Commentary # 9 by Paul Francis
Week of March 18th, 2024
This commentary is available as a PDF here:
The release of the so-called “one-house” budget bills by the Senate and Assembly in the second week of March are usually a predictable mix of alternative provisions to the Executive Budget that represent the opening gambit in Budget negotiations. One thing the one-house budgets typically are not, however, is surprising.
The Health section of the one-house budgets the Senate and Assembly released last week upended the usual pattern. They included a proposed tax on managed care organizations (“MCO tax”) that purports to raise $4 billion annually in incremental federal funding with no need for a net increase in State spending. This enabled the Senate and Assembly to restore virtually all of the Health cuts proposed in the Executive Budget and to add $3.1 billion and $3.3 billion in new spending for Medicaid (Assembly and Senate, respectively) and (in the case of the Senate) another $400 million for public health.
Because, as described in the footnote below, the State would need to use 40% of the proceeds of the MCO tax to increase Medicaid reimbursement to Medicaid MCOs to enable them to pay the tax, the total amount of the MCO tax would actually need to be approximately $6.7 billion in order to generate an incremental $4 billion in federal funds. It may be the case that the Assembly, at least, does not recognize that generating $4 billion in incremental federal revenue will require the underlying tax to be about two-thirds more than $4 billion.[1]
I posted a roughly 10,000-word Issue Brief last Thursday titled An Analysis of the FY 25 Executive Budget and Legislative Proposals for Financially Distressed Hospitals that discussed the proposed MCO tax in some detail. The purpose of this Commentary is to offer both a more succinct description of the issue and the potential implications for the FY 25 Budget, as well as to make some additional observations based on examining the issue for the last few days.
I should note that at least two of my fellow travelers in the world of health policy wonks have written about the California MCO tax: Bill Hammond of the Empire Center and Michael Kinnucan of the Fiscal Policy Institute. Both are worth reading. I assume lots of other smart people are analyzing this issue privately.
The legislature modeled its proposal on an MCO tax in California that the Centers for Medicare and Medicaid Services (CMS), the federal agency with oversight over Medicaid, reluctantly approved in December 2023. The California MCO tax is the state budget equivalent of turning straw into gold, so you can understand why the proposal’s approval would trigger California Dreaming in New York.
The proposed MCO tax is what is known as a “health care-related tax” under Medicaid. The basic idea of health care-related taxes under Medicaid is simple: assume that the State imposes a tax on some Medicaid providers or managed care organizations, which hypothetically would generate $100 million in tax revenue for the State. To make it possible for the Medicaid providers or managed-care organizations 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 draws down $60 million from the federal government as the federal share of the increased reimbursement.
The financial position of the Medicaid providers or managed care organizations is unchanged ($100 million in tax payments are offset by $100 million in new Medicaid reimbursement). The State comes out $60 million ahead because it only needs to put up $40 million of the increased reimbursement and pockets the remaining $60 million in tax proceeds. And the federal government ends up $60 million behind by providing this budget relief to the state.
The federal government understands this dynamic and is supportive of the concept within limits. However, the federal government recognizes the potential for Medicaid taxes like the MCO tax to become a federal printing press for states and so over the years has developed a complicated set of rules to prevent that. The thrust of the rules governing these taxes is to ensure that the primary purpose of the tax is not to solely generate additional federal revenue.
One of these rules is that the tax be “uniform” for all parties in the “class” subject to the tax. Providers and managed care organizations are considered separate classes for the purposes of this “uniformity” test, but all managed care organizations (whether or not they include Medicaid members) are considered to be in a single class. CMS regulations state that it may waive the uniformity test if the tax is “generally redistributive.”
As best I can tell, the term “generally redistributive” seems to have two meanings: first, the federal share must be redistributed through the healthcare system to benefit the Medicaid entities that were taxed. Given that money is fungible, and New York intends to increase overall Medicaid spending in FY 25, this is an easy standard to meet.
The more complicated meaning of “generally redistributive” appears to be that the net tax burden must be greater on parties in the class that do not receive the benefit of increased Medicaid reimbursement than those that do. On the other hand, if there is no substantive impact on any of the parties that are required to pay the MCO tax, CMS would then conclude that the sole purpose of the tax is to generate additional federal revenue. In other words, someone’s ox needs to be gored by the tax or it fails at least the spirit of the uniformity test.
California constructed a program that meets the statistical test CMS applies to determine whether a tax is “generally redistributive,” even though it resulted in Medicaid managed care organizations paying a tax rate of roughly 100 times higher than the rate paid by commercial plans. If commercial MCOs in California had been required to pay a tax at the same rate as Medicaid MCOs, it would have significantly increased health insurance premiums, which would have made it politically more difficult, if not impossible, to enact. If there is a Hall of Fame for Medicaid Financial Engineers who work to maximize federal funding, the architect of the California MCO tax will surely be inducted.
Federal regulations specify when health care-related taxes are permissible[2] and as discussed above, they specify that a health care-related tax will fail the “uniformity” requirement if the net impact of the tax “is not generally redistributive, as specified in paragraph (e) of this section.”[3] The regulations require that the State demonstrate its proposed tax is “generally distributive” through a statistical test based on linear regression analysis.[4]
I confess that I was not taught linear regression analysis in law school and have not needed to perform such analysis in my professional career. Even those who are proficient at linear regression analysis may not be able to replicate the results in the CMS approval letter, because the letter does not include the patient day and rate information by plan, that California provided to CMS. All we know is that with the values provided, California’s MCO tax structure satisfied the statistical test.
What is critical to understanding CMS’s approval of the California CMO tax is the regulatory subsection that says if the State demonstrates that the statistical tests is met, CMS "will automatically approve the waiver request. (emphasis added)”[5] I have talked to a number of people smarter than I am and more familiar with this issue, who are unable to explain in an intuitive way how the California MCO tax, with its 100 to 1 ratio of burden between Medicaid and commercial managed-care plans, meets or allows the statistical test to override the “generally redistributive” test. I assume at some point it will become clear how this “magic trick” was performed, but so far it is a mystery to me and most other people.
Although CMS was compelled by its regulations to approve the California MCO tax, CMS left no doubt that it regards the California program as exploiting a loophole that is inconsistent with the spirit if not the letter of CMS policy. The approval letter stated that: “[P]lease be advised that any changes to the federal requirements concerning health care-related taxes may require the State to come into compliance by modifying its tax structure.” This suggests to me that if CMS modifies its regulations to close this loophole, California would no longer be able to impose the current MCO tax, notwithstanding the four-year term of its plan.
CMS’s approval letter to California[6] was accompanied by an unusual “companion letter” that made clear that CMS believes the California MCO tax violates at least the spirit of the “generally redistributive” standard notwithstanding that it passed the statistical test. The letter states:
“In order to meet the uniformity test, the proposed tax must be ‘generally redistributive’. The result … 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.”
The $4 billion question for the FY 25 budget is whether New York will be able to replicate the California MCO tax and receive CMS approval of its plan.
Our understanding is that Massachusetts and perhaps other states are in the process of applying to CMS with their own version of the California MCO tax. It seems that this will be a race between the ability of CMS to close this gaping hole in its rules regarding Medicaid health care-related taxes and its obligation to follow the letter of its existing regulations which California took advantage of. Given the legislative MCO tax proposal, New York officials must be seeking guidance from CMS about its intentions.
A dynamic unique to New York that may or may not factor into its discussions with CMS about a version of the California MCO tax is that New York benefits from many health care-related taxes as part of the New York Health Care Reform Act of 1996 (HCRA). Many of these would not pass the “broad-based and uniform” test but for the existence of 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 that grants New York a unique exemption from the broad-based and uniform tax requirements for its HCRA taxes. It is unclear whether a new MCO tax based on the California design would affect the grandfathering of the existing HCRA health care-related provider taxes.
Since the outcome of this race may be hard to predict with certainty, the legislature’s proposal of a New York MCO tax threatens to create a major impediment to finalizing the Budget. With $4 billion of additional federal revenue, there is no need to make any hard choices in the Health budget. But if the administration is unwilling to accept the risk of federal disapproval, and unable to come up with an alternative proposal that CMS would be more likely to approve, then the parties are at least $3.3 billion apart in gaining three-way agreement to achieve an Enacted Budget.
In the recent past, the Enacted Budget has suspended the effective date of Budget cuts provided that it received federal approval of additional revenue. However, also in the recent past – specifically, the payment of COVID-19 bonuses to healthcare workers – the executive agreed to make the bonus payments irrespective of whether federal approval was received. Federal approval was not received, and the State subsequently wrote off a significant portion of the expected federal revenue and backfilled with State-only funding.
Without knowing more about the executive’s conversations with CMS about this issue and without visibility into the broader dynamic of Budget negotiations between the executive and the legislature, it is impossible to handicap how this issue will be treated in the FY 25 Budget. My surmise is that the executive and the legislature will split the baby. They will include some restorations or spending increases made conditional on federal approval of the MCO tax (or some variant thereof) and commit to making some restorations or spending increases irrespective of federal approval. Otherwise, it’s hard to see how the parties will close this gap of at least $3.3 billion anytime soon.
Having said that, I am no political seer, and I would not put money on my prediction.
Paul Francis
March 19, 2024
[1] The Assembly budget proposal states: "The MCO tax generates $4 billion in receipts from Managed Care plans. This revenue is be used by the State to repay the tax obligation for each plan through their capitated rates. This repayment generates an additional $4 billion in federal funding to then be used by the State as the non-federal share of investments in the Medicaid program.”https://nyassembly.gov/Reports/WAM/AssemblyBudgetProposal/2024/ at page 47-2 (page 102 of the PDF). Although some reporting on the California MCO tax implies that it is raising $19 billion in additional federal funding, it seems that the MCO tax is estimated to raise $19.4 billion over close to four years, but only $11.1 billion of the tax revenue (presumably the federal share) is being used to increase the rates to providers participating in Medi-Cal. Read more at: https://www.law360.com/articles/1781899?copied=1
[6] Technically, California’s request was for a waiver of the broad-based and uniformity requirements related to its MCO tax. And since California’s MCO tax was already previously approved, this submission constituted an “update.”
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