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Why Do Hospitals Want Higher Taxes?

Hanns Kuttner

It is a strange thing when those who would pay them support higher taxes. Yet that is what we are seeing around the country as states wrestle with how to shoehorn the burgeoning cost of Medicaid into their budgets.

Health care providers, led by hospitals and nursing home operators, are stepping forward to support taxes on their revenues. They are hoping states will take the tax money, use it to get Medicaid matching funds from the federal government, and then leave health care out of the fray when cutting state budgets.

To some, this may rightly sound like a form of money laundering or a public sector Ponzi scheme. In fact it is the approach that has proven the path of least resistance in many states over the past twenty years. Forty-six states play some form of this game. In the past two years at least nine states have established or increased their tax.

It is not surprising that South Carolina’s hospitals have proposed to fill part of that state’s budget hole by increasing a tax on hospital revenues. The state began the year projecting that Medicaid spending would be $225 million more than expected this fiscal year and $475 million next. In a state with $5 billion in total general fund spending for 2011, those are sizeable sums.

Each dollar hospitals put on the table would allow South Carolina to grab more than two times that amount from the federal government. Going along with this scheme would allow the state to close its fiscal gap without touching Medicaid payments to hospitals.

It would also require fewer dollars from the general fund for Medicaid. The hospitals would be ahead, the state treasury would be ahead. All would be at the expense of the federal government, but who cares them about them?

South Carolina’s new governor, Nikki Haley, seems to care. She has told the hospitals that their idea is “immoral.” At a time when taxpayers are struggling, she doesn’t think hospitals should be exempt from taking a hit. “Why are they exempt when no one else is?” she asks.

Haley’s plea reflects the fiscal dysfunction that has overtaken Medicaid. Medicare and Medicaid began in the same strokes of Lyndon Johnson’s pen. While Medicare had no built-in fiscal discipline, Medicaid had governors and state legislatures, operating under state constitutions requiring balanced budgets. Enthusiasm for expanding Medicaid to get access to open-ended matching funds got held back by state unwillingness to pony up state dollars.

Twenty-five years ago states first tried using sources other than general revenue as their match for federal Medicaid dollars. What began as “donations” became mandatory “fees,” or in the phrase of the honest, “taxes.” These taxes paid by those who benefitted from Medicaid payments eroded Medicaid’s fiscal discipline. Total Medicaid spending no longer reflects a state’s willingness to trade off nurses’ aides and school classroom aides.

The erosion in state fiscal discipline is one factor behind Medicaid’s enormous growth. Its federal cost this year will be 16 times what it was thirty years ago, a faster rate of growth than Medicare over the same period.


One of the lessons of the financial crisis has been the dangers of too much leverage. Taxes on health care providers have enabled states to apply leverage to the federal matching formula. Much of the resulting federal match is dollars governors and legislators would not have taken if they had to turn away other claimants on the public purse or raised broad-based taxes to get them.

A democratic form of government should allow the people to have as much government as they are willing to pay for. Taxes on health care providers to gain more federal matching funds undermine this principle. Adhering to this principle will not make life easier for governors, but as Nikki Haley has shown, it can be done.

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