Closing the Loophole? A Closer Look at CMS’s Medicaid Provider Tax Proposal

A Balancing Act in Medicaid Finance

In May 2025, CMS released a proposed rule titled “Preserving Medicaid Funding for Vulnerable Populations—Closing a Health Care-Related Tax Loophole.” While the rule is framed as a corrective measure to ensure Medicaid provider taxes are applied fairly and in compliance with federal law, its potential impact has sparked a range of responses across the healthcare policy and compliance communities.

As with many CMS actions, the intent is clear: protect federal Medicaid funds from misuse and ensure compliance with existing requirements for provider taxes. But the rule raises important questions about state flexibility, equity in funding, and the downstream effects on coverage and care—especially for vulnerable populations.

What the Rule Proposes

CMS is targeting specific provider tax arrangements that, while technically legal under current rules, may violate the spirit of federal Medicaid financing guidelines. These taxes are supposed to be:

• Broad-based: Applied across all providers in a given class.

• Uniform: Levied at the same rate across those providers.

• Redistributive: Structured so that the burden doesn’t fall disproportionately on Medicaid services.

Under current regulations, states can apply for a waiver if a tax fails these tests—using statistical models (like the B1/B2 test) to demonstrate that the tax doesn’t inappropriately target Medicaid. CMS argues that some states have exploited these models to tax Medicaid more heavily while passing the waiver test on paper.

The proposed rule would prohibit approval of tax waivers if Medicaid is taxed at a higher rate—even if the B1/B2 statistical test is technically satisfied.

CMS’s Rationale: Ensuring Integrity and Equity

Supporters of the rule argue it’s long overdue. Their reasoning:

• Protecting Federal Dollars: CMS estimates the loophole could cost over $33 billion in improper federal matching funds over five years.

• Restoring Balance: By stopping preferential tax schemes, the rule levels the playing field and ensures states don’t use backdoor methods to increase federal match beyond what the law intends.

• Upholding Congressional Intent: Provider taxes were meant to be fair, not tools for budget manipulation.

From a compliance perspective, it reflects CMS’s shift toward more rigorous enforcement of statutory guardrails. It’s about fidelity to the rules, not just the outcomes.

Voices of Concern: Potential Unintended Consequences

Not everyone sees the rule as a win for Medicaid or for vulnerable populations. Critics raise several concerns:

1. Reduced State Flexibility

   States rely on provider taxes to fund their Medicaid programs—especially those that expanded Medicaid or provide state-funded coverage to noncitizens.

   
   

   Implication: If states lose this flexibility, they may face budget shortfalls or be forced to cut services.

   
   

2. Impact on Immigrant Health Coverage

   States like California and Illinois use provider tax revenue to offer coverage to individuals ineligible for federal Medicaid, including undocumented immigrants. Under the proposed rule, such arrangements could result in reduced federal match.

   
   

   Implication: Programs serving immigrants could be curtailed, even if funded by state dollars.

   
   

3. Risk to Nonprofits and Safety-Net Providers

   While the rule doesn’t target nonprofits, it could result in broader-based provider taxes to maintain state revenues—potentially increasing the burden on nonprofit hospitals and clinics.

   
   

   Implication: These organizations could face higher taxes without a corresponding increase in reimbursement.

   
   

4. Administrative Complexity

   The rule adds new documentation and compliance layers for states seeking waivers. Medicaid agencies, already stretched thin, may find it harder to navigate these requirements.

   
   

   Implication: Delays, increased compliance costs, and slower implementation of Medicaid initiatives.

Between Integrity and Innovation

CMS is threading a difficult needle. On one side is the mandate to protect federal funds and enforce compliance. On the other is the reality of how Medicaid operates at the state level—with creativity, financial pressure, and a constant push to cover more people with fewer dollars.

Whether the rule achieves a meaningful balance remains to be seen. For compliance professionals, it’s a reminder that regulatory enforcement is about more than checkboxes—it’s about the broader impact on access, equity, and the sustainability of care.

Key Takeaways for Compliance Leaders:

• Monitor how your state’s provider tax structure may change.

  
  

• Understand the fiscal implications for your organization, especially if you're a nonprofit or safety-net provider.

  
  

• Engage early with state Medicaid agencies on potential redesigns and compliance strategies.

Do you have questions about this blog? Please contact jessicazeff@simplycomplianceconsulting.com

— Jessica