Medicaid operates through a partnership between states and the federal government, with states required to fund a portion of Medicaid spending that the federal government then matches. To raise state dollars, nearly all states levy taxes on hospitals, nursing homes, managed care plans, and other providers. Under the “One, Big, Beautiful Bill,” all existing provider taxes are frozen, and the safe harbor cap in expansion states will drop from 6% to 3.5% of patient revenue. As a result, states will be forced to either identify new funding sources or make cuts to Medicaid programs and eligibility.
Understanding the Provider Tax in Medicaid
Provider taxes are fees that states impose on healthcare facilities and providers to generate revenue that helps them receive federal Medicaid matching funds. The arrangement allows states to expand Medicaid coverage and increase reimbursement rates without relying completely on general tax revenue.
This mechanism works through a relatively straightforward formula. When a state collects provider taxes, it counts that revenue as part of its Medicaid spending. The federal government then matches that spending based on the Federal Medical Assistance Percentage (FMAP), which varies by state.
Federal law (42 CFR §433.68) establishes a “safe harbor” threshold for provider taxes at 6% of net patient revenue. States can impose provider taxes up to this limit without triggering additional federal scrutiny or requirements. This provision ensures states maintain reasonable tax levels while preventing them from exploiting the system.
For many states, these taxes have become indispensable. They fund Medicaid expansion, support safety net hospitals serving uninsured populations, and maintain adequate reimbursement rates that encourage provider participation in Medicaid. Without these taxes, states would need to cut services, reduce eligibility, or find alternative sources of revenue.
The One, Big, Beautiful Bill
The “One, Big, Beautiful Bill” (OBBBA) was signed into law on July 4, 2025. A key section of this bill focuses on provider tax reform. The law freezes all existing provider taxes, meaning states cannot enact new provider taxes or increase current rates. It also lowers the safe harbor cap for many states. Specifically:
- No New or Higher Taxes: States may not adopt any new provider tax or raise an existing one beyond current levels. Provider taxes are frozen at 2025 levels.
- Safe Harbor Reduction (Expansion States): For states that expanded Medicaid under the ACA, the safe harbor limit will drop from 6% to 3.5% of net patient revenue. This reduction happens in steps, starting in FY 2028 with a 0.5% drop each year until it reaches 3.5%.
- New Tax Threshold: Any new provider tax imposed after enactment effectively has a 0% hold-harmless cap, meaning it cannot be guaranteed back to providers.
Implications for Providers & Expansion States
Lowering the safe harbor limit forces states to make difficult choices. States currently using provider taxes above 3.5% must either reduce their tax rates or navigate the complex requirements for exceeding the cap. Neither option provides an easy solution.
Reducing provider taxes would create immediate budget shortfalls, requiring states to fill the gap with general funds, spending cuts, or both. States seeking to maintain higher provider taxes would face significant administrative and legal hurdles to prove compliance with federal rules for broad-based, uniform taxation. This uncertainty and delay could disrupt state budgets and Medicaid operations.
Ultimately, lowering the safe harbor limit will likely reduce Medicaid reimbursement rates, increase financial instability, and create greater volatility in provider taxes. Hospitals, especially safety net and rural facilities, face the greatest risk, and some will struggle to remain open amid reduced funding and ongoing uncertainty.
Looking Forward: Preparing for Change
The path forward remains uncertain, but the stakes are clear. Provider tax policy directly affects millions of Medicaid beneficiaries who depend on the program for essential healthcare services. As states adjust to the reduced safe harbor limits under the OBBA, healthcare leaders should anticipate the financial impact of lower provider taxes, explore alternative funding sources, and plan how to sustain operations with reduced Medicaid reimbursement. Although navigating uncertainty is challenging, organizations that prepare now will be better equipped to adapt and thrive in the face of change.