Introduction
Funding for financially distressed hospitals is one of the two “burning houses” in the FY 25 Health budget, the other being the need to address the inexorable growth of personal care spending. The FY 25 Executive Budget Briefing Book (the “Briefing Book”) describes the spending trends for both of these sectors as “unsustainable.”[1] Although State share spending on operating subsidies to financially distressed hospitals continues to be dwarfed by spending on personal care, the rate of growth in State spending on operating subsidies for financially distressed hospitals is even greater than the rate of growth in State spending on personal care.
The growth in subsidies for financially distressed hospitals reflects both significant expansion of the operating deficits of hospitals that have long required operating subsidies, as well as an alarming increase in the number of hospitals in New York that require operating subsidies to maintain their existing service offerings, or in some cases, to continue operating at all. According to the Briefing Book, “[C]urrently, 75 of 261, or 29 percent, of New York’s hospitals, are financially distressed, and overall distressed hospital spending has increased by over 400 percent since FY 2017.”[2]
Our recent Policy Brief titled, The Challenges of Financially Distressed Hospitals in New York, describes the reasons for the growing financial distress of many hospitals since the COVID-19 pandemic and offers several recommendations for how the State can move forward on this difficult issue. The purpose of this Issue Brief is to analyze how the FY 25 Executive Budget and the legislative one-house budget proposals address issues related to financially distressed hospitals. We also analyze proposals from two major stakeholders regarding hospital funding, which will also have an impact on budget negotiations.
The first section of this Issue Brief explains the funding for operating subsidies to financially distressed hospitals that is included in the FY 25 Executive Budget and how this relates to the “unmet need” of financially distressed hospitals, which is identified in the Briefing Book.
The level of funding for financially distressed hospitals is always controversial and this year is no exception. The Greater New York Hospital Association (GNYHA) and 1199SEIU have been jointly running a highly visible campaign that cites the fact that Medicaid reimbursement rates do not fully cover hospitals’ costs for providing services and generally calls for an increase in Medicaid funding of reimbursement rates over four years to address the shortfall. At the same time, a coalition of financially distressed hospitals is waging a separate campaign that calls for increasing funding that is targeted strictly to safety net hospitals. To the extent that there is only so much money to go around, there is a tension between these two stakeholder proposals about the extent to which additional funding should be directed to address inadequate Medicaid rates at all hospitals even if that leaves fewer resources than the financially distressed hospitals appear to need.
The one-house budgets of the Senate and Assembly were released earlier this week. Both one-house budgets include a proposal for a new tax on managed-care organizations, which the houses suggest could raise $4 billion in incremental federal revenue annually for the next three years, with no attendant requirement of additional State spending net of proceeds from the new tax. This proposal, which is modeled on a California MCO tax that was approved by CMS, promises to upend the usual table of health budget negotiations. The proposed MCO tax will likely become the threshold issue that must be decided before the rest of the Health budget can be determined. We analyze the complicated set of federal requirements that govern these types of Medicaid health care-related taxes.
The final topic of this Issue Brief is Gov. Hochul’s FY 25 Executive Budget proposal to establish the Healthcare Safety Net Transformation Program (the “Safety Net Transformation Program”). The Safety Net Transformation Program would provide capital funding and regulatory flexibilities to encourage partnerships between financially distressed hospitals and healthcare facilities or organizations, “who can serve as partners in the transformation of the safety net hospital.”[3]
The proposal includes an important change in the process of awarding capital funding and specifies that only partnerships between financially distressed hospitals and larger health systems are eligible to apply. In contrast to the existing healthcare capital Request for Applications (RFA) process, which significantly limits communication between the State and applicants about their submissions during the RFA process, the Safety Net Transformation Program would enable the State to work strategically with potential hospital partnerships that are seeking funding, which is a better approach to crafting these complicated arrangements.
The Executive Budget dedicated only $500 million of existing capital appropriations to fund the Safety Net Transformation Program. Nevertheless, increases in capital funding typically emerge from budget negotiations rather than the Executive Budget. The need for the kind of structural change to which the Safety Net Transformation Fund aspires has never been greater. But to be successful, it will require a much greater commitment of capital resources than either the Executive Budget or the legislative one-house budgets have provided.
The one-house budgets reject the framework of the Safety Net Transformation Program in favor of appropriating new capital to be awarded under the healthcare capital program the State has deployed for nearly a decade. This program makes capital available to healthcare providers of all types, which has not resulted in the kind of structural change that is necessary to alter the financial trajectory of severely financially distressed hospitals. The one-house budgets do offer the executive more latitude in designing the criteria for making capital awards than has been the case in the past, and it is possible that the end result will be a program that looks more like the Safety Net Transformation Fund with more funding behind it that was included in the Executive Budget.
FY 25 Executive Budget Provisions Relating to Financially Distressed Hospitals
The clearest picture of how the FY 25 Executive Budget addresses the funding needs of financially distressed hospitals (hereafter, “financially distressed hospitals” or “FDH”) is presented in the Gross Financially Distressed Hospital Historical Support chart (the “FDH Funding Chart”) in the Briefing Book.[4] The FDH Funding Chart, which is reproduced below, is commendable for its transparency in showing the sources of funding for operating subsidies to financially distressed hospitals since FY 16, hospitals’ growing need for financial support following the COVID-19 pandemic, and the level of “unmet need” of financially distressed hospitals based on the funding available in the FY 25 Executive Budget.
Although the FDH Funding Chart is the most comprehensive representation of funding available for financially distressed hospitals in the FY 25 Executive Budget, it leaves out several important components of the FY 25 financial equation for financially distressed hospitals. In particular, it does not reflect funding under the newly approved 1115 waiver that is expected to be available for supporting financially distressed hospitals. In addition, the FDH Funding Chart does not explicitly address the repayment in FY 25 of $1.1 billion in State advances to financially distressed hospitals in FY 24, which is contemplated by the Executive Budget’s financial plan.[5]
A major source of confusion in understanding how the Budget addresses the needs of financially distressed hospitals has often been the distinction between gross funding (i.e., including both the State and federal share) and the State share funding (whether as State-only spending or as the State match to federal funding). From the standpoint of financially distressed hospitals, the only thing that matters is the total amount of funding (i.e., the gross amount) they receive. On the other hand, from the standpoint of the State Budget, the only thing that matters is the amount of State Operating Funds that are spent. This orientation of Budget reporting creates a disconnect because understanding the amount of gross funding available is essential to appreciating the Budget’s impact on financially distressed hospitals, while the description of funding for financially distressed hospitals in the Budget documents is almost entirely limited to State share funding (the FDH Funding Chart above being the notable exception).
Another source of confusion regarding the level of State funding required to provide operating subsidies to financially distressed hospitals is that the Budget is based on a cash methodology, which only records cash receipts and expenditures during a particular Budget as revenue or expense, rather than the accrual accounting method that applies under generally accepted accounting principles (GAAP), which would match revenue to the same time period as the right to receive the revenue was created.
Various subsidy programs for financially distressed hospitals generate a receivable of federal funds in a particular fiscal year that may not get paid to the State until the next fiscal year. The State, not infrequently, “advances” the federal share of funding in the current fiscal Budget year knowing that it has a receivable from the federal government in a subsequent time period. This State advance is treated as spending in the year it is provided. When funding from the federal receivable is received in the subsequent budget year, that funding typically is available to explicitly repay the State advance or to offset State spending that would otherwise be necessary in that succeeding Budget year.[6]
The Executive Budget indicates that the State advanced $1.1 billion in funding to financially distressed hospitals (all of which is characterized as being related to the federal share of Directed Payment Template (DPT))[7] advances from FY 22 and FY 23 that initially was expected to be recouped in FY 24, but which now is expected to be recouped in FY 25. Budget presentations implied that the financially distressed hospitals simply chose not to make this repayment of the State advance in FY 24. However, our understanding is that the failure to receive federal funds in FY 24 generated by the FY 24 DPT program resulted in financially distressed hospitals using the federal funding received in FY 24 in connection with the FY 22 and FY 23 DPT programs, for current operating expenses. It is misleading to think that the hospitals are carrying substantial amounts of excess cash on their balance sheets and simply refuse to repay it to the State by the end of the FY 24 fiscal year.
We expect that federal funding attributable to the FY 24 DPT program will be received in FY 25, in addition to federal funding that is generated by hospital operations in FY 25. Whether this will be sufficient for hospitals to repay the $1.1 billion State advance as contemplated by the FY 25 Executive Budget depends on the overall level of other distressed hospital funding available in FY 25. If hospitals believe that they do not have sufficient funding to operate in FY 25, it could lead to another repayment standoff with the State. For the purposes of our analysis, however, we assume that the $1.1 billion State advance shown to be recouped in FY 25 will, in fact, be repaid, and will not result in additional financial plan expense in FY 25.
The FDH Funding Chart indicates that the FY 25 Executive Budget only includes State share funding to support approximately $2.1 billion of funding on a gross basis, while showing financially distressed hospitals’ estimated gross need of at least $3.1 billion and perhaps as much as $3.5 billion in gross dollars.
The FY 25 Executive Budget does not specify the amount of State funding that is available to generate $2.1 billion of funding on a gross basis. However, the amount of State funding in the Executive Budget base for FY 25 would appear to be $984 million. For reference, the FY 23 Executive Budget included base funding of $884 million and the FY 23 Enacted Budget added $800 million in funding on top of that base amount, $700 million of which was provided on a nonrecurring basis. The FY 24 Executive Budget included $984 million of base funding and the FY 24 Enacted Budget added $500 million of distressed hospital funding to the base, all of which was provided on a nonrecurring basis.
Part of the “unmet need” will be filled through funding from the newly approved 1115 waiver that is earmarked for financially distressed hospitals. This funding is not reflected in the FDH Funding Chart, but the State share of the 1115 waiver funding is reflected elsewhere in the Executive Budget. The 1115 waiver includes $2.2 billion that can be spent in connection with financially distressed hospitals in four payments spread over the four fiscal years that span the three-year life of the waiver. There is some debate about the amount of such funding that must be connected to transformation initiatives including preparation for participation in a “global budget” model, as opposed to being used simply for budget relief.
The FY 25 Executive Budget shows the use of $275 million of State funding in FY 25[8] as a match for federal funding under this portion of the 1115 waiver, which will result in gross funding of $550 million in FY 25 that is not reflected in the FDH Funding Chart. In an effort to not overstate the amount of additional State funding that will be required to satisfy the “unmet need” of financially distressed hospitals in FY 25 but still acknowledge that some of the 1115 waiver funding will be dedicated to new initiatives, I would assume that approximately $50 million of the 1115 waiver funding will be required for new initiatives and $500 million will be available to provide budget relief.[9] This suggests that the apparent shortfall in gross funding available for the “unmet need” of financially distressed hospitals in FY 25 through the Executive Budget is in the neighborhood of between $500 million (gross) and $900 million (gross).
The amount of additional State share funding that would be required to generate between $500 million and $900 million of gross funding is a function of the amount of federal match that would be available for any additional State funding. We estimate that the required State share to support this amount of gross funding would be approximately $200 million at the lower end of the range and $600 million at the higher end. The availability of a federal share match of State spending on financially distressed hospitals is limited by various federal requirements, including the Upper Payment Limit (UPL),[10] facility specific DSH caps,[11] and a ceiling on the level of enhanced reimbursement rates in the DPT program.[12] Because of these limitations, the amount of increased federal funding is not strictly proportional to the amount of additional State share funding.
A good deal of the machinations involving different structures for supporting financially distressed hospitals is based on minimizing the amount of State-only funding and maximizing the amount of federal funding available for these operating subsidies. The precise amount of additional federal funding that could be generated from each dollar of additional State share funding is difficult to determine without hospital-specific information that is not easily accessible to the public.
There is another dynamic affecting the availability of federal funding beyond the limits that would require an offset of other federal payments. In some cases, increased DPT rates could be eligible for a federal match, but it might be more efficient to use State-only funds on a targeted basis. At some point, increasing DPT rates is inefficient because it uses scarce State share resources to drive funding beyond the financial need of certain hospitals – what the State has always called “leakage.”
A reasonable assumption is that increased State share funding for DPT rates could efficiently drive a maximum of $300 million of federal funding, which would require $200 million of State share match funding. In the absence of a novel mechanism for increasing the amount of federal match, there is a good chance that any additional State funding would have to be made on a State-only basis.
The Table below reflects the assumption that additional State funding of between $216 million and $600 million not currently reflected in the FY 25 Executive Budget would be required to fully satisfy the “unmet need” of between $3.1 billion and $3.5 billion of gross overall need, as reflected in the FDH Funding Chart.
It is important to note that the amount of “unmet need” is, to some extent, a subjective determination about the operating needs of individual financially distressed hospitals. There is always some degree of difference in the perspective of the financially distressed hospital and the State about what the hospital “needs to have” and what it would “like to have.” To some extent, this may account for the difference between $3.1 billion in “unmet need” and $3.5 billion in “unmet need.” The State always seeks to find a balance between providing additional funding to match the “unmet need” and identifying initiatives to reduce the amount of “unmet need.”
Even at the higher boundary of “unmet need,” however, the level of funding available generally does not provide sufficient funding for larger transformation initiatives or for improving the hospitals’ working capital position. The State sometimes refers to the target level of funding as the amount of financial assistance to hospitals to achieve a “zero cash balance.” No one believes this is an ideal policy. However, providing subsidies to financially distressed hospitals has been like trying to catch a falling knife. As operating deficits have continued to grow, the State has never been able to get far enough ahead to provide the funding that would be needed for a large transformation initiative or a stronger working capital position that does not hinder day-to-day operations.
Finally, there is another important caveat with respect to the “unmet need” shown in the FDH Funding Chart. Because the State generally has limited visibility into the finances of hospitals to which it is not already providing operating subsidies, the “unmet need” estimate does not account for additional hospitals that may require operating subsidies in FY 25 for the first time. The FDH Funding Chart also does not fully reflect some known problems – Nassau University Medical Center comes to mind – for which the State has been content to kick the can down the road. The experience of the last several years is that one or more hospitals will come forward requiring substantial financial assistance that is not available with the budgeted level of funding and which is not reflected in the “unmet need” of the FDH Funding Chart.
Stakeholder Proposals to Increase Funding for Financially Distressed Hospitals
There are two publicly available stakeholder proposals that began to circulate in earnest after the release of the FY 25 Executive Budget. Both stakeholder proposals seek to increase funding for financially distressed hospitals, which reflect their position that even funding sufficient to satisfy the “unmet need,” as reflected in the FDH Funding Chart, would fall far short of the actual needs of hospitals in New York. One proposal comes from the New York State Safety Net Coalition (the “Coalition”), which comprises nine private hospitals that are recipients of safety net DPT funding[13] and the public hospitals that are part of New York City Health and Hospitals Corporation.[14] The Coalition proposal calls for increases in Medicaid funding that are targeted exclusively to safety net hospitals, implicitly defined as members of the Coalition, other private hospitals in the safety net DPT program, and certain public hospitals that meet the minimum levels of Medicaid patient mix requirement of the safety net DPT program. The Coalition says it would also welcome an across-the-board increase in Medicaid reimbursement rates, but that is not part of its proposal.
The second stakeholder proposal comes from the Greater New York Hospital Association (GNYHA) and 1199SEIU, which calls for a 30% increase in funding for Medicaid reimbursement rates over four years. The proposal does not offer a specific allocation formula for the distribution of that increase, but GNYHA has said that it believes the increase would be disproportionately directed to financially distressed hospitals even though all hospitals would receive reimbursement rate increases. The GNYHA/1199SEIU proposal is supported by an advertising campaign that is critical of the FY 25 Executive Budget and Gov. Hochul for not adequately supporting safety net hospitals. The campaign highlights that Medicaid rates do not cover hospitals’ operating expenses, thereby contributing to inequities in the healthcare system.
The New York Safety Net Hospital Coalition Proposal
The Coalition proposal is based on a legislative proposal introduced last year titled the “Health Equity Stabilization and Transformation Act.” The bill would require the State to increase enhanced rates under the safety net DPT program to a level equal to the regional average commercial rate. This is in contrast to the State’s existing, CMS-approved arrangement that requires Medicaid rates, including both the base rate and the enhanced DPT payment, to remain below the average commercial rate of the hospitals participating in the DPT program, which is a lower ceiling than the regional average commercial rate. In addition, the legislation would expand the safety net DPT program to include most public hospitals.
There appears to be some precedent for CMS's approving the use of regional commercial rates in DPT programs, but there is no assurance that CMS would give New York that authority. The bigger obstacle beyond CMS approval is that the State would need to be prepared to provide the State share match required to finance that higher level of DPT funding, which historically has not been the case. Moreover, although the Coalition argues that enhanced DPT rates could be provided on a more targeted basis than they are today, increasing DPT rates all the way to average regional commercial rates would result in providing certain hospitals more funding than their current operating deficits.
The Coalition has not publicly disclosed how much additional gross funding would result from the increase in safety net DPT rates and expansion of the safety net DPT program to additional public hospitals. Budget hearing testimony calls for “an investment of at least $1.4 billion in operating funding to support the needs of our coalition hospitals.” Although the testimony does not state explicitly whether this $1.4 billion is an additional State investment or a gross amount, based on the Coalition’s proposal last year (and its comment that the Coalition’s private hospital members alone have an unmet need of approximately $1.5 billion), we think the Coalition is seeking an additional $1.4 billion in State share funding just for its public and private member hospitals and the smaller number of non-member hospitals eligible for safety net DPT program funding.[15] Depending on the availability of federal match, the Coalition’s request for an additional $1.4 billion in State investment would generate additional gross funding of approximately $3.5 billion, assuming a 60% federal share.
The Coalition does not directly address the difficult-to-explain interplay between increased DPT rates and offsets of other federal funding, including the amount hospitals receive in DSH payments. The simplest way to explain this issue is that every hospital has what is known as a “facility specific DSH cap,” which is based on the hospital’s financial losses from serving Medicaid (about 80% of the total) and uninsured patients (about 20% of the total). Increased Medicaid rates reduce the losses from serving Medicaid patients. Hospitals that receive DSH payments below their facility specific DSH caps have “headroom” for additional DPT payments before triggering an offset of DSH payments. Once the headroom is used up, DSH payments are reduced dollar-for-dollar for all DPT payments made above the facility specific DSH cap.
The facility specific DSH limitation is particularly an issue for public hospitals because they generally receive DSH payments equal to 100% of their facility specific DSH cap. As a result, increased base Medicaid rates or DPT payments will offset the portion of DSH payments related to losses on Medicaid patients on a dollar-for-dollar basis. The two financial benefits to public hospitals of higher rates are (i) the DSH recapture does not apply to fee-for-service payments that account for approximately 10-15% of total Medicaid payments; and (ii) Medicaid managed care payments (including DPT payments) receive a 60% federal match, while DSH payments only generate a 50% federal match, thereby freeing up State share for other purposes. The DSH payment offset is an issue for private hospitals participating as well, but because they receive much lower DSH as a percentage of their facility specific DSH cap (about 30% on average), it is a smaller problem for them.
The GNYHA/1199SEIU proposal
The GNYHA/1199SEIU proposal calls for Medicaid payments to cover 100% of the “actual cost” of care. Budget testimony said that the State “must start to close and then eliminate the 30% gap between the cost of care and the amount Medicaid pays for hospital services, phasing up to 100% over four years.”[16] Investments under the proposal would be tied to hospitals’ meeting mutually agreed-to metrics on reducing health disparities. The GNYHA/1199SEIU proposal states that it would require an increase in Medicaid payments of approximately $6.9 billion (gross) to reach its target of full reimbursement of cost. To put this in context, based on the 2022 institutional cost reports, adjusted for certain accounting anomalies, aggregate losses of hospitals in New York totaled approximately $3.4 billion, while 49 hospitals in New York generated a positive operating margin of approximately $1.9 billion. Based on recent trends, those financial results may deteriorate by the time a $6.9 billion increase in Medicaid funding was phased in.
Medicaid operating payments to NYS hospitals this year will be in the neighborhood of $23 billion, not including capital, DSH payments, and State-only operating subsidies. The full $6.9 billion increase implemented through these Medicaid operating payments would require an increase of approximately 30%. The approximate State share of a $6.9 billion gross increase would be approximately $2.7 billion. Phasing in one-quarter of that amount in FY 25 would require additional State funding of approximately $690 million.
The general rule of thumb is that financially distressed hospitals represent approximately 25% of total Medicaid spending on hospitals. However, the GNYHA/1199SEIU proposal could use a variety of allocation methodologies to shift more of the increase to financially distressed hospitals. It is difficult to model all of these alternative methodologies, but we can make a ballpark estimate that roughly 40% of any increase in base Medicaid rates would flow to financially distressed hospitals that are receiving other State operating subsidies, which could potentially offset a portion of those targeted operating subsidies.
The GNYHA/1199SEIU proposal recognizes that such a large increase in base Medicaid reimbursement rates would trigger offsets of other federal payments to hospitals. To address this issue, the GNYHA/1199SEIU proposal (as well as the Coalition proposal) suggests reducing DSH payments and using the State share that would be freed up to support increased rates. In addition to the DSH issue, a 50% increase in base Medicaid reimbursement would likely exceed the UPL for certain services. The UPL limitation, which applies only to the fee-for-service payments that still account for approximately 10%-15% of total Medicaid payments, generally provides that Medicaid rates cannot exceed Medicare rates for a particular service.
Prior to the release of the one-house budgets, both the Coalition proposal and the GNYHA/1199SEIU proposal could be seen as being aspirational, with the biggest question being where distressed hospital funding would land within the context of the “unmet need” and the split between funding directed only to financially distressed hospitals and additional funding to address the extent to which Medicaid rates do not fully cover costs at all hospitals. As discussed below, the legislative one-house budgets with their proposed MCO tax may, or may not, change the center of gravity in this debate.
Legislative One-House Health Budgets
The Senate and Assembly released their one-house health budgets on March 11 and March 12, respectively. These one-house budgets are the starting gun and the opening gambit in what will become an intensive period of negotiation with the executive.
In most years, the legislative houses respond to the Executive Budget within the same general construct as the Executive Budget proposals. The one-house budgets accept some proposals and reject others, restore many spending reductions advanced in the Executive Budget, and make new investments or incrementally add to the spending levels proposed in the Executive Budget. The houses and the executive have different ideas about what the endgame will produce, but they typically are in the same general ballpark in terms of the size of the fiscal envelope in which to work.
What is different this year is that both houses have advanced a plausible (if unlikely to succeed) strategy to draw down new federal funding which requires no new net State spending in an amount that enables the houses to reject virtually all of the Executive Budget’s savings proposals and to provide new funding that comes close to matching the funding requests of nearly all health stakeholders. This strategy is based on the State’s enacting and CMS’s approving, a new tax on managed care organizations (the “MCO tax”) that is supposed to generate an additional $4 billion in federal funding per year for the next three years without requiring any additional State spending net of proceeds from the MCO tax. The Senate’s Budget Resolution describes the intent in layman’s terms:
"The Senate directs the Department of Health to submit a federal waiver to impose a per member per month tax on all managed care companies, with higher rates imposed on Medicaid Managed Care plans compared to non-Medicaid plans. This tax is expected to yield approximately $4 billion in additional federal financial participation per year for three years."[17]
The proposed MCO tax is what is known as a “health care-related tax” under Medicaid. “Health care-related taxes” are more commonly imposed on providers, thus are often referred to generically as “provider taxes.” Almost all states have provider taxes, but 14 states also impose health-related taxes on managed care organizations.[18]
The basic idea of health care-related taxes under Medicaid is simple: the State could impose a tax of, for example, 1% on all hospital net patient service revenue, which hypothetically would generate $100 million in tax revenue for the State. To make it possible for the hospitals to pay the tax, the State increases Medicaid reimbursement by $100 million. The State accomplishes this by putting up $40 million of the $100 million in tax revenue it expects to receive and drawing down $60 million from the federal government as the federal share of the increased reimbursement rates. The financial position of the hospitals is unchanged (i.e., $100 million in tax payments offset by $100 million in new Medicaid reimbursement). The state comes out $60 million ahead because of the tax revenue it receives, which does not need to be reinvested in reimbursement. The federal government ends up providing $60 million in budget relief to the State, which the State will typically use to fund other healthcare investments.
The federal government understands this dynamic and is supportive of the concept within limits. Those limits are critical, however, because the federal government recognizes the potential for abuse of the system that drives more federal funding without the State having skin in the game.
Even by the high standard of complexity of Medicaid regulations in general, navigating the rules governing the limits on health care-related taxes is difficult. It begins with the following set of general principles, as described by the governmental Medicaid and CHIP Payment and Access Commission (MACPAC):
“Under current federal regulations, states may use health care-related taxes as a source of non-federal share of Medicaid if they meet all three of the following requirements or qualify for a waiver (42 CFR 433.68): Broad based. A broad-based tax is imposed on all the non-governmental health care entities, items, and services within a class and throughout the jurisdiction of the applicable unit of government. For example, the tax cannot be exclusive to hospitals that treat a high proportion of Medicaid patients. Uniform. A uniform tax applies consistently in amount and scope to the entities, items, and services to which it applies. For example, the tax rate cannot be higher on a managed care plan’s Medicaid revenue than on its non-Medicaid revenue. Does not hold taxpayers harmless. Taxpayers cannot be held harmless; that is, they cannot be given a direct or indirect guarantee that they will be repaid for all or a portion of the amount of taxes that they contribute.
The MACPAC summary continues:
“An indirect hold harmless guarantee exists if a health care-related tax produces revenue that exceeds 6 percent of net patient revenue, what is referred to as the safe harbor threshold…. The Secretary of the U.S. Department of Health and Human Services may waive the broad-based and uniform requirements as long as states can demonstrate that the net impact of the tax program is generally redistributive (i.e., proportionally derived from Medicaid and non-Medicaid revenues within a class)….Specifically, states must provide a statistical analysis that demonstrates the tax burden on Medicaid under the proposed approach meets or exceeds a 95 percent correlation with a perfectly redistributive tax.”
To give you an idea of how complex this becomes, here is the language regarding that statistical analysis:
“(i) A State seeking waiver of the uniform tax requirement (whether or not the tax is broad based) must demonstrate that its proposed tax plan meets the requirement that its plan is generally redistributive by: (A) Calculating, using ordinary least squares, the slope (designated as (B) (that is, the value of the x coefficient) of two linear regressions, in which the dependent variable is each provider's percentage share of the total tax paid by all taxpayers during a 12-month period, and the independent variable is the taxpayer's “Medicaid Statistic”. The term “Medicaid Statistic” means the number of the provider's taxable units applicable to the Medicaid program during a 12-month period. If, for example, the State imposed a tax based on provider charges, the amount of a provider's Medicaid charges paid during a 12-month period would be its “Medicaid Statistic”. If the tax were based on provider inpatient days, the number of the provider's Medicaid days during a 12-month period would be its “Medicaid Statistic”. For the purpose of this test, it is not relevant that a tax program exempts Medicaid from the tax. (B) Calculating the slope (designated as B1) of the linear regression, as described in paragraph (e)(2)(i) of this section, for the State's tax program, if it were broad based and uniform. (C) Calculating the slope (designated as B2) of the linear regression, as described in paragraph (e)(2)(i) of this section, for the State's tax program, as proposed.
New York State’s Medicaid program has many health care-related taxes which have been approved by CMS and raise approximately $6 billion annually as part of New York’s Health Care Reform Act of 1996 (HCRA). The two taxes generating the most revenue for HCRA are the 7.04% surcharge on hospital service revenues, and the Covered Lives Assessment that imposes a regionally adjusted assessment per covered life on both health insurers and employer-sponsored health plans that in aggregate totals approximately 1.4% of plan premiums or employer-sponsored health care expenditures.
New York’s ability to maintain the HCRA tax structure and shift cost to the federal government is related to what is known as the “D’Amato provision.” Senator Alphonse D’Amato was able to insert a provision in federal law at the time of the original HCRA statute which grants New York a unique exemption from the broad-based and uniform tax requirements for its HCRA taxes.[19]
Some of these existing health care-related taxes might not meet the current standards CMS applies in the absence of the D’Amato provision. There are a number of reasons that New York has been reluctant to enact new health care-related taxes, one of which is that efforts to modify the taxes subject to the D’Amato provision could undermine the State’s protection for its existing health care-related taxes.
What has changed since last year, and which obviously caught the eye of the legislature, is that CMS approved a new MCO tax in California in 2023 that is expected to generate approximately $19 billion in incremental federal funding for California over the next three years.[20] One of the difficult tests for an MCO tax to navigate is the requirement of uniform application within the provider (or payer) class. If commercial insurance plans in California needed to pay a tax at the same level as Medicaid MCOs’ California MCO tax, it would dramatically increase health insurance premiums. California was able to overcome this problem by constructing a program that met the statistical test set forth above, even though it resulted in Medicaid MCOs’ paying a tax rate roughly 100 times higher than the commercial rate. Other states have moved to enact their own version of an MCO tax along the lines of California’s.
The approval letter from CMS is novel in its form. There is first a simple letter acknowledging that CMS is required to approve a health care-related tax that meets its statistical test and therefore was approving the California MCO tax. At the same time, CMS sent a “companion letter” to California which makes clear that CMS believes California found a loophole in the regulations which CMS will move to close as soon as possible.[21]
The companion letter notes that the purpose of the health care-related tax rules is to prevent States from generating federal revenue without that is not supported by a bona fide purpose other than maximizing Medicaid federal financial participation. That is why states cannot “hold harmless” all parties on whom the tax burden falls. Similarly, the “uniformity test” is designed to prevent States from gerrymandering the tax to apply only to Medicaid providers.
The companion letter notes that the guiding principle of uniformity is that the tax burden be “generally redistributive” in the sense that the Medicaid program – as a result of receiving the federal match – benefits disproportionately compared to others on whom the tax burden falls.
For example, New York imposes a 1.75% tax on the premiums of all for-profit Medicaid and commercial insurers in New York. While the State reimburses Medicaid MCO’s for the cost of the tax, for-profit commercial plans receive no such benefit. In that sense, the tax is redistributive away from commercial plans and toward Medicaid MCOs.
By contrast, California structured its program so that Medicaid member months (which was the unit of measurement for the tax imposed) accounted for “about 50% of all member months but experienced over 99% of the total tax burden.” As such, CMS said the tax burden under the California MCO tax was not “generally redistributive” and would not have been approved but for the fact that regulations require approval of any tax that met the CMS statistical test, even if it contravened the purpose of the rules.
The Companion letter said:
“In order to meet the uniformity test, the proposed tax must be ‘generally redistributive.’ The result of the statistical tests, in these instances, do not appear consistent with either the definition of generally redistributive or reflective of the expected results based on the intended design of the statistical test. Therefore, CMS intends to develop and propose new regulatory requirements through the notice-and-comment rulemaking process to address this issue (emphasis added)…. Please be advised that any future changes to the federal requirements concerning health care-related taxes may require the state of California to come into compliance by modifying its tax structure.”
Stripped of its bureaucratese, CMS is telling California that it got away with one by successfully finding a loophole that violated the intention of the regulations but is now on notice that CMS intends to “address the issue.”
It remains to be seen how the executive will respond to the one-house budget proposals to mimic the California MCO tax. It is conceivable but unlikely that the Hochul administration would choose to roll the dice with CMS and follow the California approach, notwithstanding the companion letter that seems intended to discourage others from going down that path. It is more likely that the administration will seek to develop a different health care-related tax. It will take creativity to design a new health care-related tax that can generate enough incremental federal funding to be meaningful but still not impose undue burdens on other parts of the health ecosystem, such as commercial insurance rate payers.
In any event, the legislature’s proposed MCO tax and perhaps the development of an alternative health care-related tax by the executive will complicate the Health budget negotiations. It is inconceivable that the State could get a definitive answer from CMS on such a complex issue by the April 1 Budget deadline, although it might be able to get informal guidance.
Unless the State feels confident that a health care-related tax will be approved by CMS, it would be taking a big risk to count on the incremental federal revenue from the MCO tax to balance the Medicaid Global Cap and the larger Enacted Budget. Alternatively, if the legislature would accept the State’s conditioning substantial reimbursement rate increases and the elimination of savings initiatives in the one-house budget on receipt of CMS approval, stakeholders who are advancing these positions would run the risk of coming up empty-handed if CMS failed to approve the health care-related tax.
In any event, it seems likely that the proposed MCO tax is a threshold issue that will have to be resolved at higher levels before much progress can be made on other issues at the Health budget table. Unless there is a breakthrough that provides very significant new federal funding from a health care-related tax, it is unlikely that the Enacted Budget will reflect increases in State share funding to the level reflected in the one-house budgets and the stakeholder proposals.
It is almost a given that the State will increase the amount of State share funding available for financially distressed hospitals from the roughly $1.25 billion included in the FY 25 Executive Budget. But if there is not enough money in the Budget to both meet the needs of financially distressed hospitals and increase Medicaid rates for all hospitals, it creates a Hobson’s choice for the State. Historically, the State’s choice has been to limit the overall growth in Medicaid spending by targeting all available increased funding to the financially distressed hospitals that, in the absence of sufficient operating subsidies, would need to severely curtail services or close.
I suspect that the collective decision of the executive and the legislature regarding this trade-off may be different in this year’s Budget than it has been in other years, both because of political pressure from the GNYHA/1199SEIU campaign to increase Medicaid reimbursement rates for all hospitals and the fact that, without increased reimbursement from Medicaid, the number of hospitals that will be unable to sustain operations without operating subsidies will continue to grow. This will put increasing pressures on financially distressed hospitals, especially those for which financial sustainability depends on a significant restructuring through a transformation plan.
The Healthcare Safety Net Hospital Transformation Fund
The Healthcare Safety Net Transformation Program (the “Safety Net Transformation Program”) is a proposal in the FY 25 Executive Budget designed to foster partnerships between safety net hospitals and stronger health systems. This has long been the State’s goal, but the strategy has been stymied by the unwillingness of stronger health systems to participate. The Safety Net Transformation Program seeks to facilitate these partnerships by creating a more streamlined process for requesting State capital support for these partnerships, as well as giving DOH the authority to waive regulations that might hinder the creation or operation of the strategic partnerships. Most of the detail regarding the Safety Net Transformation Program is included in Part S of the Article VII Bill that would create the program, which was further clarified in the 30-day Amendments.[22]
In contrast to the existing healthcare capital Request for Application (RFA) process, which prohibits communications with applicants about their active submissions, the Safety Net Transformation Program will enable the State to work strategically with potential partnerships to craft a structure that is acceptable to all parties including the State, which would provide financial support. It is less clear how the regulatory waiver authority would come into play, but it is good to have the tools to expedite transactions to the extent possible without sacrificing existing transparency protections.
The Safety Net Transformation Program approach is an important innovation that is overdue. However, to be successful in overcoming long-standing resistance to the creation of these strategic partnerships, the program will require much more capital funding than the $500 million of already allocated capital included in the FY 25 Executive Budget. In the 30-day Amendments, the administration dedicated $300 million of that amount to support a transformation initiative at University Hospital at Downstate Medical Center. Based on past experience, it seems reasonable to assume that nearly every true transformation partnership will require a minimum of $300 million-$500 million per facility being transformed to restructure a financially distressed hospital and its ambulatory care network in a way that improves the chances of sustainability.
The one-house budgets proposed to increase the amount of capital available for healthcare providers from $500 million to $1.5 billion. However, the one-house proposals contemplate a capital program modeled on the State’s healthcare capital programs over the last decade, in which the full range of healthcare providers are eligible to apply for an award (as opposed to just financially distressed hospitals in partnership with a larger health system) and which includes a requirement that some consideration be given to regional balance.
Although the application and eligibility process proposed by the houses represents a lost opportunity compared to the more strategic focus of the Safety Net Transformation Program, the bigger issue in my view is that the houses (as well as the Executive Budget) fail to recognize the magnitude of capital funding required to make widespread structural changes to financially distressed hospitals in New York.
Our Policy Brief on financially distressed hospitals called for the creation of a $4 billion-$6 billion Healthcare Transformation Financing Fund as a new public authority financed by inflation-adjusting the Covered Lives Assessment (CLA) to its 2009 level. As we noted in that paper, successful implementation of most hospital transformation plans is likely to require significantly more capital than the state has appropriated for hospitals in the past. Our belief is that transformational levels of capital investment would be significantly offset over time by the reduction of State operating subsidies.
Because the CLA is financed by all commercial payers for healthcare services, it is the most broadly based user fee available to fund healthcare. At one time, the State’s CLA assessment for individuals covered by commercial insurance or self-funded plans amounted to approximately 2.0% of such expenditures. Because of inflation, the CLA now amounts to approximately 1.4% of such expenditures. Inflation-adjusting the CLA by restoring it to the 2.0% level would generate approximately $500 million per year, which would be sufficient to support debt service for capital funds as large as $4-$6 billion. The CLA is also a health care-related tax, but one whose structure does not carry the regulatory risks of something similar to the California MCO tax.
Another alternative for creating a major new capital program for financially distressed hospitals would be to use a portion of the State’s financial reserves to fund the pool. The chart of Closing Fund Balances in GNYHA’s Budget testimony is truly striking. The level of reserves that the State has been holding since the COVID-19 pandemic ended is truly unprecedented.
Graph and source note from GNYHA Budget testimony, SFY 24-25: https://www.nysenate.gov/sites/default/files/admin/structure/media/manage/filefile/a/2024-01/greater-new-york-hospital-association.pdf
Reserves beyond a certain level should be used to buy down future operating expenses, or the pressure to use reserves for current operating expenses will, at some point, become irresistible. Former New York City Mayor Bloomberg did this years ago when he created a capital fund to offset future unfunded retirement health benefits. I believe that a capital investment of $4 billion-$6 billion to fund the transformation plan of a number of severely financially distressed hospitals would reduce future operating subsidies and represent a legacy investment for the Hochul administration and our current legislative leaders. It is hard to think of a more strategic use for a meaningful portion of the State’s excess financial reserves.
Capital appropriations frequently do not come into being until close to the end of budget negotiations. My hope is that the legislature and the executive will recognize that these types of partnerships require much greater capital support than has generally been available in the past and will add substantially more capital for the program in the final Budget. If the Enacted Budget includes sufficient capital to support at least a handful of major hospital transformation programs, and the administration is able to develop an enforceable mechanism to ensure ongoing operating support for the financially distressed hospital junior partner for a number of years, it may open the door to participation by stronger health systems in these transformation partnerships. That, in turn, could lead to real structural change that stabilizes a number of the State’s most financially distressed hospitals and reduces ongoing operating subsidy requirements.
It is difficult to overstate the need for a massive capital investment, a credible commitment to ongoing opportunities for a number of years, and a clear and compelling case that the transformation plan will meet the healthcare needs of the community to overcome local resident and stakeholder resistance to significant restructuring of financially distressed hospitals. The ongoing drama over the contemplated transformation plan for University Hospital at Downstate Medical Center is a cautionary tale about how difficult it is to bring about structural change to institutions even when the case for change is compelling.
The specific plan for the transformation of Downstate Medical Center is still in development, but the broad outlines involve building up the outpatient clinical care network while, at a minimum, transferring elective surgeries to neighboring hospitals. It is generally thought likely that the transformation plan would ultimately involve transferring certain services of University Hospital to Kings County Hospital and other neighboring hospitals, which would potentially lead to the closure of University Hospital. The downsizing or closure of University Hospital, if it ever occurs, would free up resources to strengthen rather than weaken the other parts of Downstate Medical Center, such as the medical school, that more directly serve Downstate’s academic mission. This is an idea that has been discussed for 20 years, but this is the first time that SUNY has advanced a specific proposal with support from the Executive Budget.
Predictably, the proposal has drawn sharp opposition from the community, elected officials, labor stakeholders, and clinicians at University Hospital who would be most affected by the changes. The widely respected journalist, Errol Lewis, wrote a column on February 28, 2024, in New York magazine that was headlined, “Stopping This Hospital Closure Is a Key Test of Black Political Power In New York.”[23] It is granted that journalists are not always responsible for the headlines of their stories, but in this case, the headline captured the thrust of the piece. The potential merits of the proposal were barely mentioned while the negative consequences of discontinuing underutilized beds were taken as a given.
Shortly thereafter, the lead story in Crain’s New York Health Pulse appeared to show some of the backers of the Downstate transformation plan already in retreat. Mitch Katz, the CEO of NYC Health + Hospitals, whose Kings County Hospital facility is supposedly the intended recipient of a $300 million capital appropriation in the FY 25 Executive Budget to be able to absorb services from University Hospital, said, “We are never in favor of hospital closures.” Gov. Hochul’s office similarly seemed to walk back its support for the implications of the transformation plan, with a spokeswoman for the governor saying that “under [Gov.] Hochul’s direction, ‘SUNY will continue to listen to the voices of residents as it finalizes plans to invest in and revitalize Downstate - not close it.’”[24]
If there is a way forward to bring about a fundamental transformation at Downstate, it will probably involve an even greater investment in building up ambulatory care and outpatient specialty services than has already been proposed. As we discussed in our Policy Brief on financially distressed hospitals, experience has shown that the public can be persuaded that an outpatient facility of the quality of Lenox Hill Greenwich Village can offer better healthcare services than a struggling hospital. A clear and funded vision for how healthcare services can be provided outside of the hospital, combined with the Vital Brooklyn strategy of integrating housing and addressing a wide range of health-related social needs as part of a comprehensive strategy, can build the support necessary to close an underutilized hospital, as happened with the Kingsbrook Jewish Medical Center Hospital as part of the Vital Brooklyn plan. To be successful, however, such an initiative will require more capital funding and ongoing operating support than is made available by either the FY 25 Executive Budget or the legislative one-house budgets.
Conclusion
Compared to seemingly intractable challenges facing New York, the need to restructure New York’s hospital system to adapt to the disruptive change wrought by technological innovation and new business models should be something the government can accomplish. But even if these situations should be manageable individually, the scale of the financial requirements of restructuring combined with the public’s resistance to change makes the problem of financially distressed hospitals one of the most important issues the State needs to deal with. Already, roughly 30% of the State’s hospitals require operating subsidies beyond regular reimbursement rates to maintain services. That number is likely to continue to grow by the year as the underlying forces driving financial distress show no signs of abating. At the same time, the extent of the operating deficits of the most severely financially distressed hospitals continues to expand inexorably.
The FY 25 Enacted Budget presents an opportunity to address the issue of financially distressed hospitals in a more comprehensive manner than has been the case since 2015, when the State began providing failing hospitals with operating subsidies and appropriated $700 million in capital that catalyzed the creation of One Brooklyn Health. How far the FY 25 Budget goes in addressing these problems remains to be seen, however. The legislature has rejected nearly all of the savings initiatives proposed in the Executive Budget in other parts of the Health Budget, which by definition means less funding for financially distressed hospitals. Instead, the legislature has pinned its hopes on dramatically increasing federal funding based on a strategy that CMS has signaled it does not support.
In contrast to the ambitions of the proposals to increase operating support to financially distressed hospitals, neither the executive nor the legislature have so far committed the amount of capital that would be needed to significantly restructure financially distressed hospitals. The executive has at least proposed a better structure – the Safety Net Transformation Program – for designing partnerships and providing capital support to advance these initiatives. But the legislature seems inclined to continue with an incrementalist approach that spreads available funding too broadly to drive fundamental change. We can still hope that a capital program that matches the scale of the financially distressed hospital challenge emerges from the Budget negotiations.
The Health portfolio entered the FY 25 Budget season with two burning houses – the unsustainable growth in personal care spending and the ever-increasing challenges of financially distressed hospitals. The legislature in its one-house budgets rejected incremental changes proposed in the Executive Budget to control the growth in personal care spending and did not include the ambitious proposal to eliminate partial capitation MLTC plans even though a bill to accomplish that has been introduced by the Chairs of the Senate and Assembly Health Committees.
With respect to financially distressed hospitals, it is possible that the MCO tax modeled on the California MCO tax – or some alternative health care-related tax that the executive might develop – will provide so much additional federal revenue that it will eliminate the need to make difficult decisions in the FY 25 Health Budget. What is more likely is that the ongoing problems with unsustainable growth in personal care spending and ever-growing needs of financially distressed hospitals will present the State with a Hobson’s choice of, on the one hand, providing operating subsidies that are sufficient to preserve the status quo but insufficient to drive longer-term structural change; or, on the other hand, accepting the significant political cost of the reduction or elimination of hospital services, including full hospital closures.
The Hochul administration certainly recognizes the magnitude of the problem. Its Commission on the Future of Health Care is intended to approach the problem with more of a scalpel and less of a sledgehammer – but its recommendations will, at the soonest, inform the FY 26 Executive Budget. Similarly, the upcoming Master Plan for Aging may include new strategies for addressing the challenges of long-term care.
The unprecedented level of financial reserves the State is holding and the possibility of unanticipated new federal funding from a health care-related tax suggest that the fire in the two burning houses of the Health portfolio will at least be doused by the FY 25 Enacted Budget. But the State is at or rapidly approaching a crossroads for dealing with these complex and deep-seated problems. The FY 25 Budget will be an important signal of which way the State will turn at this particular fork in the road.
Endnotes
[1] Executive Budget Briefing Book, Page 72.
[2] Executive Budget Briefing Book, Page 72. This represents the number of hospitals receiving supplemental operating subsidies from the State, including the 18 critical access hospitals (CAH) and 20 sole community hospitals (SCH) receiving relatively small subsidies under the CAH/SCH DPT program.
[3] Health and Mental Hygiene Article VII Bill – FY 2025 NYS Executive Budget, page 229.
[4] Executive Budget Briefing Book, p. 72.
[5] Executive Budget Financial Plan, p.112.
[6] Sometimes, the timing of cash receipts works in the other direction. In FY 21 and FY 22, financially distressed hospitals received more funding from the federal government in COVID-19 Provider Relief Funding and Medicare advances than they had in COVID-19 expenses. Although the hospitals recognized the liability to repay Medicare advances on their financial statements prepared in accordance with generally accepted accounting principles, the State – consistent with its approach to liabilities generally – instructed the hospitals to use those advances in the current year even though doing so would increase their need for State share spending in the subsequent year when the federal funding needed to be repaid.
[7] For an explanation of the DPT program, see "The Challenge of Financially Distressed Hospitals In New York."
[8] Executive Budget Financial Plan, p. 112.
[9] Some stakeholders have raised concerns that using only $50 million per year to prepare for 1115 Waiver requirements may be insufficient. The estimate that $500 million per year will be used for budget relief is not a conclusion that this is the right balance between new initiatives and budget relief, but rather a reflection of the amount that hospitals may need to apply to support existing operations given their other sources of funding.
[10] CMS applies an upper payment limit (UPL) calculation to fee-for-service (FFS) payments only. The UPL caps the amount of available federal funding for FFS rates at the higher of 1) hospital cost or 2) the equivalent of what Medicare would have paid.
[11] DSH caps are based on hospital losses from serving Medicaid and uninsured patients. The DSH cap only limits the amount of Medicaid DSH funding that a hospital may receive, not the amount received through regular FFS rates or DPT payments.
[12] As discussed in more detail below, CMS sets a ceiling based on commercial rates, which a DPT payment may not exceed.
[13] The State also has a DPT program that provides supplemental payments to all Critical Access Hospitals and Sole Community Hospitals in New York State. However, it is roughly 10% of the size of the safety net DPT program and is much less relevant to the State's efforts in support of financially distressed hospitals. Unless the context otherwise requires, references in this paper to the DPT program are to the safety net DPT program.
[14] This is based on the hospitals listed on the New York State Safety Net Coalition website as of the date of this paper.
[16] The testimony adds that "The same gap must be closed on the nursing home side over the next two years." However, the nursing home funding issue is beyond the scope of this paper.
[17] Senate Budget Resolution, p. 32.
[18] “[A]lmost all states have enacted taxes on hospitals (44) and nursing facilities (46) but only 14 states have enacted taxes on managed care organizations.” https://ccf.georgetown.edu/2020/05/14/taxing-medicaid-managed-care-to-mitigate-medicaid-cuts/
[19] https://cbcny.org/research/six-things-know-about-new-york-state-health-care-reform-act-hcra-taxes
[21] Ibid.
[22] Amendments Narrative | Health and Mental Hygiene Article VII Bill | FY 2025 NYS Executive Budget
[23] https://nymag.com/intelligencer/article/suny-downstate-hospital-closure-tests-black-political-power.html#/
[24] Crain's Health Pulse: "Resistance mounts to SUNY Downstate closure plan as surrounding hospitals brace for influx of patients," March 7, 2024.
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