CMS’ Provider Tax Proposed Rule: More Grandfathering Than States Expected, Paired with New Financing Risk

Provider taxes fund more than a quarter of the state share of Medicaid. CMS’ new proposed rule would preserve more than its earlier guidance signaled, while changing how states must prove they comply.

Authors: Anne Karl and Avi Herring

Editors: Patti Boozang and Amanda Eisenberg

tl;dr

• On July 21, the Centers for Medicare & Medicaid Services (CMS) released a proposed rule implementing H.R. 1’s new limits on provider taxes, the financing tool 49 states use to help fund the non-federal share of Medicaid, which generated nearly $100 billion in 2026.

• H.R. 1 bars new or increased provider taxes effective Oct. 1, 2026; grandfathers only taxes “enacted and imposed” as of July 4, 2025; and, in expansion states, ratchets the 6% ceiling in place prior to H.R. 1 down to 3.5% by federal fiscal year (FFY) 2032.

• The proposed rule would grandfather more provider taxes than CMS’ November 2025 preliminary guidance. It adopts broader definitions of “enacted” and “imposed,” meaning more states that implemented new or increased taxes in the run-up to H.R. 1’s passage would have their taxes preserved (prior to the phasedown in expansion states).

• But it also shifts compliance from a prospective to a retrospective test, meaning states may not know for years whether a tax they have already collected and spent exceeded the limit — and then be on the hook to either refund tax collections or pay significant amounts back to the federal government. Comments are due Sept. 21.

The 80 Million Impact

Much of the H.R. 1 conversation has centered on work requirements and coverage losses. But one of the law’s most consequential changes runs through a financing tool most people (outside of the biggest Medicaid wonks) have never heard of: the provider tax.

Medicaid is jointly funded: the federal government pays a share, and each state covers the rest of the costs of its program. To raise a portion of its share, nearly every state (except Alaska) taxes health care providers, most often hospitals and health plans. The practice dates to the 1980s. In 2026, provider taxes generated close to $100 billion, more than a quarter of the total state share of Medicaid, with hospital taxes ($61 billion) and managed care taxes ($28 billion) making up 90% of the total.

Federal law and regulations have long drawn several red lines. First, a provider tax cannot guarantee that the providers subject to the tax will receive all of their tax payments (or more) back through Medicaid or other payments. To stay clear of that “hold harmless” prohibition, states could tax up to 6% of a provider’s net patient revenue. In addition, provider taxes must be “broad-based” and “uniform,” meaning that they tax all providers in a CMS-defined “class” (e.g., inpatient or outpatient hospital services) at the same rate, or obtain a waiver of those requirements through complex statistical tests defined in federal rules. The broad-based and uniform requirements are designed to ensure that states do not disproportionately shift the tax burden to the Medicaid program.

H.R. 1 tightened provider taxes in three ways. First, effective Oct. 1, states generally cannot create new provider taxes or increase existing ones; only taxes “enacted and imposed” as of July 4, 2025, are grandfathered. Second, in states that expanded Medicaid, even grandfathered taxes will shrink: The 6% cap drops half a point per year starting in FFY 2028 until it reaches 3.5% in FFY 2032, with nursing facility and intermediate care facilities for individuals with intellectual disabilities taxes exempt from the phase-down. Third, beginning Jan. 1, 2027, for some states and later in 2027 for others, states must comply with tighter broad-based and uniformity requirements.

The effect is not just technical. In the proposed rule, CMS estimates that H.R. 1’s provider tax limits will reduce federal spending by more than $246 billion over 10 years (the Congressional Budget Office puts the reduction at $183 billion). Because state-directed payments (SDPs) are often financed with provider taxes, some of H.R. 1’s SDP savings overlap with its provider tax savings. Even accounting for that overlap, CMS estimates that the provider tax provisions would still reduce federal Medicaid spending by more than $90 billion over 10 years.

Congress enacted the new provider tax limits in H.R. 1. What the states did not know until the proposed rule’s release was how CMS would decide which taxes are grandfathered. And on that question, CMS gave states more flexibility than many expected. Its November 2025 preliminary guidance read as an effort to invalidate provider taxes states had rushed to enact before H.R. 1 passed: It would have required a tax to be actively collected, and its waiver approved (if applicable), before July 4, 2025. The proposed rule drops both requirements. A tax now counts as “enacted” if the state finished its legislative process by that date, and “imposed” if it created a legally enforceable obligation to pay before July 4, 2025. The lower bar would grandfather more provider taxes under the law, including some that were implemented in the run-up to H.R. 1.

But relief on the front end comes with new risk on the back end. The proposed rule replaces today’s prospective compliance approach, where states demonstrate compliance using projected net patient revenue data, with a retrospective one. Specifically, CMS proposes judging compliance on actual tax collections and net patient revenue only after the fiscal year closes. Although CMS does plan to publish interim provider tax caps for states to use as a benchmark, compliance will be judged against final caps that will not be known until years later.

The compliance approach change, if finalized, will be risky for states in practice and operationally complex to manage. Consider this scenario in FFY 2028, the first year of the phase-down, when the cap for expansion states falls from 6% to 5.5%: A state taxes inpatient services at a fixed amount per day, projects $1 billion in net patient revenue, collects $55 million, and reasonably expects to sit at the 5.5% threshold. Then, SDP cuts and work reporting requirement coverage losses reduce actual net patient revenue to $900 million. The same $55 million now equals 6.1%, above both the 5.5% phased-down cap and the long-standing 6% ceiling. Under the rule, the state could be required to refund taxes it has already spent, or face a federal penalty calculated on the full value of the tax — not just the overage.

The exposure is greatest in some expansion states that, by state law, finance coverage only through provider taxes and cannot fall back on the general fund. And because their thresholds phase down every year, those states face this cycle annually.

The Bottom Line

The decision that states will lean less on provider taxes was made by Congress in H.R. 1, not by CMS. What this rule does is answer the questions states have been asking, like which taxes are grandfathered and how compliance will be judged. On the first one, the news is better than states feared. Broader grandfathering gives states more room to navigate H.R. 1’s fallout.

But the shift to after-the-fact compliance introduces a different risk: states may learn of taxes that exceeded their limits years after the fact, putting state budgets, provider payments, and — in some states — Medicaid coverage at risk. To hedge against these risks, states may choose to collect taxes below their allowable threshold, leading to an effective cut in provider tax revenue not required by Congress. As comments come due Sept. 21, the states with the most at stake would be well served to request that CMS maintain its longstanding prospective compliance approach. If CMS insists on a retrospective compliance framework, states should seek clarity on how quickly interim thresholds will arrive and whether good-faith projections will be protected from penalty. In an era of shrinking thresholds, financing certainty may prove as valuable as financing flexibility.