CMS Takes Aim at Medicaid Kickback Loophole
Some states have found a lucrative way to make federal taxpayers pick up more of their Medicaid costs: tax health care providers, use the tax revenue to claim additional federal Medicaid matching funds, and then direct higher Medicaid payments back toward the providers being taxed.
It amounts to a kickback-style financing arrangement. The providers supply money that helps the state qualify for more federal Medicaid dollars, while Medicaid payments can send money back to the same provider class. The state can increase Medicaid spending without putting up the same amount of state general revenue that would normally be expected.
Congress moved to restrict these arrangements as part of the Medicaid reforms enacted in 2025. Now, the Centers for Medicare & Medicaid Services (CMS) is proposing rules to implement those restrictions. CMS estimates the changes will reduce federal spending by $246 billion over 10 years.
How the Scheme Works
Medicaid is supposed to be a federal-state partnership. When a state spends money on Medicaid, the federal government contributes matching funds based on a formula that varies by state.
A state can impose a tax on hospitals, nursing facilities, health insurers, or other health care providers. It then uses the tax revenue to help finance its share of Medicaid and collect federal matching dollars. At the same time, the state can increase Medicaid payments to the provider class paying the tax.
Consider the basic transaction. A hospital pays a provider tax to the state. The state counts that revenue toward its Medicaid financing, receives federal matching funds, and uses Medicaid payments to send money back toward hospitals.
Money goes from the provider to the state, federal money comes down to match it, and Medicaid payments flow back toward the providers.
Federal law already prohibits states from simply guaranteeing providers that they will get their tax payments back. But more complicated arrangements can produce a similar financial result without an explicit dollar-for-dollar guarantee.
Federal Taxpayers Get Stuck With the Tab
The Government Accountability Office found that provider taxes and local government funds supplied $63 billion, or 28 percent, of the nonfederal share of Medicaid payments in 2018. GAO estimated that these financing arrangements effectively increased the federal government's share of net Medicaid payments by 5 percentage points.
GAO illustrated the problem with a simple example. With a 50 percent federal Medicaid match and no provider contribution, the federal government finances half of a $100 net Medicaid payment. If providers contribute $40 toward the state's share, however, the provider's net payment falls to $60 while the federal government still contributes $50. The federal government is effectively financing 83 percent of the net payment.
Congress targeted these arrangements because they leave federal taxpayers covering more of the Medicaid tab while states put up less of their own money.
CMS Is Tightening the Rules
The 2025 Medicaid reforms tightened the limits on these arrangements, particularly the rules governing when providers are considered to be held harmless from the cost of a provider tax.
CMS is now proposing regulations to put those changes into effect. The agency would establish the new hold-harmless thresholds, restrict new and increased provider taxes, eliminate an existing test that allowed some taxes above the threshold to remain permissible, and require states to submit more detailed information about their provider-tax structures.
Those reporting requirements matter because the next loophole may not look exactly like the last one. States have a powerful financial incentive to design Medicaid financing arrangements that maximize federal matching dollars while minimizing the amount coming from state coffers.
CMS should judge those arrangements by their economic substance, not simply the labels or structures states attach to them.
CFE Takeaway
Medicaid is a federal-state partnership, not a mechanism for states to manufacture federal matching dollars through circular transactions with health care providers.
Congress tightened the law to curb financing arrangements that shift Medicaid costs from states to federal taxpayers. CMS should enforce those reforms aggressively and make sure states cannot recreate the same kickback-style arrangement with a new structure.
The principle should be simple: if states want to spend more through Medicaid, they should bear their share of the cost.
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