Taxing Medicaid Managed Care to Mitigate Medicaid Cuts

In many states, Medicaid is under budgetary siege.  The steep recession brought on by the COVID-19 pandemic has led to large revenue shortfalls and budget deficits, most notably an estimated $54 billion in California for the fiscal year ending June 30 and the next.  States must balance their budgets, and they have only a few basic policy levers to do so:  cut spending; raise revenues; use “rainy day” funds; furlough state employees; reduce payments to local governments.  Because Medicaid is a large component of state spending, accounting for just under 20 percent of state general fund spending and 29 percent of total state spending (including federal funds) on average,  it is inevitably part of any budget-balancing conversation.

The obvious solution to state revenue shortfalls during the pandemic is for the federal government to step in.  To date, the federal government has provided a temporary increase in the federal Medicaid matching rate, but the 6.2 percentage point increase is simply not enough (it should be at least 12.0).   And under Treasury Department guidance states are prohibited from using the state fiscal relief funds provided by the CARES Act either to fill their revenue holes or to meet their state share obligation. The federal government can and should do much better, and quickly, because many states are now reconsidering their budgets in light of the recession.  But until it does, states will need a Plan B.

One option state policymakers should explore is imposing a tax on managed care organizations, or increasing the rate of an existing tax on MCOs.  If it is structured in a way that meets federal guidelines, such a tax can produce revenues the state can use to help pay its share of Medicaid costs.  Over two-thirds of all Medicaid beneficiaries are enrolled in about 275 Medicaid MCOs in 38 states and DC.  Several large national insurers with Medicaid managed care subsidiaries have reported strong financial results; unlike hospitals and nursing facilities, the revenues of those subsidiaries could well increase as Medicaid enrollment grows.  And as our colleague Sabrina Collette of the Center on Health Insurance Reform points out, a number of insurers will be receiving payments from the federal government as the result of a $12 billion Supreme Court decision in their favor.

In FY 2019, according to the Kaiser Family Foundation, 14 states had taxes on managed care organizations in place (CA, DC, LA, MD, MI, MN, NJ, NM, OH, OR, PA, RI, TN, and TX); two states planned to implement such taxes in FY 2020 (AR, IL). (In comparison, 44 states had hospital taxes in place, and 46 states had nursing facility taxes in place in FY 2020).  All of the 14 states contract with MCOs to furnish services to Medicaid beneficiaries, but the statutory option to enact such a tax is available to all states, managed care or fee-for-service.  Under federal guidance, non-benefit operating costs incurred by Medicaid MCOs, including expenses related to taxes and licensing and regulatory fees, are included in the capitation rates paid by state Medicaid agencies.

Federal Medicaid law and regulations impose some requirements on how an MCO tax must be structured in order for the state to use the revenues generated by the tax to pay its share of Medicaid costs.  The tax must be (1) “broad-based” and (2) “uniform,” and (3) the provider or insurer paying the tax can’t be held harmless. The purpose of these criteria is to prevent states from taxing only Medicaid revenues received by providers or insurers and using the resulting revenues to draw down more federal Medicaid matching dollars.

A tax is “broad-based” if it is imposed on all entities in the class; in the case of a managed care organization tax, it must apply to all managed care organizations, whether or not they contract with Medicaid—i.e., not just Medicaid MCOs.  A tax is “uniform” if it applies consistently in amount and scope; in the case of a managed care organization tax, the rate on an insurer’s Medicaid revenues can’t be higher than the rate on its non-Medicaid revenues.  The Secretary has the authority to waive the broad-based and uniform requirements if the tax is “generally redistributive” as determined by statistical tests.   A tax can meet the hold harmless requirement if it produces revenues that do not exceed 6 percent of net patient revenue.   Tennessee’s tax is an example of a straightforward tax of 6 percent on all health maintenance organization premium revenues.

It is a truth universally acknowledged that a man or woman who has seen one Medicaid program has seen one Medicaid program.  The same may be said of managed care organization taxes.  Not only does each state have its own Medicaid program, it has its own spending and revenue policies and its own budget politics.  As a result, there is lots of variation from state to state in whether to adopt a managed care organization tax and, if so, how much revenue to raise from it and how to structure it.  This variation is further amplified by the Secretary’s authority to waive the “broad-based” and “uniform” requirements—an authority that has been relied on by a number of states in recent years to enact taxes that are acceptable to insurers that have small or no Medicaid revenues and do not want to pay taxes on their other revenue streams. Last month’s CMS approval of a waiver of these requirements for California’s “modified MCO tax” is a case in point, as is its approval of waivers for Illinois, Michigan, and Ohio.

The Administrator of CMS is not a fan of the current federal rules for state taxes of providers or managed care organizations.    Last November, CMS proposed to tighten those rules, and  make other related policy changes, in what it called the “Medicaid Fiscal Accountability Rule.”  Among other things, the proposal would add a new, additional test for granting a waiver of the “broad-based” and “uniform” requirements: that the tax not impose an “undue burden” on health care items or services paid for by Medicaid.  As my colleague Edwin Park has explained, the proposed changes, if implemented, would severely disrupt current arrangements for state financing of their share of the cost of their Medicaid programs.  Even if adopted, however, the proposed changes would not prohibit state adoption of MCO taxes.

Enacting a new tax on managed care organizations, or raising existing tax rates, is a very high-degree-of-difficulty undertaking.  Technically, these taxes are complicated to design and explain, as the California approval letter demonstrates.  Politically, proponents of this revenue source will have to solve not just for the state’s governor and legislature, but also for CMS, which needs to approve such a tax.  The insurance industry is not particularly enthusiastic about being taxed and it is a well-resourced and savvy opponent.  There is a reason that almost all states have enacted taxes on hospitals (44) and nursing facilities (46) but only 14 states have enacted taxes on managed care organizations.

On the other hand, if the federal government does not step in, states will need revenues if they are to avoid savaging their education systems, Medicaid programs, and other services.  A number of health insurers are enjoying strong financial results, so taxes on managed care organizations are likely to produce revenues, and CMS has shown a willingness to approve such taxes, at least for the time being.  And despite their complexity, taxes on managed care organizations, and the rationale for such taxes, can be explained to policymakers, the press, and the public.  They can be used to build coalitions of patients and providers.

At the end of the day, it may be that other revenue sources are more attractive to state policymakers.  But a tax on managed care organizations is an option that should be on the table.




Andy Schneider is a Research Professor at the Georgetown University McCourt School of Public Policy.