Businesses generally, but not always, oppose taxes on their operations.  Exceptions typically involve a “tax” which benefits the business and functions like a subsidy.  Medicaid provider taxes provide such an example, and reveal Medicaid’s deep structural flaws.

Provider taxes are an obscure part of Medicaid.  If you know about them and aren’t a healthcare administrator, then you might be a policy wonk.  Former Vice President Joe Biden characterized provider taxes as a “scam,” and it is not hard to understand his reasoning.

Medicaid is a joint state and Federal program providing health insurance for low income, disabled, and some elderly Americans.  Washington sets rules governing state programs and provides almost 60 percent of the funding through matching grants, under which each dollar a state spends gets matched by Federal dollars.  The matching rate varies based on state income, ranging from a $1 to $1 match in the highest income states to $3 from Washington for every dollar which Mississippi spends.  Alabama gets about $2 from Washington for every dollar we spend.

This structure allows states to tailor their programs to local conditions and preferences, with Federal dollars helping states spend more than they would if they funded Medicaid entirely from state taxes.  Low income states have more low income families needing assistance and smaller tax bases, and so consequently get more Federal help.

Provider taxes help states game the matching requirement.  Every state (except Alaska) imposes provider taxes, most frequently on nursing homes and hospitals.  States count the tax as part of providers’ expenses, justifying higher Medicaid reimbursement rates.  Essentially states tax nursing homes and hospitals and then refund the money, but get to count the pass-through money toward their share of the match.  Both conservative and liberal policy analysts share Vice President Biden’s assessment of provider taxes.

Provider taxes are poor public policy because they erode states’ financial buy-in.  States make many decisions about their Medicaid programs, including reimbursement rates and coverage for optional beneficiary groups and treatments.  State lawmakers must have some of their money on the line or will have an incentive to be excessively generous with Federal dollars.

Why do Washington policy makers tolerate such subterfuge?  States typically set Medicaid reimbursement rates much lower than for Medicare or private insurance.  Consequently low-income Medicaid patients struggle to find doctors willing to see them.  Administrators in Washington believe that provider taxes increase reimbursement rates and improve the situation.

Alabama taxes nursing homes and hospitals.  Indeed, Alabama imposes a privilege assessment, supplemental privilege assessment, secondary supplemental privilege assessment, and monthly surcharge on nursing homes.  We can understand why our (and other states’) lawmakers will game the system until Washington changes the rules.

Still, provider taxes have risks and costs for states.  Some states have used provider taxes to expand Medicaid coverage.  Cutting spending and terminating beneficiaries’ eligibility (for any government program) is much harder than never initiating spending.  How will Alabama fund its Medicaid commitments if Washington ends this scam?

Furthermore, taxes and increased reimbursement rates do not affect all providers equally.  The taxes must be imposed uniformly; for example, Alabama’s nursing home privilege assessment is currently $1,899.96 annually per bed.  But because nursing homes and hospitals do not treat the same proportion of Medicaid patients, some may be worse off.

Finally, provider taxes really function as a subsidy, as mentioned above, and subsidies generally drive up prices.  Nursing homes get a far larger percentage of their revenue from Medicaid than hospitals, and so Medicaid is most likely to affect prices here.  Other residents will pay more than if Medicaid patients couldn’t afford this care.  This is not all bad, but still a cost.

State lawmakers might feel that they have outsmarted Washington with provider taxes.  I fear that provider taxes might blow up on states, like one of Wile E. Coyote’s elaborate schemes to catch the Road Runner.  And any program built on scams is also in great need of a major overhaul.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.  The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.25