How New Limits on State Provider Taxes Will Affect Medicaid Funding

Congress authorized more than $900 billion in Medicaid cuts, the largest in the program’s 60-year history, when it passed its budget reconciliation bill in July 2025. The tax and spending law, known as H.R. 1 or the One Big Beautiful Bill Act, significantly limits states’ ability to impose or raise taxes on health care providers, one of the primary tools that states have at their disposal to fund their portion of Medicaid financing. With this change, states will face greater challenges raising money to pay for their residents’ Medicaid coverage. As explained below, this change in policy is likely to lead to coverage losses, lower provider payment rates, diminished access to care for Medicaid enrollees, and a weakened health coverage safety net for some of the nation’s most economically and socially vulnerable individuals.

How do states currently use provider taxes to fund Medicaid?

Medicaid, the public coverage program for people with low income and individuals with disabilities, is jointly funded by the federal and state governments. To raise funding for their share of program costs, states levy taxes on providers like hospitals, ambulance companies, nursing homes, and managed care organizations. States then use that revenue to “draw down,” or claim their share of, federal matching dollars. The specific level of federal funding a state draws down is based on the state’s Federal Medical Assistance Percentage (FMAP) rate, which ranges from 50 percent to 83 percent, with an enhanced FMAP of 90 percent for the Medicaid expansion group.

This provider tax revenue funds approximately $37 billion of the annual state share of Medicaid funding, or an average of 18 percent of that share nationwide. States have used these funds since 1980 to finance an array of Medicaid services, such as maternal health care, services for patients with disabilities, and children’s behavioral health services.

What did provider tax requirements look like before H.R. 1?

For a state to receive matched federal dollars for Medicaid, its provider tax must be the same for all providers in a class, such as all hospitals. States also cannot guarantee that providers will receive all or most of their payment back through direct payments or indirect arrangements designed to cover the cost of the tax (the “hold harmless” provision).

Before H.R. 1, states were allowed to draw down a federal match as long as their provider taxes did not exceed 6 percent of a provider’s net patient revenue — known as the “safe harbor” threshold. The diagram below illustrates how provider taxes work.

How have provider taxes changed under H.R. 1, and when did these changes take effect?

The law immediately placed a nationwide moratorium on new provider taxes and prohibits states from increasing the rates of any existing provider taxes.

H.R. 1 also significantly decreases the safe harbor threshold, from its current rate of 6 percent to 3.5 percent, for states that expanded Medicaid eligibility under the Affordable Care Act. Specifically, the law requires Medicaid expansion states to gradually reduce their provider taxes by 0.5 percentage points per year, beginning in 2028, until they reach the new lower limit of 3.5 percent by 2032. This requirement applies to taxes on most provider classes, except for nursing facilities and intermediate care facilities for individuals with intellectual disabilities.

While Medicaid expansion states are required to phase down their provider taxes, nonexpansion states continue to have their rates frozen at 2025 levels as long as H.R. 1 remains in place.

Which states are impacted?

The moratorium on new provider taxes affects all states. However, the mandatory reduction in existing provider taxes affects states differently depending upon whether they have expanded Medicaid, the types of provider taxes they have, and their provider tax rates. At least 25 Medicaid expansion states have one or more provider taxes above the new threshold and will have to adjust their Medicaid financing approach to comply with H.R. 1. This includes at least 18 Medicaid expansion states that have hospital provider taxes over 3.5 percent, nine that have ambulance taxes over 3.5 percent, and five whose taxes on managed care organizations are over the 3.5 percent threshold.

The table below shows the Medicaid expansion states that will have to reduce their provider taxes to comply with H.R. 1. Provider taxes in nonexpansion states, however, will be allowed to remain at current levels, including in Alabama, Kansas, Mississippi, Tennessee, and Texas, where hospital or ambulance rates are near 6 percent.

How could changes to provider taxes impact state budgets, health care providers, and patients?

The new limits on provider taxes are expected to cause 2.4 million people to lose their Medicaid health coverage over the next 10 years and to reduce federal spending on Medicaid by $225.7 billion. This decreased federal investment in Medicaid is driven by the reduction of existing provider taxes in Medicaid expansion states as well as by the prohibition on enacting new taxes.

Ultimately, this funding reduction puts the future sustainability of state Medicaid programs at risk. States’ reliance on provider taxes has grown in recent decades, with states turning to them during economic downtowns when revenues shrink. States also use them to increase provider reimbursement rates — without raising general taxes on residents — to better match the cost of providing care. The new limits on provider taxes will likely create budget shortfalls for states at a time when they are already facing fiscal pressure.

Reductions in provider taxes are also likely to affect patients and providers. Hospitals’ average base fee-for-service rate is below the cost of providing care for Medicaid enrollees, and provider taxes fund supplemental payments that help cover that gap. Without alternative funding, states may have to cut provider reimbursement rates, raise other taxes, or restrict eligibility for nonmandatory services such as adult dental and home and community-based care.

States also may opt to reduce or eliminate coverage for optional groups, such as individuals with disabilities or pregnant women and children, above mandatory income levels. For example, a recent survey of state officials administering Medicaid home and community-based services revealed that approximately one-third of states were planning to adopt a new strategy to contain spending on these services in fiscal year 2026, even before passage of historic Medicaid cuts. This means that more states will likely implement cost-saving strategies. The strategies most frequently reported by survey respondents were to restrict the total number of beneficiaries that can receive home and community-based services and/or to cap total spending on each beneficiary, which limits the amount of these services one person can receive.

Declining provider payments from reductions in provider taxes also could threaten hospitals’ financial stability, as Medicaid is the largest single source of coverage for children, very low-income adults, and people with disabilities under age 65. Inadequate reimbursements may lead to staffing cuts, reductions to critical services such as behavioral health and trauma centers, and even hospital closures, especially in rural areas.

How are state Medicaid agencies preparing for H.R. 1?

To prepare for the law’s changes, many states are analyzing the implications and planning how to adjust their Medicaid programs to absorb the anticipated loss from lower provider taxes. Many states (such as Arizona, Colorado, Oregon, and Vermont) are informing governors and state legislatures, which are responsible for adjusting provider tax rates to comply with the law. Hospital associations and patient advocacy groups are also highly involved both in analyzing impact and proposing solutions.

To ensure compliance with the new federal limits, states must submit all proposed provider tax changes for approval by the federal Centers for Medicare and Medicaid Services (CMS). As of October 2025, states had not yet submitted these formal requests, known as state plan amendments, to modify their provider taxes. When state legislative sessions begin in January, we will likely see legislative proposals and extensive debate.

What’s next?

Unlike with other H.R. 1 provisions, Congress did not require that CMS issue guidance to states on how they should implement the law’s changes to provider taxes. CMS issued a related proposed rule in May 2025, and, in a November 2025 letter, the agency indicated plans to pursue additional rulemaking and accept public comments.

In the meantime, states are under immense pressure to enact complex changes to their Medicaid programs — implementing new work requirements, assuming increased financial risk for erroneous payments, and more frequently redetermining enrollees’ eligibility for coverage — all while striving to preserve the nation’s health coverage safety net.