Krit Chanwong and Dominik Lett
For years, states have used creative financing schemes to game the Medicaid system, effectively laundering billions in federal dollars with little transparency or accountability. Even the Government Accountability Office (GAO), tasked with auditing how federal programs spend taxpayer dollars, can’t keep track of the full costs of these schemes.
Finally, Congress is considering cracking down on these financing gimmicks in its 2025 reconciliation bill. Curbs on payment abuses are long overdue and would mark a meaningful step toward restoring a modicum of fiscal responsibility to one of the federal government’s fastest-growing entitlement programs.
What Are These Financing Gimmicks?
States and the federal government jointly fund Medicaid. States set total Medicaid spending. The federal government then reimburses a percentage of this total. Theoretically, states that want to spend more money on Medicaid would be paying for that with higher taxes. Financing gimmicks, however, allow states to spend more money on Medicaid without tax increases. There are three basic types:
- Provider Taxes: State governments levy a “tax” from providers, such as hospitals and/or managed care organizations. States then use this tax revenue to increase Medicaid payments to hospitals. See New Mexico SB-17 2024.
- Intergovernmental Transfers: State governments borrow money from city or county governments. States use this money to increase Medicaid spending, thus claiming more Medicaid federal funds. Some of the federal money is then returned directly to the city or county governments. See Los Angeles County’s transfer to the California state government in 2016.
- Certified Public Expenses: A county- or state-run hospital spends some money on a service approved by Medicaid. The hospital then claims this money from the state, which then uses the expenses incurred to claim more money from the federal government.
Watch the video below from the Paragon Health Institute explaining how the provider tax scheme works.
What Do These Financing Gimmicks Fund?
States use financing gimmicks to increase Medicaid spending without raising state taxes. Figure 2 plots federal revenues from financing gimmicks as a percentage of federal Medicaid funds, total Medicaid funds, and total state spending. In 2022, one out of every five dollars spent on Medicaid was drawn down by states through financing gimmicks.
Some states actually depend on financing gimmicks to reduce their state-incurred deficits. For example, California plans to use $1.3 billion of financing gimmick revenues to close the state’s $12 billion deficit in fiscal year 2025–2026. Medicaid providers also benefit from financing gimmicks. According to a 2021 GAO report, states used 73 percent of non-federal financing gimmick revenue to increase Medicaid payment rates in 2018. Providers received the remaining 27 percent in the form of ‘supplemental payments,’ which the GAO defines as “lump sum payments made to providers that are not tied to a specific individual’s care.”
In theory, supplemental payments are supposed to subsidize hospitals that lose money due to Medicaid’s low payment rates. In reality, supplemental payments usually subsidize large, profitable health systems. For example, Brian Blase and Niklas Kleinworth, in a 2024 report on Medicaid financing gimmicks, detail how New Mexico, Nevada, and North Carolina used Medicaid supplemental payments to subsidize large, profitable healthcare corporations.
Why Are These Taxes Harmful?
Financing gimmicks encourage overspending, driving up federal deficits. When the Medicaid program started, the financing burden was shared roughly equally between states and the federal government. Today, partly because of increased utilization of financing gimmicks, states cover just a quarter of the program’s spending. States lose incentives to spend wisely when they bear a smaller burden for financing Medicaid. Future federal taxpayers end up shouldering the costs of fiscal irresponsibility.
Over the last decade, Medicaid has been the fastest-growing major federal non-interest spending program, increasing in real terms from $492 billion in 2016 to $656 billion in 2025. This increased spending adds to the national debt and worsens the US fiscal outlook. Higher debt levels slow economic growth, reduce incomes, drive up inflation, push interest rates higher, and ultimately risk a catastrophic fiscal crisis.
There is also some evidence that these financing gimmicks lower healthcare accessibility. In 2024, health analysts Ann Kempski and Ge Bai found that North Carolina’s provider taxes would push Medicaid inpatient payment for hospitals to 226 percent of Medicare rates. North Carolina’s payment policies, Kempski and Bai argue, tilt “the competitive playing field to hospitals, promoting hospital-centric consolidation and eliminating competing care alternatives for patients and payers.” As such, there seems to be a very good case that Medicaid financing gimmicks can prevent ordinary Americans from accessing healthcare.
What Should Be Done?
Medicaid financing gimmicks are made possible by the federal government’s offer to match all state spending. Without federal matching, states would simply have to raise taxes to pay for more Medicaid spending. As such, the only way to definitively end all Medicaid financing gimmicks is to block-grant Medicaid. Short of this, however, Congress still has some options to rein in the most egregious Medicaid offenses.
For one, Congress should limit or eliminate the so-called “safe-harbor” threshold. Before 1991, states could effectively guarantee hospitals that they would eventually profit from a Medicaid provider tax. These guarantees made it much easier for states to enter into agreements with providers governing those schemes. However, after 1991, Congress banned such guarantees for taxes that were worth more than six percent of net patient revenue for a given provider class. Eliminating, or even reducing, this threshold would make it harder for states to use financing gimmicks.
Moreover, Congress should eliminate all supplemental payment programs. As noted above, Medicaid supplemental payments have been used as a cash cow by large, profitable healthcare corporations. Eliminating all supplemental payments would thus reduce billions of dollars in wasteful spending.
Don’t Miss a Golden Opportunity
As part of the 2025 reconciliation package, legislators are considering several reforms to the Medicaid program, including gradually scaling back provider taxes and placing limits on supplemental payments. These are promising first steps and represent a very modest course correction to a program fraught with overspending and waste.
If states want to continue spending on Medicaid at the current pace, they should do so honestly and transparently, not through budget gimmicks and shady financing schemes. Sunsetting provider taxes entirely, abolishing untethered supplemental payments, and ultimately converting Medicaid into a block grant program would curb waste and reduce the deficit.
The authors are grateful to Romina Boccia for her sharp eye and helpful edits.