The Proposed Regulation on IGTs

HCFA’s proposed rule addresses a loophole in Medicaid regulations that allows states to set Medicaid rates for public facilities, such as county- and city-owned hospitals, in excess of both the average payment to other, nonpublic facilities, and the actual cost of providing covered services to persons who are Medicaid beneficiaries. (In 1987, HCFA required states to adhere to the UPL for state-owned or -operated as well as privately operated facilities.) Under this loophole, 19 states permit the public facilities to claim higher Medicaid reimbursement rates (which are federally matched) and then divert or transfer some or all of the federal funds for other state programs. According to HCFA, the agency has applications pending from nine other states to do the same.

The regulation would phase out such arrangements over five years for states with approved plans in effect before October 1, 1999, and over two years for states that have lapsed since that deadline, with the first changes starting in FY 2002. “This change is necessary to ensure that the Medicaid regulations conform to Medicaid statutory requirements that promote efficiency and economy,” the proposed regulation says.²

The proposed rule would modify Medicaid UPLs for the following services: inpatient hospital, outpatient hospital, nursing facility, intermediate care facility for the mentally ill, and clinic. In terms of each type of Medicaid inpatient service, “current regulations place an upper limit on overall aggregate payments to all facilities and a separate aggregate upper limit on payments made to state-operated facilities.” The proposed regulation “would establish a third aggregate upper limit that would apply to payments made to all other types of government facilities that are not state-owned or state-operated.”

In terms of outpatient hospital and clinic services, “current regulations place a single upper limit on aggregate payments made to all facilities.” The proposal would establish “a separate aggregate upper limit on payments made to state-owned or -operated facilities and an aggregate upper limit on payments made to all other government-owned or -operated facilities.”³

There is a significant exception, however, one that the chairman of the Finance Committee strongly opposes. States still will be able to pay as high as 150 percent of the UPL to public hospitals that are not state-owned or -operated. The exception is based on HCFA’s belief that “allowing higher Medicaid payments will fully reflect the value of public hospitals’ services to Medicaid and the populations it serves.” Because the agency is concerned that the “public hospitals may be required by state or local governments to transfer back a portion of payments that they receive under Medicaid,” it indicates that it will require in its final rule a separate identification and reporting mechanism on how the funds are used.⁴

The proposed rule, which Acting HCFA Administrator Michael M. Hash signed on October 3 and DHHS Secretary Donna E. Shalala announced on October 5,⁵ had a 30-day comment period that ended on November 9. In a statement reacting to the secretary’s announcement, Roth concluded that the Clinton administration would not be able to finalize the regulation before it leaves office at the end of January. Commenting on the exception, he said:

The proposed regulation permits facilities to be reimbursed for providing services at a rate one and a half times what Medicare would have paid for a given service. Then states are free to pocket the difference between that payment level and the often much lower Medicaid payment rates through intergovernmental transfers. Not only does the regulation allow those who are exploiting the program to continue to do so, it also invites all others to come in and help themselves. The regulation permits the scam to continue while only modestly attempting to contain its magnitude.⁶

The chairman included a provision to implement the regulation in omnibus legislation, the Medicare, Medicaid, and SCHIP (State Children’s Health Insurance Program) Benefits Improvement and Protection Act of 2000, that the 106^th Congress was seeking to pass as this issue brief went to press. Under the Roth language, the regulation would become effective on December 31, 2000. At the same time, California, Illinois, New York, Pennsylvania, New Mexico, and Wisconsin have gotten provisions in the bill protecting them from the regulation’s ban, raising the ire of other states and their legislators that the payments could undermine the Medicaid program itself. The Congressional Budget Office has given the pending UPL reforms a “score” of $21.5 billion in savings to the federal government over five years and $76.7 billion over ten years, even with the loopholes that would be permitted in the regulation.

Background on HCFA’s Latest Action

The most recent round in the federal-state tug-of-war started last spring when HCFA circulated a draft regulatory proposal (to some state organizations and other concerned parties) to extend the UPLs to county and city facilities. Meant to address the UPL loophole, it reflected Westmoreland’s concern that HCFA’s policy of allowing states to draw down more Medicaid dollars through the IGT mechanism was unfair, not only to states that were not taking part in the practice but also to beneficiaries for whom the Medicaid program was intended.⁷

The Finance Committee subsequently asked the GAO to investigate the matter and pressed Shalala to take action. On June 30, Roth released letters to both in a news release charging “that tens of billions of Medicaid dollars are being bilked from federal taxpayers to fill holes in many states’ budgets” and that Medicaid “is not intended to serve as an accounting gimmick to funnel increased federal payments to the states.” Referring to the earlier provider donation and provider tax controversies, he warned that, “unless the Administration acts immediately, we are on the brink of a spending scandal unlike any we have seen since Medicaid was used to pay for roads, bridges, and highways.”⁸

Westmoreland followed up on July 26 by sending a letter of intent to state Medicaid directors, with copies to the American Public Human Services Association, the National Conference of State Legislatures, and the National Governors’ Association. In the letter, he contended that some states are

calculating the maximum amount [the UPL] that, in theory, could be paid to each Medicaid facility; adding these amounts together to create excessive payment rates to a few county or municipal facilities; claiming federal matching dollars based on these excessive payment rates; and then directing these county or municipal facilities to transfer large portions of the excessive payments back to the state government.⁹

Estimating that federal Medicaid spending for FY 2000 grew by $3.4 billion over earlier projections, he attributed $1.9 billion of the increase to funds raised by the UPL loophole.¹⁰ (In the October 10 proposed regulation, DHHS says the overall impact is “approximately $3.7 billion in federal spending annually … based on state reported federal fiscal information submitted with state plan amendments and state expenditure information where available.”)¹¹

In the letter, Westmoreland pointed out that some states are using the additional funds to finance various health programs. These include helping pay for uncompensated care, circumventing DSH by going beyond its statutory definition to provide services, boosting the state share of Medicaid, contributing to SCHIP, and funding other health programs (such as community-based care for persons who are elderly or have disabilities). He also cited sources indicating that some states are using, or intend to use, the additional funds to fill budget gaps, reduce state debt, give tax decreases, or pay for education programs. He stated HCFA’s intent to issue a proposed regulation in the near future.¹²

When HCFA had not acted by the time Congress returned from its August recess, the Finance Committee held a September 6 hearing on the issue. Westmoreland testified, along with Michael F. Mangano, principal deputy inspector general, DHHS, and Kathryn G. Allen, associate director of health financing and public health issues in the Health, Education, and Human Services Division of GAO.

The philosophical and political differences that characterize the debate over this issue were readily apparent in the opening statements of the senators who participated in the hearing. Whereas Roth said flatly that the current IGT gimmick “cannot and will not be permitted to continue,” Sens. Daniel Patrick Moynihan (D-N.Y.) and John B. Breaux (D-La.) were more sanguine. Moynihan indicated that millions of people are now covered because of the payment policy. Breaux pointed out that HCFA had approved the applications of the states that are involved in the practice, which “is legal until it is declared illegal.” (Westmoreland has refused to approve any of the pending state Medicaid plan amendments. Because he does not have the right of disapproval, the pending amendments lapse into approval 90 days after submission.) Breaux warned against blaming states for taking advantage of loopholes in order “to provide much needed services.” Sen. Chuck Grassley (R-Iowa), who is next in line for the Finance Committee chairmanship in the 107^th Congress due to Roth’s defeat in the November 2000 election, defended the UPL arrangements of Iowa on the grounds that the money is being used for Medicaid home- and community-based services.

Referring to “manipulative financing schemes,” Mangano used Pennsylvania as an example in his oral testimony and included Alabama and Nebraska in his written statement. He stated that Pennsylvania, which has been involved in the practice since 1991, is expected “to generate about $900 million in excessive federal financial participation per year if HCFA does not take action to stop this abusive and costly practice.”¹³ The following is his description of Pennsylvania’s draw-down of $393.3 million on June 14 of this year:

The Pennsylvania state government calculated a maximum allowable enhanced payment amount that could generate a corresponding federal match. It obtained county government agreements to have 20 counties borrow and transfer, for only one day, tens of millions of dollars into a state bank account. The state immediately repaid the amount to the same county governments, labeling the transaction as a transfer of enhanced payments to the counties for their county-owned Medicaid nursing facilities. The state then billed the federal government for the federal share of the enhanced payments. The remitted federal share was commingled in state accounts that could be used for any purpose the state wished.¹⁴

Allen testified that “this financing practice violates the integrity of Medicaid’s federal/state partnership.” Citing the actual or intended uses of the additional funds in the states of Alaska, Iowa, Michigan, New Jersey, South Dakota, Tennessee, and Washington, she concluded:

Because of the potential for excessive payments to persist in other forms, the Congress should consider implementing a recommendation that remains outstanding from our 1994 work to enact legislation to prohibit Medicaid payments that exceed costs to any government-owned facility. Finally, continuing attempts to exploit program loopholes also point to the need to be ever vigilant to identify the next innovative arrangement before it reaches such financial magnitude that it becomes both a staple of state financing and a potential threat to the integrity of the funding partnership.¹⁵

State Facilities

The first loophole to be addressed involved states’ making excessive payments to state-owned or -operated health facilities in order to increase their federal Medicaid matching funds. This practice was restricted in 1987 regulations that established UPLs for state inpatient and institutional facilities.

Provider Donations and Provider Taxes

The second and third loopholes—states’ use of provider donations and provider taxes, respectively—in order to increase their federal Medicaid matching funds drew more attention during the second half of the 1980s than the concern about state facilities, which was more cut-and-dried. In terms of provider donations, HCFA had published a regulation in 1985 that allowed donations, both public and private, to be sources of states’ share of Medicaid. In terms of provider taxes, HCFA had put out a Medicaid manual instruction in 1987 that distinguished between taxes of general applicability (imposed on all kinds of goods and services and not just Medicaid providers) and provider-specific taxes (imposed only on health care providers). In general, the first could be used to draw down federal Medicaid matching funds and the second could not.

Estimates by HCFA and the DHHS Office of the IG determined that the state programs cost the federal government nearly $500 million in FY 1990. By 1991, the amount of revenue generated from state provider donation or tax programs was approximately $2.3 billion in federal funds. A survey of state Medicaid agencies by the American Public Welfare Association [now the American Public Human Services Association] indicated that this figure could rise to $6 billion in 1992.]¹⁶

HCFA, the DHHS IG, GAO, and the Senate Finance Committee—the same players involved in the current IGT debate—investigated what they viewed as state schemes to increase federal Medicaid expenses without adding to the states’ contributions. A comprehensive report, Medicaid Provider Tax and Donation Issues, prepared for the Robert Wood Johnson Foundation by Health Policy Alternatives, Inc., and issued in July 1992 documented the issues, the federal and state perspectives on them, and the practices, with case studies on Connecticut, Delaware, Pennsylvania, Tennessee, and Texas.

For example, Tennessee had used revenues from provider donations to draw down more federal dollars since 1987, when the state legislature authorized the practice, according to Gordon Bonnyman, author of that state’s case study. The state faced a rapidly increasing Medicaid budget, which grew from slightly more than $1 billion in FY 1988 to nearly $2.3 billion in 1992. The growth was due in part to the state’s own commitments to expansion of indigent care and state aid for certain high-volume Medicaid hospitals. It was due in part to federal statutory changes (such as expanded coverage for low-income mothers and children). It also was due in part to other factors, such as health care inflation. In 1987, 30 of the state’s 150 hospitals donated $19 million. The largest donor was Regional Medical Center in Memphis, the largest public hospital in the state.¹⁷

Because Tennessee’s federal Medicaid percentage was 70 percent (that is, the federal government pays 70 cents and the state pays 30 cents), the $19 million generated approximately $63 million, Bonnyman reported. Of the $63 million, $24 million increased DSH subsidies, $31 million went to expanded Medicaid coverage for pregnant women and children who were below 100 percent of the federal poverty level, and the balance for a rise in the annual inpatient hospital coverage limit from 14 to 20 days. Most of the subsidies went to the providers that had provided the donations.¹⁸

When HCFA disallowed most of the matching funds raised by the donations, the state, while appealing the disallowance and continuing with its donation policy, turned to a hospital gross receipts tax (similar to one used by Florida) as a means of increasing its federal matching funds. Because some hospitals opposed the tax, the state and the hospital industry agreed instead on sharp increases in hospital licensing fees. The legislature approved the hospital license fee policy in 1989 and extended the mechanism to nursing homes in 1990. Meanwhile, the DHHS Departmental Appeals Board had reversed HCFA’s disallowance of the donations mechanism, so the state had both the donations and tax options open to it.¹⁹

As more states moved to take advantage of the provider donation and tax policies, HCFA became more and more concerned. As it considered revising the 1985 regulation and the 1987 instruction, Congress—spurred by the states—imposed moratoria on its taking action in 1989 and in 1990. After considerable debate during 1991, the Medicaid Voluntary Contribution and Provider-Specific Tax Amendments of 1991 were enacted, banning provider donations and restricting provider taxes as mechanisms for states to draw down federal Medicaid matching funds.

Medicaid DSH Payments

The fourth loophole involves Medicaid DSH payments. The Medicaid DSH program offered states a mechanism to increase federal Medicaid dollars after the Omnibus Budget Reconciliation Act (OBRA) of 1987 had established minimum criteria for them to meet beginning July 1, 1988, and had required them to make payment adjustments to hospitals qualifying under the criteria.²⁰ DSH was an attractive mechanism because, as already indicated, states could exceed the UPL in providing funds to hospitals providing high volumes of care to low-income patients.

According to a September 1998 Urban Institute study of Medicaid spending, “between 1990 and 1992, Medicaid grew at an extraordinary 27.1 percent annual growth rate, with expenditures increasing from $73.7 billion to $119.9 billion in just two years.” The study indicates that DSH payments “increased by over 250 percent per year.” From 1990 to 1992, “DSH payments grew at an average annual rate of 263 percent, accounting for about $1.3 billion in 1988 and growing to more than $17 billion by 1992.” From 1995 to 1996, in contrast, the growth rate fell to −19.6 percent, reflecting efforts to curb the program.²¹

The 1991 legislation that banned provider donations and restricted the types of provider taxes that states could use also had provisions limiting the growth of DSH payments to the level of overall program expenditures and capping DSH payments at 12 percent of program expenditures. Subsequent legislation, OBRA 1993, provided that only those hospitals that had Medicaid utilization of at least 1 percent could receive DSH payments and prohibited states from paying hospitals more than they were losing through low Medicaid reimbursement rates or uncompensated care. Both the 1991 and the 1993 laws had a chilling effect on states’ DSH payments to hospitals and on states’ Medicaid programs.²²

As states changed their DSH programs to comply with the 1993 legislation, which became effective for different categories of hospitals in 1994 and in 1995, they began to turn to IGTs, shifting funds between different levels of government. “For the DSH program, many states began to transfer funds from public institutions such as state psychiatric facilities, university hospitals, and county or metropolitan hospitals to the state Medicaid agency.” The state then provided DSH payments to the facilities and received federal Medicaid matching funds in the process.²³

The Balanced Budget Act of 1997 (BBA) included additional restrictions on the states. It imposed state-specific “caps” on the total federal matching payments available to hospitals receiving DSH payments. In addition to the provisions in the pending congressional omnibus bill to implement the UPL regulation and allow protections for certain states, the legislation would raise the BBA caps for FY 2001 and future years.

It is important to note—to prevent confusion—that there is also a Medicare DSH adjustment. An add-on to Medicare prospective payment system diagnosis-related groups, it is defined differently than the Medicaid DSH. The Medicare DSH, as stated in the Social Security Amendments of 1983, directs the DHHS secretary “to take into account the special needs … of public or other hospitals that serve a significantly disproportionate number of patients who have low income or are entitled to benefits under Part A [Medicare].” The Medicare DSH adjustment has no bearing on the federal-state Medicaid match situation.

Use of Matching Funds

During the late 1980s and early 1990s, rumors were rife that some states were using federal Medicaid matching funds raised through provider donations and provider taxes in creative ways, such as to build highways. In testimony before the Subcommittee on Health and the Environment of the House Committee on Energy and Commerce [now the Commerce Committee] in 1991, HCFA Administrator Gail R. Wilensky said:

We believe that some states are using these “free” federal funds to increase services, expand access, and make other positive changes. But nothing in the current situation even allows us to ensure that ‘free’ federal funds are used in this manner.

On the other hand, the IG reported “these programs are generally not used to increase services to Medicaid recipients or improve the quality of care. More often, they are ‘carefully crafted’ finance techniques that allow states to reduce their share of Medicaid costs and force the federal government to pay more.”

In any case, these funds are fungible and states can use federal funds generated through donation and tax programs for any purpose they want.²⁴