Unleashing Prosperity Through
Deregulation,'' was issued on January 31, 2025. For E.O. 14192
accounting purposes, savings to the Federal government that are
classified as transfers in regulatory impact analyses do not count as
cost savings.
C. Detailed Economic Analysis
To enforce the requirement that taxes have a net impact that is
``generally redistributive'' in accordance with section
1903(w)(3)(E)(ii)(I) of the Act when a State is seeking a broad-based
and/or uniformity waiver, CMS established certain tests such as the P1/
P2 and the B1/B2 tests. These tests are described in detail in section
I.C. of this rule.
To determine the economic impact of this rule, as we did with the
proposed rule, we started with information collected by CMS on provider
taxes that we anticipate will be affected by these changes. We
identified nine taxes in seven States that will be affected by this
final rule. This data is collected via the Form CMS-64 \24\ and through
State submissions for waivers, and to a lesser extent, as part of State
plan amendments and State-directed payment preprints. The information
collected included: the type of provider or health care-related entity
taxed (for example, MCOs or hospitals); the expected amount of tax
revenue to be collected; the percentage of total tax revenue paid based
on association with Medicaid (the Medicaid taxable units); and the
percentage that Medicaid constitutes of the total tax base for the
relevant permissible class for the tax. In these eight cases, the
amount of tax revenue paid based on Medicaid taxable units would be
used to fund higher provider payments to account for the taxes paid by
the providers to the States.
---------------------------------------------------------------------------
\24\ The Form CMS-64 is a collection under OMB 0938-1265 (CMS
10529).
---------------------------------------------------------------------------
While we acknowledge that there is uncertainty about how States
would respond, our approach does not assume any change in the total tax
revenue; we assume that the burden of the tax would shift from
disproportionately taxing Medicaid taxable units to a more proportional
distribution on all taxable units. We calculated the amount of tax paid
under the expected percentage of the tax paid based on Medicaid taxable
units and compared it to the amount that would be paid if the burden
for Medicaid taxable units was the same as
[[Page 4829]]
the Medicaid-associated percentage of the total tax base. For example,
for MCO taxes, we calculated the current tax burden that is assessed on
Medicaid tax units (premiums or member months for Medicaid enrollees)
and the overall amount of tax revenue. Then we calculated the tax
burden that is assessed against Medicaid taxable units assuming that
the tax was assessed evenly across all units (premiums or member
months). For hospital taxes, we did the same analysis using the taxable
units for hospitals (which could be revenue, hospital stays, or days
hospitalized). This data is shown in Table 4.
[GRAPHIC] [TIFF OMITTED] TR02FE26.004
For 2024, we estimated that these taxes accounted for $24.0 billion
in revenue for 7 States. For States with waivers that started in 2025,
we included the first year's revenues in 2024 for this analysis. Of
this amount, we estimate that $20.4 billion was assessed against
Medicaid taxable units (85 percent) and thus was ultimately paid by the
Medicaid program. We also estimated that if the taxes were assessed
proportionately on all taxable units, that only $11.7 billion (49
percent) would have been assessed against Medicaid taxable units.
The following example illustrates how we calculated the impact of
the proposed policy change. Assume a State has a provider tax that
exploits the loophole and is expected to collect $1 billion in revenue.
Ninety-five percent of the taxes are assessed against Medicaid taxable
units, but only 50 percent of the total taxable units are Medicaid
taxable units. As a result, the Medicaid program (that is, the State
and the Federal government) bears 95 percent of the tax burden, even
though Medicaid only accounts for 50 percent of the basis for taxation
(such as Medicaid member months or hospital days) for this service in
the State. Under existing regulations with the loophole, the Medicaid
program would be expected to pay for $950 million of the tax revenue
(via higher payments to providers) [95 percent * $1 billion = $950
million]. Under the proposal, the Medicaid program would be expected to
pay for approximately $500 million for the tax revenue [50 percent * $1
billion = $500 million], because $500 million is 50 percent of the $1
billion collected in tax revenue, which reflects the share of the tax
base attributable to Medicaid usage (or total taxable units). In that
case, total expenditures made by the Medicaid program would be
anticipated to decrease by $450 million [$950 million-$500 million].
We estimated that the impact on Federal Medicaid expenditures would
be the difference in the taxes paid by Medicaid under current law
multiplied by the average FFP matching rate. The average Federal share
includes higher Federal matching rates for certain services or
populations, most notably the 90 percent matching rate for expansion
adults in States that expanded Medicaid eligibility under the
Affordable Care Act. For example, if the average Federal share in the
State for expenditures in the relevant permissible class in the
previous example is 70 percent, then the Federal savings would be $315
million [$450 million * 70 percent].
To calculate the impact in future years, we made the following
assumptions. We assumed no new additional waivers would be approved
beyond the 9 currently in place. We also assumed that the 9 current
waivers would be transitioned to new tax waivers under the transition
schedule described in section II.D. We projected that the amount of tax
revenues would increase at the same rate as Medicaid spending growth in
the budget (based on the projections in the Mid-Session Review of the
FY 2025 President's Budget). The Federal share of these impacts was
estimated using the average Federal share for each State and service
category by tax; this would include adjustments to the base Federal
matching rates (notably, the 90 percent matching rate for costs for
expansion adults). We estimated that the rule would reduce Federal
Medicaid spending by $78,2 billion from 2027 through 2036 (in real 2027
dollars). This estimate accounts for the transition period applicable
as described in Section II.D. These estimates have been updated from
the proposed rule to account for changes in the transition schedule.
Notably, we now project the financial impacts would begin in 2027 as
compared to 2026 in the proposed rule. The annual impacts are shown in
Table 5. In addition to the Federal savings, we also project a
reduction in State Medicaid expenditures of $46.9 billion over 2027
through 2036. The annual impacts are shown in Table 5.
[[Page 4830]]
[GRAPHIC] [TIFF OMITTED] TR02FE26.005
Because it is possible, and we believe likely, that additional
States may implement new taxes that exploit the waiver statistical
loophole if current policy is unchanged, and that States may increase
the revenues raised by existing taxes, we also developed estimates for
an illustrative scenario where additional States submit similar taxes
over the next several years. In this scenario, we assumed that 2 States
would submit new MCO tax waivers for 2026, and 4 additional States
would submit MCO tax waivers each year from 2027 through 2030 (reaching
25 States by 2030). We also assumed that 2 additional States would
submit hospital tax waivers each year from 2027 through 2030 (reaching
9 by 2030). We produced estimates for both MCO taxes and hospital taxes
based on those for which we have already seen loophole taxes.
However, we note that we believe this loophole could be exploited
on any permissible class. Tax revenue and burden on the Medicaid
program is projected to increase at the same rate as the underlying
service spending in Medicaid based on the mid-session review (MSR) 2025
projections. We assume that the impacts on other States are
proportional to the largest MCO and hospital taxes currently approved,
in the scenarios described herein. For MCO taxes, we assumed that the
Medicaid program would account for 99.8 percent of the tax revenue
using the loophole and would account for only 50 percent of the revenue
under the proposed policy; we also assumed that the tax revenue
attributable to the Medicaid program would be equal to about 23 percent
of State Medicaid managed care spending. For hospital taxes, we assumed
that the Medicaid program would account for 44 percent of the tax
revenue using the loophole and for only 32 percent under the proposed
policy; and we assumed that that the tax revenue attributable to the
Medicaid program would be equal to about 19 percent of State Medicaid
hospital spending. We did not assume any additional nursing facility
taxes. We note again that this scenario reflects not only the current
taxes, but the impact if these taxes are allowed to proliferate. Under
the illustrative estimate, the Federal government would avoid $312.7
billion in Medicaid spending over 2027 through 2036 (in real 2027
dollars) and State Medicaid expenditures would be $170.1 billion lower,
as shown in Table 6.
[GRAPHIC] [TIFF OMITTED] TR02FE26.006
1. Transfers (Additional Discussion)
We note that the amounts described in the previous section do not
necessarily represent the total Federal burden that may arise from
loophole taxes, and therefore the total savings that will result from
closing the loophole. As discussed in the preamble section I.C. in this
final rule, States can and sometimes do use the tax revenue generated
by shifting the burden to Medicaid (and therefore onto the Federal
government) through the loophole to fund additional payments to
providers. Those subsequent payments can again be claimed as
expenditures and receive Federal match, thus further increasing Federal
spending; to the extent States reduce the revenue collected by provider
taxes and in turn reduce Medicaid spending, the impacts on Federal and
State Medicaid expenditures may be even higher than what we have
estimated here.
However, it should be noted that effects on the Federal budget (as
well as the costs to States and taxpaying entities) are highly
dependent on how States respond to these changes. Broadly, we believe
States generally have several ways to address these changes, and they
are not mutually exclusive, with varying consequences for magnitude of
regulatory effects and for who pays and receives transfers. As we
estimated previously, States may decide to maintain the current level
of revenue in these tax programs, with less revenue based on Medicaid
taxable units and the burden distributed across other payers (which
could include Medicare for non-MCO taxes--thus generating some tendency
toward overestimation in the Federal budget savings estimates appearing
elsewhere in this regulatory analysis--and private health insurers).
States may choose to reduce or eliminate these taxes and may make up
the revenue elsewhere (for example, through other taxes, health care-
related or not). States may also opt to reduce spending--in Medicaid or
in other parts of the State budget--to account for the decrease in tax
revenue. We expect that these decisions will depend on several factors
beyond our ability to predict, including: the relative impact these
policies have on the State Medicaid program and overall State budgets;
the response from other health care payers and providers of potentially
higher tax burdens; and impacts on other entities, including on
providers and beneficiaries in the State. We sought comments on how
affected States would respond to these proposed changes.
The following is a summary of the public comments on our regulatory
impact analyses:
Comment: A few commenters expressed concern that the proposed rule
did not contain a ``meaningful'' RIA. A few commenters requested that
CMS conduct a comprehensive impact
[[Page 4831]]
analysis on safety net hospitals before finalizing the rule. A
commenter stated the RIA fails to consider key relevant impacts of the
proposed rule, including the potential for serious harm to Medicaid
funding and delivery, thus falling short of RIA standards. A commenter
similarly stated that the RIA was inaccurate due to the uncertainty of
the proposed rule's impact on patient access. A commenter recommended
that CMS seek feedback from States on the proposed rule's budgetary and
programmatic impact.
Response: States have many options for how to respond to the
changes made by this rule. A State may maintain payments funded by a
loophole tax through other means such as general fund revenue. The
State may continue payments in a manner permitted by the tax waiver
once brought into compliance with Federal law not to overburden the
Medicaid program. We also acknowledge that they may, as the commenter
was concerned, stop or decrease certain payments. We described these
possible effects in the RIA, but continue to believe that quantifying
the possible effects is especially speculative. We took the approach
that best reflected the known outcomes and available data while
acknowledging the uncertainty in how States will respond to these
changes. We also believe it is not possible to quantify the effects on
any particular providers or groups of providers, while noting it is
possible that States may reduce spending that affects some providers
more than others. Seeking feedback from loophole States would not have
changed the rulemaking decision, since this rule, even before the
passage of WFTC legislation, is addressing an action that was already
impermissible.
Comment: Several commenters expressed concern regarding estimates
included in the proposed rule's RIA, with a few commenters stating
generally that the estimated savings specific to this rule are not
accurate. A commenter stated that the estimated $33.2 billion reduction
in Federal Medicaid spending is an underestimate due to CMS' assumption
that all States will expand existing taxes to all payers or due to the
moratorium on further adoption of similar taxes. A commenter believed
the estimated savings are now inaccurate due to WFTC legislation.
Similarly, a commenter expressed concern that the rule's RIA is no
longer relevant due to WFTC legislation. A commenter specifically
recommended that CMS clarify its estimates by distinguishing between
waiver-authorized programs in Table 3 of the proposed rule and those
that have not been identified as contributing to redistributive
imbalance. Finally, a commenter stated that allowing more States to
qualify for transition periods will undermine the savings estimates in
the rule's RIA.
Response: We believe that the estimates are accurate. We do not
assume new taxes or significant expansions of existing taxes as an
explicit part of the baseline, and thus do not assume any cost impacts
beyond the current taxes in place. To address the possibility of an
increase in the use of these taxes in the future, we did provide the
alternative scenario in the RIA in the proposed rule. As noted above,
while we acknowledge that States may take steps in response to this
change (which could include changing the terms of the taxes to be in
compliance with the statute, finding other revenue sources, or reducing
Medicaid spending), we do not believe it is possible to quantify those
impacts. We have noted and described these possible outcomes in the
RIA.
Under OMB Circular A-4, our analysis for instances such as this,
where a rule could be regarded as merely codifying a change already
made in statute, utilizes a ``pre-statute'' baseline for our impact
assessments. Therefore, we are maintaining our analysis from the
proposed rule, although at that time, the baseline was ``no action.''
In other words, the underlying circumstances have changed, but the
primary impact analysis we should provide remains the same, just
through another route, which is through statute. We also believe that
the effects of section 71117 of the WFTC legislation and the proposed
rule are effectively the same, and thus the projected impacts are the
same as well. However, as the transition periods have been modified and
one additional tax has been identified, we have updated the estimates
in this analysis accordingly.
As a result of the public comments, we are only updating the
discussion of the baseline to reflect the ``pre-statute'' baseline.
2. Regulatory Review Cost Estimation
If regulations impose administrative costs on private entities,
such as the time needed to read and interpret the proposed rule, we
should estimate the cost associated with regulatory review. Due to the
uncertainty involved with accurately quantifying the number of entities
that will review the rule, we assume the following entities will
review: State Medicaid Agencies, State governments, MCOs, and health
care providers. We assume at least three people at every State Medicaid
Agency (56) will review and two people in every State and territory
government (56), for a total of 280 reviewers. We then estimate an
additional 20 reviewers in every State Medicaid Agency affected by
these policies (7 States, 140 reviewers), as well as 1,124 members
across seven State Legislatures, for a total of 1,544 reviewers. It is
more difficult to predict how many individuals in how many MCOs and
providers will review, so we are therefore doubling the number from the
previous estimate, for 3,088 total reviewers. We acknowledge that this
assumption may understate or overstate the costs of reviewing this
rule. We also recognize that this is a relatively short rule with a
single policy focus, and therefore for the purposes of our estimate, we
assume that each reviewer reads 100 percent of the rule. We sought
comments on this assumption. We did not receive any comments on our
regulatory review cost estimates, and therefore we are maintaining our
assumptions.
Using the wage information from the BLS 2024 Occupational
Employment and Wage Statistics (https://www.bls.gov/oes/tables.htm) for
medical and health service managers (Code 11-9111), we estimate that
the cost of reviewing this rule is $132.44 per hour, including overhead
and fringe benefits. Assuming an average reading speed, we estimate
that it would take approximately 2 hours for each person to review the
proposed rule. For each person that reviews the rule, the estimated
cost is $264.88 (2 hours x $132.44). Therefore, we estimate that the
total cost of reviewing this regulation is $0.8 million ($264.88 x
3,088).
D. Alternatives Considered
We considered replacing the B1/B2 with another statistical test
(discussed in more detail below) for all waivers of the uniformity
requirements. Updating the statistical test to one that directly
reflected Medicaid burden would have several advantages. First, it
would have been administratively simple for CMS to implement, where one
test would merely be replaced by another during a waiver review.
Second, it would have had the clear effect of eliminating the
statistical loophole. Third, it would have been a purely statistical
test that would not require a separate decision-making process on the
part of CMS.
This test would have measured Medicaid's proportion of the total
business (numerator) compared to Medicaid's share of the expected total
tax revenue (denominator). For example, suppose a tax on nursing
facilities existed where there were
[[Page 4832]]
390,000 total bed days of which 330,000 bed days were Medicaid-paid bed
days. Divide the second number 330,000 by the first number, 390,000 to
receive a percentage of approximately 84.6 percent Medicaid bed days.
Assume further that the total tax revenue collected was $11,000,000.
Assume that the total tax amount collected based on Medicaid taxable
units was $9,000,000. Divide the second number $9,000,000 by the first
number $11,000,000, to receive a percentage of approximately 81.81
percent of tax revenue derived from Medicaid taxable units. Divide the
first percentage, 84.6 percent, by the second percentage, 81.81
percent, to arrive at the final percentage, 103.41 percent.
We also considered various figures that would have represented a
``passing'' (that is, approvable) figure under this test, including 90
percent, or 95 percent, which may have allowed more existing taxes that
do not exploit the loophole to pass. However, we ultimately decided
against proposing this overall new statistical test option for several
reasons. First, we believed that this test would have been
unnecessarily disruptive to our existing approved health care-related
taxes with broad-based or uniformity waivers, many of them
longstanding. Several of these waivers that did not exploit the
statistical loophole would have failed this test, such as some nursing
facility taxes, possibly due to excluding Medicare or other permissible
differences in tax structure. We realize that States have become
accustomed to the B1/B2 test over a long period of time and wanted to
solve the tax loophole issue while being minimally disruptive to their
legislative and regulatory activities related to the Medicaid program,
including their programs of health care-related taxes that do not
exploit the statistical loophole. Finally, we realized that if we set
the passing figure too low, several taxes that are exploiting the
loophole would be able to continue with their tax programs that are not
generally redistributive. We did not want to undertake a change that
would not close the loophole completely or that risked opening a new
one. In addition, through our experience of testing this new
statistical test, we assessed the disruption to existing taxes and
State processes that would result from replacing the B1/B2 test,
regardless of the specific details of that test. As a result, we did
not contemplate alternate statistical methodologies or tests.
In addition to the wholesale replacement of the B1/B2 by this new
statistical test for all waivers of the uniformity requirement, we also
considered various limiting conditions to the universe of tax waivers
to which it would apply. For example, we considered having this new
test apply only to taxes on services of MCOs, since most of the
loophole exploiting taxes fall in this permissible class. However,
there is at least one tax that we know of on hospitals that has
different, higher, tax rates for Medicaid-payable days than non-
Medicaid payable days. We wanted a fix that would cover this tax as
well, because we believe that the higher rate imposed on Medicaid
taxable units is not consistent with the statutory requirement that
health care-related taxes for which waivers are approved must be
generally redistributive. Additionally, applying this test only to MCOs
would have left the Federal government open to future State tax waiver
proposals that used the B1/B2 loophole in other permissible classes,
including but not limited to inpatient hospital services and outpatient
hospital services. In the proposed rule, we aim to be as comprehensive
as possible to reduce the necessity of pursuing further rulemaking in
this area in the short-term.
We also considered proposing this new statistical test discussed in
the prior paragraphs, but proposing to apply it only to taxes that had
separate tax rates for Medicaid taxable units compared to non-Medicaid
taxable units, or separate tax rates for providers with Medicaid
taxable units compared to providers with taxable non-Medicaid units.
For example, a tax that had a rate of $20 per Medicaid-paid bed day
compared to $2 per non-Medicaid paid bed day would fall under this
category. To take another example, providers with more than 100
Medicaid bed days are taxed $20 per bed day compared to providers with
less than 100 Medicaid bed days are taxed $2 per bed day. This would
have been similar in scope to our current proposal. First, we would
have still needed to adopt some kind of ``Medicaid substitute''
provision similar to Sec. 433.68(e)(3)(iii) to address situations
where the State did not use the word ``Medicaid'' in their descriptions
but achieved the same effect. Second, we believe that this approach
would have been somewhat confusing for States to implement. It would
have required a longer learning process while we instructed the States
how to conduct the test. We wanted to adopt the simplest, most
straightforward option. As a result, we decided against adopting this
test into regulation to measure whether a tax waiver is ``generally
redistributive'' in any format at the present time.
In addition, we considered not proposing that Medicaid proxies be
addressed at all in this regulation. Up until this point, we have not
received any proposals that we would consider to be ``Medicaid
substitutes'' in the context of the B1/B2 loophole. However, up until
this point, States have had no incentive for taxes that use the B1/B2
loophole not to describe groups using the word ``Medicaid.'' Under the
provisions in this rule, they have that incentive since, absent the
``substitute'' provision, the new regulation does apply only to States
that explicitly target Medicaid. While closing one loophole, we did not
wish to open another one with the exact or very similar effect as the
first loophole. We believe that leaving the door open to this kind of
manipulation would undermine the entire purpose of this rulemaking. We
attempted to be as comprehensive as possible to foreclose the necessity
of future rulemaking in the near-term if we were able to identify and
preemptively prevent any serious deficiencies. This helps to create a
stable, level, regulatory framework, reducing the needs for updates and
changes. This is beneficial for both CMS and the States. States have a
clear expectation of the regulatory framework within which they operate
and can plan their budgets and legislative sessions accordingly. And
CMS does not need to undertake new rulemaking soon after concluding
prior rulemaking on the same subject. As a result, we believed that
proposing the ``Medicaid substitute'' provision was necessary to make
sure we were capturing the full universe of problematic practices that
result in tax waivers that are not generally redistributive and
effectively close the regulatory loophole.
As a result, we believe that the option we chose to propose
mandating that Medicaid taxable units not be taxed at a higher rate
than the rate imposed on any taxpayer or tax rate group based on non-
Medicaid taxable units had several advantages. First, it removes the
full universe of current taxes that exploits the statistical loophole.
Second, it is narrowly tailored only to those taxes that exploit the
statistical loophole. Third, it is not unnecessarily disruptive on
States with currently approved tax waivers of the uniformity
requirement that do not exploit the statistical loophole. All those
factors combined, make it the option that we have proposed.
Finally, we considered alternatives to our approach in the
transition period section. Within that section, we have some
alternatives on which we invited comment, including no transition
[[Page 4833]]
period for any waivers. We are confident that all States engaged in
this practice are aware they are exploiting a loophole, and no
transition period aligned with our intent to close the loophole as
quickly as possible. However, we ultimately decided to initially
propose a short transition period for waivers we had not approved most
recently and therefore had not communicated with the State about this
specific issue as recently. We also considered longer timeframes for
transition periods for all waivers, but we did not want to extend the
time that these loopholes are burdening the Medicaid program any longer
than necessary. Finally, we considered associating the length of
transition periods to how long the tax has been in place. We are
finalizing the transition periods with modifications discussed
previously.
E. Accounting Statement and Table
Consistent with OMB Circular A-4 (available at https://www.reginfo.gov/public/jsp/Utilities/a-4.pdf), we have prepared an
accounting statement in Table 7 showing the classification of the
impact associated with the provisions of this final rule.
[GRAPHIC] [TIFF OMITTED] TR02FE26.007
F. Regulatory Flexibility Act (RFA) and Section 1102(b) of the Social
Security Act
Effects on Health Care Providers
The RFA requires agencies to analyze options for regulatory relief
of small entities, if a rule has a significant impact on a substantial
number of small entities. For purposes of the RFA, we estimate that
many of the health care providers subject to health care-related taxes
are small entities as that term is used in the RFA (including small
businesses, nonprofit organizations, and small governmental
jurisdictions). The great majority of hospitals and most other health
care providers and suppliers are small entities, either by being
nonprofit organizations or by meeting the SBA definition of a small
business (having revenues of less than $9.0 million to $47.0 million in
any 1 year).
[[Page 4834]]
[GRAPHIC] [TIFF OMITTED] TR02FE26.008
Table 9 shows the small distribution of firms and revenues.
According to this table, we can see and understand the disproportionate
impacts among small firms and between small and large firms. According
to the US 2022 Census Statistics of US Business, the total revenue for
the four industries identified as small businesses, according to the
SBA size standard and shown in table 8, amounts to $450.97 billion and
average revenue amounts to $1.056 million. Recall, SBA defines a small
business as having revenues of less than $9.0 million to $47.0 million
in any 1 year.
[GRAPHIC] [TIFF OMITTED] TR02FE26.009
Table 10 combines the small firm's size and revenue data with the
cost estimates determined in this final rule to understand the economic
impact on small entities. As mentioned previously, the only costs that
will be incurred as a result of this rule are the collection of
information costs, at a cost of $33,754, and when taking into account
the Federal administrative match of 50 percent, we estimate a one-time
State cost of $16,877. The cost to review this rule, amounts to $0.8
million. Therefore, the total cost to implement this rule is $850,631.
When this cost is distributed amongst the 427,221 entities identified
as being small according to the SBA, each of these small entities
incurs a cost less than $2.00.
[[Page 4835]]
[GRAPHIC] [TIFF OMITTED] TR02FE26.010
1. Number of Small Entities
We used the most recent revenue data available from the 2022
Statistics of U.S. Businesses (SUSB) from the Census Bureau to
determine the number of small entities and their revenue.
[GRAPHIC] [TIFF OMITTED] TR02FE26.011
Based on the latest available 2022 SUSB data records, we estimate
that 427,221 health care provider entities may be considered small
entities either because of their nonprofit status or because of their
revenues, as detailed in Table 11. Approximately 0.35 percent (1,494)
of these are hospitals, 27.97 percent (141,446) are physician
[[Page 4836]]
practices, 33.11 percent (119,497) are dental practices, and 38.57
percent (164,784) are other health practitioners.
We calculated the percentage of revenue represented by the
annualized cost per firm divided by the average revenue times 100, and
none exceeded the 3 to 5 percent of revenue threshold, as summarized in
Table 10. Therefore, according to the revenue tests, the economic
impact was less than one percent. All the costs were evenly distributed
among the 427,221 small entities; thus, for the purposes of this RFA,
there were no disproportionate impacts among small firms, and between
small and large firms.
Individuals and States are not included in the definition of a
small entity. As previously stated, this rule will not have a
significant impact measured change in revenue of 1 to 3 percent on a
substantial number of small businesses or other small entities. We do
not anticipate that States will seek to rebalance the revenues to that
extent through small entities, as the permissible classes affected by
this rule are not small entities. Nearly all the taxes that this policy
will end are taxes on MCOs. As its measure of significant economic
impact on a substantial number of small entities, HHS uses a change in
revenue of more than 1 to 3 percent. We do not believe that this
threshold will be reached by the requirements in this rule. Therefore,
the Secretary has certified that this rule will not have a significant
economic impact on a substantial number of small entities. We sought
comments on this assessment.
We did not receive any comments on this section and are finalizing
our assessment as proposed.
In addition, section 1102(b) of the Act requires us to prepare a
regulatory impact analysis if a rule may have a significant 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
the 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 do not believe this
rule will have a significant impact on small rural hospitals. Although
as stated previously we cannot predict the ways a State may respond to
the cessation of a Federal funding stream, we do not anticipate based
on the requirements in this rule those revenues will be sought from
small, rural hospitals, as States often seek to insulate these
providers from increased costs. Therefore, the Secretary has certified
that this rule will not have a significant impact on the operations of
a substantial number of small rural hospitals.
G. Unfunded Mandates Reform Act (UMRA)
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) also
requires that agencies assess anticipated costs and benefits before
issuing any rule whose mandates require spending in any 1 year of $100
million in 1995 dollars, updated annually for inflation. In 2025, that
threshold is approximately $187 million. The UMRA's analysis
requirement is met by the analysis included in section IV. of the
proposed rule, conducted per E.O. 12866. This final rule does not
mandate any requirements for local or tribal governments, or for the
private sector. Costs may shift from the Federal government to States.
H. Federalism
Executive Order 13132 establishes certain requirements that an
agency must meet when it promulgates a proposed rule (and subsequent
final rule) that imposes substantial direct requirement costs on State
and local governments, preempts State law, or otherwise has Federalism
implications. Allowing States to continue to exploit a loophole in
current regulations undermines the statutory framework, and, as GAO has
noted, undermines the cooperative Federalism that lies at the heart of
the Medicaid program.\25\ For this reason, we believe that it is
necessary to address the statistical loophole to ensure fiscal
integrity of the Medicaid program.
---------------------------------------------------------------------------
\25\ GAO-08-650T ``Medicaid Financing Long-standing Concerns
about Inappropriate State Arrangements Support Need for Improved
Federal Oversight'' April 3, 2008.
---------------------------------------------------------------------------
Hence, this rule does not impose substantial direct costs on State
or local governments, preempt State law, or otherwise have Federalism
implications.
Comment: A commenter disagreed with the Federalism assessment,
stating that the proposed rule would limit their State's ability to tax
providers and, therefore, would infringe on their sovereignty, which
they stated was inconsistent with basic principles of Federalism.
Response: Nothing in this rule changes a State's ability to
establish a health care-related tax that is consistent with Federal
law. Even before this change was reinforced by the WFTC legislation,
the policies finalized in this rule would only affect those taxes that
improperly overburdened the Medicaid program in a manner already
inconsistent with the generally redistributive requirement of the Act.
We are therefore not making any changes to our assessment of Federalism
impacts as a result of comments.
I. Conclusion
The policies in this rule will enable us to ensure FFP is
distributed equitably and as intended and contemplated by statute.
In accordance with the provisions of Executive Order 12866, this
regulation was reviewed by the Office of Management and Budget.
Mehmet Oz, MD, Administrator of the Centers for Medicare & Medicaid
Services, approved this document on January 13, 2026.
List of Subjects in 42 CFR Part 433
Administrative practice and procedure, Child support, Claims, Grant
programs-health, Medicaid, Reporting, and recordkeeping requirements.
For the reasons set forth in the preamble, the Centers for Medicare
& Medicaid Services amends 42 CFR Chapter IV as set forth below:
PART 433--STATE FISCAL ADMINISTRATION
0
1. The authority citation for part 433 continues to read as follows:
Authority: 42 U.S.C. 1302.
0
2. Amend Sec. 433.52 by adding the definitions of ``Medicaid taxable
unit'', ``Non-Medicaid taxable unit'' and ``Tax rate group'' in
alphabetical order to read as follows:
Sec. 433.52 General definitions.
* * * * *
Medicaid taxable unit means a unit that is being taxed within a
health care-related tax that is applicable to the Medicaid program.
This includes units that are used as the basis for Medicaid payment,
such as Medicaid bed days, Medicaid revenue, costs associated with the
Medicaid program such as Medicaid charges, or other units associated
with the Medicaid program.
Non-Medicaid taxable unit means a unit that is being taxed within a
health care-related tax that is not applicable to the Medicaid program.
This includes units that are used as the basis for payment by non-
Medicaid payers, such as non-Medicaid bed days, non-Medicaid revenue,
costs that are not associated with the Medicaid program, or other units
not associated with the Medicaid program.
* * * * *
Tax rate group means a group of entities contained within a
permissible
[[Page 4837]]
class of a health care-related tax that is taxed at the same rate.
0
6. Amend Sec. 433.68 by--
0
a. Revising paragraphs (e) introductory text, (e)(1)(ii), (e)(1)(iii)
introductory text, (e)(1)(iv) introductory text, (e)(2)(ii) and
(e)(2)(iii) introductory text; and
0
b. Adding paragraphs (e)(3) and (4).
The revision and additions read as follows:
Sec. 433.68 Permissible health care-related taxes.
* * * * *
(e) Generally redistributive. A tax will be considered to be
generally redistributive if it meets the requirements of this paragraph
(e). If the State requests waiver of only the broad-based tax
requirement, it must demonstrate compliance with paragraphs (e)(1) and
(3) of this section. If the State requests waiver of the uniform tax
requirement, whether or not the tax is broad-based, it must demonstrate
compliance with paragraphs (e)(2) and (3) of this section.
(1) * * *
(ii) If the State demonstrates to the Secretary's satisfaction that
the value of P1/P2 is at least 1 and satisfies the requirements of
paragraphs (e)(3) and (f) of this section, the tax waiver is
approvable.
(iii) If a tax is enacted and in effect prior to August 13, 1993,
and the State demonstrates to the Secretary's satisfaction that the
value of P1/P2 is at least 0.90, CMS will review the waiver request.
Such a waiver will be approved only if, in addition to satisfying the
requirement at paragraphs (e)(3) and (f) of this section, the following
two criteria are met:
* * * * *
(iv) If a tax is enacted and in effect after August 13, 1993, and
the State demonstrates to the Secretary's satisfaction that the value
of P1/P2 is at least 0.95, CMS will review the waiver request. Such a
waiver request will be approved only if, in addition to satisfying the
requirement at paragraphs (e)(3) and (f) of this section, the following
two criteria are met:
* * * * *
(2) * * *
(ii) If the State demonstrates to the Secretary's satisfaction that
the value of B1/B2 is at least 1 and satisfies the requirements of
paragraphs (e)(3) and (f) of this section, the tax waiver is
approvable.
(iii) If the State demonstrates to the Secretary's satisfaction
that the value of B1/B2 is at least 0.95, CMS will review the waiver
request. Such a waiver will be approved only if, in addition to
satisfying the requirement at paragraphs (e)(3) and (f) of this
section, the following two criteria are met:
* * * * *
(3) Additional requirement to demonstrate a tax is generally
redistributive. This paragraph (e)(3) applies on a per class basis.
Regardless of whether a tax meets the standards in paragraphs (e)(1)
and (2) of this section, the tax is not generally redistributive if:
(i) Within a permissible class, the tax rate imposed on any
taxpayer or tax rate group based upon its Medicaid taxable units is
higher than the tax rate imposed on any taxpayer or tax rate group
based upon its non-Medicaid taxable units (except as a result of
excluding from taxation Medicare revenue or payments as described in
paragraph (d) of this section). For example, a tax on MCOs where
Medicaid member months are taxed $200 per member month whereas the non-
Medicaid member months are taxed $20 per member month would violate the
requirements of paragraph (e)(3)(i) of this section.
(ii) Within a permissible class, the tax rate imposed on any
taxpayer or tax rate group explicitly defined by its relatively lower
volume or percentage of Medicaid taxable units is lower than the tax
rate imposed on any other taxpayer or tax rate group defined by its
relatively higher volume or percentage of Medicaid taxable units. For
example, a tax on nursing facilities with more than 40 Medicaid-paid
bed days of $200 per bed day and on nursing facilities with 40 or fewer
Medicaid-paid bed days of $20 per bed day would violate the
requirements of paragraph (e)(3)(ii) of this section. As an additional
example, a tax on hospitals with less than 5 percent Medicaid
utilization at 2 percent of net patient service revenue for inpatient
hospital services, and on all other hospitals at 4 percent of net
patient service revenue for inpatient hospital services would also
violate the requirements of paragraph (e)(3)(ii) of this section.
(iii) The tax excludes or imposes a lower tax rate on a taxpayer or
tax rate group defined by or based on any description that results in
the same effect as described in paragraph (e)(3)(i) or (ii) of this
section. Characteristics that may indicate this type of violation exist
include:
(A) Use of terminology to establish a tax rate group based on
Medicaid without explicitly mentioning Medicaid to accomplish the same
effect as described in paragraphs (e)(3)(i) or (ii) of this section for
a tax rate group. For example, a tax on inpatient hospital service
discharges that imposes a $10 rate per discharge associated with
beneficiaries covered by a joint Federal and State health care program
and a $5 rate per discharge associated with individuals not covered by
a joint Federal and State health care program would violate this
requirement, because joint Federal and State health care program
describes Medicaid and a higher tax rate is imposed on Medicaid
discharges than on discharges for individuals not covered by a joint
Federal and State health care program.
(B) Use of terminology that creates a tax rate group that closely
approximates Medicaid, to the same effect as described in paragraphs
(e)(3)(i) or (ii) of this section. For example, a tax on hospitals
located in counties with an average income less than 230 percent of the
Federal poverty level of $10 per inpatient hospital discharge, while
hospitals in all other counties are taxed at $5 per inpatient hospital
discharge, would violate this requirement, because the distinction
being drawn between tax rate groups is associated with a Medicaid
eligibility criterion with a higher tax rate imposed on the tax rate
group that is likely to involve more Medicaid taxable units.
(4) Transition period. (i) The following transition periods end as
follows:
(A) For States with health care-related tax waivers on the services
of managed care organization permissible class that do not meet the
requirements of paragraph (e)(3) of this section, where the date of the
most recent approval of the waiver that violates paragraph (e)(3) of
this section occurred 2 years or less before April 3, 2026, the final
day of the transition period is December 31, 2026.
(B) For States with health care-related tax waivers on the services
of managed care organization permissible class that do not meet the
requirements of paragraph (e)(3) of this section, where the date of the
most recent approval of the waiver that violates paragraph (e)(3) of
this section occurred more than 2 years before April 3, 2026, the final
day of the transition period is the day before the first day of the
first State fiscal year beginning at least 1 year from April 3, 2026.
(C) For States with health care-related tax waivers on permissible
classes other than the services of managed care organizations class
that do not meet the requirements of paragraph (e)(3) of this section,
regardless of the date of the most recent approval of the waiver that
violates paragraph (e)(3) of this section, the final day of the
transition period is the final day of the State fiscal year that
[[Page 4838]]
ends in calendar year 2028, but no later than September 30, 2028.
(ii) By the expiration of the transition period applicable under
paragraph (e)(4)(i) of this section, States must either:
(A) Submit a health care-related tax waiver proposal that complies
with paragraph (e)(3) of this section with an effective date that is no
later than the day after the final day of the transition period
specified in paragraph (e)(4)(i) of this section; or
(B) Otherwise modify the health care-related tax to comply with
this rule and all other applicable Federal requirements with an
effective date that is no later than the day after the final day of the
transition period specified in paragraph (e)(4)(i) of this section.
(iii) Once the transition period for a tax waiver that qualifies
under paragraph (e)(4)(ii) of this section has expired, CMS may deduct
from a State's medical assistance expenditures revenues from health
care-related taxes that do not meet the requirements of paragraph
(e)(3) of this section as specified by section 1903(w)(1)(A)(iii) of
the Act and Sec. 433.70(b).
Robert F. Kennedy, Jr.,
Secretary, Department of Health and Human Services.
[FR Doc. 2026-02040 Filed 1-29-26; 4:15 pm]
BILLING CODE 4120-01-P