Commentary # 10 by Paul Francis
Week of March 25th, 2024
This commentary is available as a PDF here:
The April 1 Budget deadline is fast approaching. It is difficult to assess from the outside how close the Executive, the Senate, and the Assembly are to reaching three-way agreement. However, the likelihood of a federal revenue windfall from the MCO Tax proposed by the Senate and Assembly must be changing the internal calculus and making it easier for the parties to close down the Health budget than I expected before the introduction of the one-house budgets.
The purposes of this Addendum to my March 19 Commentary titled California Dreaming and the MCO Tax are to better explain the dynamic of how the MCO tax gets around the federal “uniformity” test for taxes of this type, correct an inaccurate statement I made in the March 19 Commentary about the amount of increased Medicaid spending that could be supported by a $4 billion MCO tax, and to make a last-minute pitch for the Enacted Budget’s structure for awarding healthcare capital.
“God, I wish I had thought of that.”
In the early days of Priceline, when it was clear that the company was going to ride on the crest of the internet wave but before it had gone public, Priceline’s Chairman, CEO, and I (as CFO) met with a few US representatives of the Japanese conglomerate, the SoftBank Group, which was a major investor in internet companies. As we discussed the challenges of managing quarterly earnings and setting guidance for future performance, one of the SoftBank representatives said they were not afflicted with such short-term pressures because they had a “300-year business plan.”[1] All I could think was, “God, I wish I had thought of that.”
As I have peeled the onion on the MCO tax over the last week, all I can say is, “God, I wish I had thought of that.”
The MCO tax, for those who have not been paying close attention to the FY 25 Health budget, is what is known as a “health care-related tax.” The primary feature of such taxes – often called “Provider taxes” – is the ability to generate additional federal revenue that can be used to finance the required State share of further Medicaid spending. Because this technique of generating incremental federal revenue is susceptible to abuse, the Center for Medicare and Medicaid Services (CMS) has a three-pronged requirement designed to ensure that the sole purpose of the tax is to generate increased federal revenue. Health care-related taxes (whether imposed on providers or managed care organizations) must be broad-based, uniform, and not hold harmless all taxpayers who are paying the tax.[2]
The MCO tax is broad-based because it applies to all managed care organizations — Medicaid as well as commercial. The uniformity test is less straightforward. In general, the tax must be “generally redistributive” in the sense that the impact of the tax is different for some taxpayers than it is for others. However, a number of years ago, CMS established a statistical test of uniformity that can be met in lieu of achieving the principle of uniform application of the tax. The “magic trick” by which the statistical test can get around the principle of uniformity is the use of different metrics (such as member months) in the statistical test rather than the tax rate or aggregate tax burden of Medicaid versus non-Medicaid managed care organizations that are subject to the tax.
As we discussed in the March 19 Commentary, it benefits states to have as large a differential as possible between Medicaid and non-Medicaid managed care organizations that are subject to the tax. This is because the tax burden of the Medicaid managed care organizations can be offset by capitated rates to reflect the cost of the tax. By contrast, there is no easy mechanism for offsetting the burden of the tax on the non-Medicaid organizations because doing so directly or indirectly would potentially violate the “hold harmless” regulatory requirement for health care-related taxes. If the burden on the non-Medicaid taxpayers is too great because it cannot be offset in other ways, the overall MCO tax becomes politically more difficult to impose.
California solved this problem of increasing the cost of commercial insurance by creating a 99-to-1 rate differential between the tax rates of Medicaid managed care organizations and non-Medicaid managed care organizations. California was able to structure its tax in a way that satisfied the statistical test of uniformity notwithstanding this vast differential in tax rates and aggregate burden of the tax. CMS reluctantly approved the California MCO tax in December 2023, but noted in a companion letter that the California MCO tax was not consistent with the principle of uniformity and that CMS would pursue regulatory changes to close the loophole created by the statistical test.
Although the impact on federal spending of approximately $19 billion over four years from the California MCO tax spurred CMS to announce that it was going to seek to change the applicable regulations, California was not the first state to use a statistical test to support an MCO tax with a vastly different rate structure for Medicaid managed care organizations versus non-Medicaid managed care organizations. For example, in 2020, Illinois adopted an MCO tax with a rate differential similar to California’s. West Virginia also appears to have an MCO tax rate structure heavily weighted toward Medicaid managed care organizations.
CMS is now trying to close the barn door after a number of horses have already fled and more (including New York and Massachusetts) are poised to take advantage of the same technique. It is possible but unlikely that CMS will find a way to slow-walk these applications until its regulations change. It is not a foregone conclusion that the Enacted Budget will include an MCO tax similar to the California MCO tax. However, indications are that some form of MCO tax, perhaps paired with other Provider tax increases, will be included in the Enacted Budget.
There are some practical limitations on the amount of federal revenue that can be generated through health care-related taxes. The amount of tax revenue a state can raise from a health care-related tax is limited to 6% of the revenue of the class of providers or managed care organizations. Moreover, New York and other states may find it difficult to identify metrics for the statistical test that support a rate differential as extreme as California’s or Illinois’s. Finally, New York always needs to navigate carefully to ensure that new health care-related taxes do not jeopardize federal revenue from New York’s HCRA program, which is exempted from the broad-based and uniform tests for such taxes because of what is known as the D’Amato Amendment that was embedded in law in 1997.[3] But even with these caveats, it seems likely that an MCO tax (and perhaps increases in other Provider taxes) will generate a large windfall of federal revenue that will go a long way toward solving the FY 25 Health budget.
It’s unlikely that the State will know the exact amount of revenue that can be raised until the MCO tax and perhaps other Provider tax increases are approved by CMS. As we discussed in the March 19 Commentary, there is still the question of whether any spending increases or restorations of cuts proposed in the Executive Budget will be subject to federal approval. Given the CMS companion letter and its admonition that states will need to conform their tax structures to more restrictive regulations if they are adopted, this revenue may only be available for one or two. The perils of “cliff funding” are real, but only the most purist budget watchdogs would suggest leaving this amount of federal funding on the table.
So kudos to the Assembly staff who figured this out. I have to say, “God, I wish I had thought of that.”
I would also say that it is a good thing that this proposal was advanced by the Legislature rather than by the Executive. CMS should be embarrassed – and probably is – that states can take advantage of this obvious loophole to drive so much additional federal revenue to the states in contravention of the long-standing principles for health care -related taxes. The Executive has lots of business in front of CMS, not the least of which was the recently approved $7.5 billion 1115 waiver. I imagine it would have been hard for the Executive to negotiate the waiver in good faith with CMS while at the same time planning to pick the pocket of the federal government to the tune of $4 billion a year through an MCO tax modeled on California and Illinois.
Even at this late stage, trying to predict the shape of the final FY 25 Health budget is even more difficult than developing a mock NFL draft. Two things I would watch for in the final product are, first, the differential in rates and aggregate tax burden between Medicaid managed care organizations and non-Medicaid managed care organizations; and second, will the Budget seek to skirt the CMS “hold harmless” prohibition by finding ways to indirectly offset the new tax burden of the non-Medicaid organizations subject to the MCO tax.
Leveraging MCO tax revenue to support additional Medicaid spending
The amount of additional Medicaid spending financed by an MCO tax or other Provider taxes is a function of how much tax revenue is available after increasing capitation rates to Medicaid managed care organizations to reflect the cost of the MCO tax.
Although many people may take issue with the conclusions of our analysis, we try hard to be accurate in our factual descriptions. I made a pretty big mistake in the March 19 Commentary’s description of the amount of an MCO tax that would be needed to generate $4 billion in additional Medicaid programmatic spending suggesting that the total amount of the tax would need to be approximately $6.7B.[4] In fact, an MCO tax that generated $4 billion of tax revenue could potentially support more than $4 billion in additional Medicaid spending as described below.
The amount of potential additional Medicaid spending that could be supported by an MCO tax is a function of the State net revenue from the tax after providing the State share for increased capitation rates to Medicaid managed care organizations. A $4 billion MCO tax would generate at least $2.4 billion in revenue to the State after it put up $1.6 billion as the State match for increased capitation rates to Medicaid managed care organizations. This $2.4 billion in new revenue to the State could become the State share of additional Medicaid spending. In actuality, the amount of net State revenue from a $4 billion MCO tax will be greater than $2.4 billion because a portion of the MCO tax will be paid by non-Medicaid managed care organizations.
This may be easier to illustrate than explain, which we have done in the table below. The examples of the total amount of the tax in the split between Medicaid and non-Medicaid organizations are strictly hypothetical.
I want to reiterate that this is a hypothetical illustration. For a variety of reasons, the ultimate level of the MCO tax may be lower than $4 billion; the State may not choose to use all of its net tax revenue on providing the State share of increased Medicaid spending, and the State may spread out this increased Medicaid spending over multiple years particularly since the MCO tax is likely to only be available for a year or two.
Healthcare Capital
The third issue I’m watching closely to see how it plays out in the Enacted Budget is healthcare capital. On its face, it looks like the Houses are generally on the same page as the Executive with respect to healthcare capital. The Senate added more than $1.5 billion and the Assembly added $1 billion in additional healthcare capital and gave the Executive wide discretion for developing allocation criteria.
However, the one-house bills would spend this capital through a continuation of the Statewide Health Care Facility Transformation Program (SHFTP) that has been used since 2015 rather than through the Healthcare Safety Net Hospital Transformation Fund (the “Transformation Fund”) proposed in the Executive Budget.
As we have discussed in previous papers, the new process embodied by the Transformation Fund would enable the State to work more strategically with potential partnerships between distressed hospitals and stronger health systems in developing and implementing a comprehensive restructuring or transformation plan. This kind of strategic collaboration is much more difficult within the construct of requests for application under the SHFTP.
There is no question that many parts of the healthcare delivery system, including financially distressed hospitals that are not able to find a larger health system partner, need additional capital funding. If the legislature believes it needs to enable a wider group of providers to compete for capital than would be possible through the Transformation Fund, I would hope they could accomplish that objective simply by adding funding to the existing SHFTP programs for which Requests For Applications are still outstanding (as opposed to requiring an entirely new round of RFAs).
In any event, it is important that the Enacted Budget include the structure of the Transformation Fund, since this is a better vehicle for developing the kind of strategic restructuring and transformation plans the State needs.
End Game
Although we got a couple of things wrong in our early appraisal of the MCO tax, I think we may get another thing right. In my Dynamics of the New York State Budget Process, I wrote:
If there is sufficient revenue without increasing taxes to achieve a balanced Budget without cuts and without creating losers, the legislature has a fairly strong hand to play. I expect that will be the dynamic this year for Gov. Hochul. Revenue has been much stronger than expected and there is a lot of money sloshing around. There is no single issue, such as bail reform last year, that the Governor must win in the Budget at all costs. The criticism that followed last year's late budget may ring in the administration's ears, which may be another motivation for the administration to take the best deal it can get by close to April 1 and just declare victory.
I don’t have visibility into issues in the FY 25 Budget outside of Health. There are difficult issues, such as housing, that are harder to fix with more revenue and spending and which could still lead to a stalemate. However, because of the surprising development of the proposed MCO tax, there is even more revenue sloshing around than I thought possible in February. I don’t expect people will have Easter dinner with the FY 25 Budget in the rearview mirror, but it does seem likely to me that an Enacted Budget will be reached in the week or two thereafter.
Paul Francis
March 26, 2024
[4] I compounded the offense by suggesting that it was the Assembly that misunderstood this.
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