As the U.S. Senate deliberates the One Big Beautiful Bill, a key healthcare issue sparking debate is how to divide Medicaid costs, which serve low-income Americans, between state and federal taxpayers.
Since 2014, Medicaid spending has surged 76%, reaching $872 billion in 2023—only 15% less than Medicare’s budget, which serves seniors and Americans with disabilities. Medicaid’s budget has grown faster than Medicare (66%), Social Security (60%), and the U.S. GDP (57%). Policymakers aiming to curb federal spending naturally focus on Medicaid.
Medicaid costs are shared between the federal and state governments. One commonly used state funding practice—provider taxes—raises fiscal concerns for the federal government, according to the Government Accountability Office. Here’s how it works:
A state levies a provider tax on hospitals and other healthcare providers, based on revenue or other measures of size. It then claims this tax revenue (e.g., $1 billion) as its share of Medicaid funding and receives $3 billion in federal matching funds. The state returns most of the combined $4 billion to hospitals and uses the reminder for self-directed purposes related to Medicaid.
It’s a lucrative investment for hospitals—pay $1, get nearly $3 back. For states, it’s an even better deal: a windfall of federal dollars with no real cost. But this game is rigged against federal taxpayers, who are left footing the bill. Worse still, both hospitals and states are now incentivized to expand provider taxes for bigger payoffs, further burdening federal taxpayers.
The Government Accountability Office found that provider taxes drive a substantial and rapidly growing share of Medicaid spending, undermining accountability to federal taxpayers and limiting resources for patients in need. Moreover, as health policy expert Ann Kempski and I wrote in Health Affairs Forefront, this harms employers and workers.
Directly, hospitals raise commercial prices to maximize Medicaid payments. Indirectly, large hospitals gain a competitive edge over smaller facilities and independent physicians, accelerating market consolidation and driving up commercial prices.
States can achieve federal matching rates exceeding 12:1 for social needs, such as purchasing air conditioners for Medicaid beneficiaries. By offering such strong incentives, the federal government is effectively urging states to pursue these windfalls. It would be almost fiscally irresponsible for states not to do so.
The root cause undermining Medicaid’s program integrity is the separation between management and funding: federal taxpayers do not administer the program but generously foot the bill, giving states every incentive to overspend in order to receive even more.
Various solutions have been proposed to address the Medicaid funding conundrum, including federalizing the program, delinking federal payments from state contributions, reducing matching rates, freezing provider taxes, and capping service payments.
Solutions that tackle the root cause—the separation between management and funding—would generate greater federal savings but face stronger resistance due to their fiscal impact on states and providers, compared to those that merely treat the symptoms. Soon, we’ll find out where the political winds in Washington settle.