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CT Hospital Tax Exploits Medicaid to Finance Irresponsible Spending

Hartford is exploiting an anomaly in the Medicaid program to extract billions from the U.S. Treasury, not to finance health care, but rather to finance otherwise unaffordable state spending, primarily state employee health care and retirement benefits.

This anomaly, or “shell game” (the term used in a U.S. Senate committee report) operates through the hospital tax. While all states impose this tax, no state imposes nearly as high a hospital tax rate. That’s what former Office of Policy and Management Director Ben Barnes told me in late 2017. He said Connecticut’s hospital tax scheme requires explicit federal approval, because the roughly 9% rate exceeds a 6% threshold that no other state exceeds.

The Medicaid program is a federal-state partnership providing medical care to poor citizens, with the federal government reimbursing states for about one-half to two-thirds of allowable fees and costs that hospitals and others charge Medicaid patients for medical care.  Under Obamacare, Connecticut and other states expanded Medicaid in return for much higher federal reimbursement percentages on the patients newly covered.

Apart from this straightforward reimbursement arrangement, states provide hospitals supplemental payments, with the federal government matching the payments, in order to achieve various policy objectives. The hospital tax exploits this supplemental payment mechanism in a manner which the General Accountability Office criticized strongly in a 2014 report.

Let’s start with some fundamental questions. Why is government taxing hospitals, which only serves to raise the cost of the nation’s primary providers of health care. Many are non-profit. Why tax non-profits? Many are for-profit and already pay corporate income taxes. Why levy a second tax? Hospital taxes are truly strange and wonderful.

Just before Christmas, the Connecticut General Assembly went into a special session, to approve unanimously a plan to extend the state’s stratospheric hospital tax for seven years. The plan will generate about $675 million annually, including $375 million in federal matching funds.

The plan requires the approval of the federal Centers for Medicare and Medicaid (CMS), which may not be forthcoming. In mid-2018, a U.S. Senate committee took a look at hospital taxes and issued a report calling hospital taxes “a shell game” and singling out Connecticut as a major perpetrator. 

Connecticut’s seven-year plan originates from a settlement of a lawsuit between the state and its hospitals charging the state with violating the original understanding under which it began taxing hospitals in 2011. The hospitals had thought they were to get more out of the arrangement than they paid in taxes, but they didn’t. So, in 2016, they filed suit for as much as $4 billion, charging that state filched on the understanding and, instead, “utilized the Hospitals Tax to balance the budget.”

On the surface, the lawsuit would seem surrealistic. Why would any industry expect to get back more than it paid in taxes? What would be the point of the state levying the tax and then paying back more than it collected? And, why would any taxpayer think that tax revenue shouldn’t be used to balance a state budget? Isn’t that what taxes are for?

So what is the hospital tax, and how does this “shell game” work?

States tax hospitals. Then, they turn around and give back to the hospitals most of the tax revenue, which, on the return voyage, is deemed to be a “Medicaid supplemental payment,” for which states are entitled to federal matching funds. 

The more a state taxes hospitals, and returns the money, the more cash it can extract from the federal treasury. There’s big money in this, and it’s not required to be spent on health care.

Connecticut’s hospital tax has grown to enormous scale – from $350 million in 2011 to about $900 million in fiscal 2018 and 2019. Together with taxes on other health care providers (e.g. nursing homes), it is nearly tied with the corporate income tax as the state’s third-biggest tax.

The state’s seven-year plan extends the hospital tax at only a slightly decreased annual average of about $860 million and increases its supplemental payments slightly to approximately $560 million, leaving the hospitals in the red (and the state in the black) by $300 million. The $560 million generates $375 million in annual federal matching funds (at a 67% match).

Combining the $375 million with the $300 million in taxes not refunded, the state will clear about $675 million annually.

This does not help the hospitals. So, the state is using another inducement to quiet the hospitals — specifically, increased reimbursement rates for Medicaid services they provide. Of course, the federal government covers up to two-thirds of these reimbursements, (more for Obamacare expansion patients).

Uncle Sam may not go along with Connecticut’s continuing machinations. Even Connecticut is worried, so there are explicit contingencies in the lawsuit settlement with the state’s hospitals in case CMS rejects it. Remember, CMS cannot just go along; it must provide explicit approval since Connecticut’s tax exceeds the 6% threshold. Below the 6 percent threshold, states don’t need specific CMS approval and they enjoy a safe harbor from any federal enforcement action.

With the Senate scrutinizing CMS policy on hospital taxes, CMS might not feel comfortable approving the most egregious case of the “shell game.”

At best, the scheme shifts most of the financial burden of the Medicaid program to the federal side, subverting any sense of partnership. At worst, as Connecticut hospitals allege, the scheme uses federal health care money to finance state budgets, inflating our national and state health care costs and every citizen’s medical bills. No wonder U.S. health care costs are the highest in the developed world.

Rejection of the settlement by CMS would have dire consequences for Connecticut. If CMS just reduced the state’s proposed 9% tax to the prevalent 6% level, the state would be out hundreds of millions of dollars annually.

Instead of relying so heavily upon such a risky “revenue” source, Connecticut should finally address the fundamental drivers of its fiscal and economic decline. One driver dwarfs all others, state employee health care and retirement benefits.

This column appeared in:

Republican American – State’s Hospital Tax ‘Shell Game’ in Peril, Jan. 15, 2020

CT Examiner – CT’s Hospital Tax Exploits Medicaid To Finance Irresponsible State Spending, Jan. 12, 2020

The Hill – Medicaid’s Federal-State Partnership is Subverted by States’ Hospital Tax Scheme, Dec. 27, 2019

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Vincent Arguimbau
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Vincent Arguimbau

Healthcare has concentrated to a point where its monopoly characteristics are becoming obvious with no possibility of fixing. It requires a Schumpeter like creative destroyer like what Uber did to the Taxi business.

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