WASHINGTON–One of the most contentious elements of Gov. Dannel P. Malloy’s recently-passed budget was a new tax on Connecticut hospitals, which won legislative approval despite fierce opposition from the industry. Now, policymakers in Washington may restrict the ability of states to enact such taxes–and they could even force Connecticut to scale back or eventually repeal its new levy.

So-called “provider taxes” are one item under discussion in the increasingly-fraught debt negotiations between the White House and congressional Republicans.

Critics say that states use provider taxes as a “gimmick” to raise revenue for their share of Medicaid spending–and to generate increased federal matching funds in the process. And they say it’s time to stop states from “gaming” the system by imposing taxes aimed mainly at snagging more federal dollars.

States say the provider taxes are a legitimate way to raise desperately needed revenue to helps pay for the exploding costs of Medicaid, a joint state-federal health insurance program for the poor. Medicaid is often one of the top three ticket items in state budgets, and the program’s rolls have swelled with the recession.

As President Barack Obama and House and Senate leaders look for ways to trim federal spending, provider taxes have become a target. The shape of any final budget-and-debt agreement–if there even is one–is still murky at best. But the scope of state provider taxes could still be an issue even if a broader debt deal falls apart.

The way it works is this: States impose a levy on hospitals, nursing homes, or other health care providers, and then they devote that funding stream to Medicaid payments that flow back to those providers.

As long as the taxes are broad based and meet other federal requirements, states can claim federal matching funds when they dole the money back out to providers as Medicaid payments.

In Connecticut, the state legislature approved a two-tiered tax on hospitals, with a rate of 5.5 percent for inpatient services and 3.8 percent for outpatient services. In all, that will raise nearly $350 million a year in revenue. The state will redistribute more than that, almost $400 million, back to the hospitals to pay the cost of caring for Medicaid patients. In the process, Connecticut’s new tax will generate as much as $150 million in federal matching funds.

“It improves the fairness of our system of paying for health care for poor people,” said Ben Barnes, Malloy’s secretary of the Office of Policy and Management. “And it makes health care for poor people more affordable to states.” Barnes conceded that provider taxes are also, as he put it, as “a grant maximization strategy.” But, he added, “it’s not a like a trick or an illegal strategy.”

To be sure, this practice has long been sanctioned by Congress and the federal Center for Medicare and Medicaid Services (CMS). Current federal law allows states to impose a tax of up to 5.5 percent on providers that serve Medicaid patients. And currently, 46 states, plus the District of Columbia, have such provider taxes on their books.

Connecticut already had a 5.5 percent provider tax on nursing homes. Barnes noted that the one just enacted on hospitals was “quite painful” to get passed because of resistance from the industry. Hospitals opposed the tax because some will lose significant revenue in the redistribution process, and the tax was coupled with an $83 million cut to hospitals for the uncompensated care they provide to the uninsured.

In Washington, the budget-and-debt talks are all about pain. The idea of nixing provider taxes to save federal money first popped up in the final report issued by President Obama’s fiscal commission.

The commission labeled these taxes a “gimmick” used to generate federal funds. And others have said they essentially allow a state to circumvent its share of Medicaid costs by borrowing money from providers. “Many states finance a portion of their Medicaid spending by imposing taxes on the very same health care providers who are paid by the Medicaid program, increasing payments to those providers by the same amount and then using that additional ‘spending’ to increase their federal match,” the fiscal commission said in its final report. “We recommend restricting and eventually eliminating this practice.”

The commission’s recommendation is now one item on the table in the debt negotiations, as Obama and congressional leaders seek to craft a deal that will reduce federal spending in exchange for an increasing in the nation’s borrowing capacity. Nixing these taxes could save the Medicaid program $5 billion in 2015 and $44 billion through 2020, according to the fiscal commission’s estimates.

It’s unclear how far negotiators have proposed to go on these taxes-whether they would trim provider taxes or kill them outright. But in his 2012 budget proposal, Obama called for the former-phasing down provider taxes over three years, starting in 2015, to 3.5 percent in 2017-rather than eliminating them entirely.

Critics don’t dispute the argument that eliminating these taxes would save Medicaid money. But they say it would do so at a huge cost to states and Medicaid patients.

Judith Solomon, vice president for health policy at the Center on Budget and Policy Priorities, a left-leaning research group, says cutting provider taxes will reduce federal Medicaid costs because states like Connecticut won’t be able to find a replacement revenue stream for Medicaid. States will then cut Medicaid services and that will lower the federal matching contributions from Washington.

Stephen Frayne, a lobbyist for the Connecticut Hospital Association, is no fan of the tax. But he said he’s not itching for it to be repealed either. “We’ve had that discussion, and it is what it is.”

Frayne expressed more concern about how it would impact the state’s finances. “The state would lose $150 million in new federal matching dollars,” he noted. “And I would suspect that they would try to look for ways to recover that.”

Indeed, Barnes said that if Connecticut was forced to eliminate or scale back the tax, “there are a couple different ways we could deal with it, but all of them would be calamitous to the state.” The state can’t afford to lose the revenue stream, hospitals can’t afford to pay the tax without the redistribution mechanism, and Medicaid patients are “not in a position to absorb” any kind of hit either.

So would Malloy and other governors around the country revolt against such a proposal? “Yes,”
Barnes said.

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