Debt Digest | CMS Closes Medicaid Provider Tax Loophole First Exposed by Cato Scholars
Links & Fiscal Facts
Here are this week’s reading links and fiscal facts:
CMS closes Medicaid provider tax loophole first exposed by Cato scholars. The Centers for Medicare and Medicaid Services recently finalized a rule included in the OBBBA “that would end states’ ability to exploit a health care-related tax loophole currently used by seven states to generate billions in federal Medicaid payments—without contributing their fair share or expanding care for Medicaid enrollees. […] CMS estimates that closing the loophole will save the federal government over $78 billion over the next 10 years.” Cato’s Marc Joffe and Krit Chanwong first exposed how provider taxes created a Medicaid funding loophole “under which the state levies a tax on healthcare providers and uses the tax revenue to pay for Medicaid. These taxes attract a federal match and thereby shift more Medicaid costs onto federal taxpayers.” While closing the loophole is a step in the right direction, “The problem stems from the perverse incentives that are caused by Medicaid’s open-ended matching structure. As such, the best solution is to eliminate these incentives by turning Medicaid into a block-grant program.”
Medicare pays more in benefits than most pay in taxes. The Hoover Institution’s Daniel Heil and Tom Church reveal the gap between what Americans pay into Medicare and what they receive: “Someone with average lifetime earnings of $50,000 can expect to receive about four dollars in Medicare benefits for every dollar of Medicare payroll taxes paid. A worker with annual wages of $100,000 on average—roughly $30,000 above the average wage in 2025—would still receive more than two dollars in benefits for every dollar paid.” The reason for this: Medicare payroll taxes only fund Part A (hospital insurance), while doctors’ visits, outpatient care, and prescription drugs under Parts B and D are financed mostly through general revenues and borrowing. The consequence, as Boccia and Thakur have highlighted: “Over just the next decade, transfers from the Treasury (borrowing) to finance SMI spending [Medicare Parts B and D] will result in $8.1 trillion in additional federal debt, or an estimated $9.5 trillion if interest costs are included.”
The payroll tax lowers workers’ wages more than the rate on the paycheck. Alex Durante of the Tax Foundation explains: “Economic theory suggests that employees bear the full payroll tax because the wage offered to them with an employer-side payroll tax is lower than the wage that would be offered if the employer-side payroll tax were not imposed.” He cites a CBO analysis which found that in the short run, 58 percent of the burden of a payroll tax increase falls on employees—and in the long run, workers bear about 152 percent of the incidence if the revenue is used for transfer payments, as additional government spending crowds out private saving. With talk of increasing the payroll tax to close the Social Security financing shortfall, Boccia and Nachkebia reveal “how these payroll tax increases would affect a worker earning the median wage today. A full-time, year-round worker earning $66,636 in 2025 would see an annual tax increase of $2,432—from $8,263 to $10,695—to keep Social Security solvent over 75 years.”
A simpler tax code works better. In a new briefing paper, Cato’s Adam Michel explains that no tax on tips and overtime makes the tax code more complex. He suggests an alternative, “If policymakers closed all those largest loopholes and used the revenue to cut tax rates, the results could be dramatic. Our back-of-the-envelope calculations suggest that $700 billion in base broadening could support an average 27 percent cut in tax rates, lowering the top rate from 37 percent to about 27 percent and the bottom rate from 10 percent to about 7 percent.” Even post-communist Russia understood that a flat tax works better, as Arthur Laffer showed, “Since the advent of the 13 percent flat personal tax (on January 1, 2001) and the 24 percent corporate tax (on January 1, 2002), the Russian economy has had amazing results. Tax revenue in Russia has increased dramatically. The new Russian system is simple, fair, and much more rational and effective than what they previously used.”
Increased utilization of new medical services drives health care costs up. The Manhattan Institute’s Chris Pope explains in City Journal: “Insurance and entitlement programs are largely passing along the rising cost of care, even as average prices paid to hospitals, physicians, and drugmakers decline in real terms. The true driver is higher utilization of medical services—especially newly developed drugs and newly available outpatient procedures.” He explains the mechanism: “Technological progress could slash costs by improving diagnosis and treatment or by replacing more expensive methods of delivering care. But that won’t happen without reforming payment policy to reward cost-saving innovations. If insurers and entitlement programs keep paying premiums for products that offer little additional clinical value, these shiny new services will do little more than push costs even higher.” Boccia and Thakur warn of the consequence of this trend for Medicare, “under the program’s current structure, it will continue to grow faster than GDP for the foreseeable future. Every pathway through which growth occurs—innovation, longer lives, cost disease—feeds directly into higher Medicare spending.”
