Public Comment: Medicaid Managed Care State Directed Pay, Fee-for-Service Targeted Practitioner Pay

July 21, 2026

The Honorable Mehmet Oz, M.D.
Administrator
Centers for Medicare & Medicaid Services
U.S. Department of Health and Human Services
200 Independence Avenue, SW
Washington, D.C. 20201

Dear Administrator Oz,

The Paragon Health Institute appreciates the opportunity to comment on the Centers for Medicare & Medicaid Services’ (CMS) Proposed Rule implementing the important limits on state-directed payments (SDPs) enacted by Congress in The One Big Beautiful Bill (OBBB). We strongly support CMS’s efforts to faithfully implement these reforms and believe the proposed rule represents an important step toward restoring accountability and integrity within the Medicaid program. We also believe CMS can further strengthen the rule, particularly with respect to grandfathered SDP arrangements.
What the Proposed Rule Does

This proposed rule1 would reduce the current cap on many payments made through Medicaid managed care organizations from 100% of the commercial rate to 100% of the published Medicare rate (110% in non-expansion states). It would also set caps at the state plan’s base rate where no Medicare rate exists. These changes implement both the OBBB and a presidential directive on combating Medicaid waste, fraud, and abuse.

In addition to the changes required by the OBBB, this proposed rule would extend similar payment limits to SDPs beyond the services (hospital, nursing facility, and academic-medical-center practitioner services) named in the statute, and to all states, the District of Columbia, and United States territories, while establishing a temporary grandfathering of existing arrangements with a phase-down so that they come into full compliance with the statutory limits.

The proposed rule also would create a new payment limit for Medicaid fee-for-service (FFS) supplemental payments to providers, which currently exceed several times Medicare rates in some states. This would close a loophole where states fund their share of these payments through provider taxes or intergovernmental transfers that flow back to the same providers.2
Benefit of Rule #1 – Protecting Seniors

This proposed rule implements a major reform to Medicaid that seeks to ensure the program no longer pays more for patients’ care than Medicare pays. This will help protect seniors’ access to care because doctors can only treat so many patients. Historically, Medicaid reimbursed less than Medicare. However, that has changed over the past few years. Using SDPs, many states now set Medicaid payments well in excess of Medicare rates. As a result, providers have incentives to see Medicaid patients over Medicare patients.

This is bad public policy and fundamentally unfair, particularly since Medicaid was expanded to able-bodied working-age adults and these enrollees constitute a large percentage of total Medicaid enrollees. Under the status quo, able-bodied working-age adults receive priority over the elderly patients on Medicare, who are more likely to have significant health care needs. A majority of Americans recognize this is unfair. More than 80 percent of voters said they opposed this outcome and do not think Medicaid should pay more than Medicare rates.3
Benefit of Rule #2 – Better Incentives and Better Care

SDPs are the principal mechanism through which provider taxes and intergovernmental transfers inflate Medicaid spending, distort provider incentives, and harm patients. In practice, these payments are almost always financed through provider taxes or intergovernmental transfers (IGTs). As a result, this proposed rule’s benefits extend well beyond limiting excessive supplemental payments. By reducing SDPs and FFS supplemental payments, CMS also reduces states’ incentives to rely on financing arrangements that distort provider incentives, increase health care costs, and reward politically favored providers rather than high-value care.

Provider taxes and IGTs create different distortions, but both encourage states to maximize federal Medicaid payments rather than efficiently deliver care.

Provider taxes effectively allow states to tax providers, increase Medicaid payments, and use the resulting federal matching funds to finance higher spending with relatively little state financial responsibility. Research suggests these taxes also increase commercial health care prices. One study found that California’s hospital provider tax increased commercial hospital prices by approximately 3 to 4 percent relative to neighboring states.4

IGTs create a different distortion by favoring government-owned providers over comparable private providers. Because governmental providers can transfer funds to the state that are then recycled back through enhanced Medicaid payments, these arrangements encourage public ownership and expansion for fiscal rather than clinical reasons. They also distort competition between public and private providers and direct resources toward institutions best positioned to maximize federal reimbursement rather than those delivering the highest-value care.

A recent National Bureau of Economic Research study found that Indiana’s nursing home IGT program diverted resources away from nursing homes and toward hospitals, contributing to a shift of residents into lower-quality nursing facilities and an estimated 50 additional resident deaths each year.5

By limiting excessive supplemental payments, this proposed rule reduces states’ incentives to rely on provider taxes and IGTs, helping restore Medicaid’s focus on efficient financing and better patient care rather than maximizing federal revenue.
Benefit of Rule #3 – Greater Social Welfare

CMS estimates that in total, the proposed rule would reduce total Medicaid spending by approximately $774.8 billion between 2026 and 2035.6 This includes $510.1 billion7 in federal savings and $264.4 billion in state savings.8

This proposed rule would significantly reduce the excess burden of taxation—the deadweight economic loss from the taxes that must be raised to finance government spending. The social loss results from consumers and producers taking inefficient actions to reduce tax exposure. This is a waste of social resources rather than a transfer. This principle of opportunity cost has long been established in OMB Guidance (A-4 and A-94) as well as HHS guidance for preparing Regulatory Impact Analyses. Regulatory actions that result in reductions of federal government spending and that reduce federal deficits have additional benefits that improve society’s overall well-being aside from the direct or “transfer” effect of the provisions. As we discuss in recommendation X below, HHS should acknowledge this social welfare improvement in the final rule’s regulatory impact analysis.9

This proposed rule represents one of the most economically significant deregulatory actions—and socially beneficial regulatory actions—in HHS’s history by reducing projected federal government spending by $510 billion over the next decade. These reductions in the excess burden of taxation are in addition to the rule’s other benefits, such as lower health costs and improved incentives for better patient care.

The excess burden of taxation can be estimated by multiplying the budgetary effect by the marginal excess burden coefficient. OMB Circular A-94 recommends using a coefficient of 0.25, although that estimate was first advanced in an earlier era when marginal tax rates (including implicit marginal tax rates) were lower, industry markup distortions were lower, and government debt had not yet exceeded annual GDP. Considering these factors, the White House Council of Economic Advisers estimates that the true coefficient is closer to 0.5.10 Thus, we expect this rule will reduce the excess burden of taxation by between $192 billion and $385 billion over the next decade based on CMS’s estimates. As a result, this rule would significantly improve social welfare.
Global Comments
I. The Proposed Rule Is Fully Within the Legal Authority That Congress Has Granted to CMS.

Section 71116 of the OBBB authorizes CMS to phase down SDPs for four specific services. Opponents of the proposed rule have written that CMS’s actions that extend the phase-down beyond those four services and cap FFS supplemental payments are inappropriate and inconsistent with the statute.

Those arguments are wrong. CMS’s actions beyond what OBBB required are well within the authorities that Congress has previously granted the agency.

CMS possesses broad authority under Title XIX and 42 C.F.R. Part 438 to ensure that Medicaid managed care payments are actuarially sound, economical, efficient, and consistent with program integrity objectives.

Section 1903(m)(2)(A)(iii) of the Act provides the requirements for the payment for care and services under managed care and requires that states shift risk to the MCOs in exchange for actuarially sound capitation payments. CMS has long held that state-directed supplemental payments to providers—paid either directly or indirectly through a managed care plan (“pass-through”)—are inconsistent with the managed care capitated payment model described in statute. The SDP regulations were developed in 2016 to limit state direction of payments and explain the circumstances where such payments would be permissible. In Section 71116 of the OBBB, Congress instructed CMS to amend one subparagraph—438.6(c)(2)(iii) of title 42—to cap the SDPs at a percentage of the Medicare payment rate, rather than the average commercial rate. The OBBB did not put any other limits on CMS’s authority to regulate SDPs.

CMS is well within its authorities to extend SDP limits and cap total payment rates for a broader set of services than currently provided for in regulation.
II. CMS’s Changes Beyond OBBB Are Good Policy Because They Prevent States From Getting Around the New Rules.

The agency’s changes beyond OBBB are also necessary to prevent states from gaming the new rules. The agency’s main rationale for going beyond OBBB is to prevent, to the greatest extent possible, states and providers from shifting to other gameable areas of Medicaid.11

Every time Congress or the agency has sought to reform provider taxes or state practices, states have responded by developing new schemes to subvert the system and increase federal revenues without commensurate state contributions.12
III. CMS Correctly Interprets the Statute’s Phasedown Requirement.

Section 71116(b) of OBBB requires that grandfathered SDPs must be phased down. It reads: “In the case of a payment described in section 438.6(c)(2)(iii) of title 42…the total amount of such payment shall be reduced by 10 percentage points each year until the total payment rate for such service is equal to” the applicable cap rate.

CMS correctly interpreted the statute’s plain language to bring approved SDPs into compliance with the limits put in place in the OBBB. Beginning with the first rating period on or after January 1, 2028, the proposed rule would require states to reduce the total dollar amount of a grandfathered SDP by at least 10 percent each year until the SDP reaches the applicable payment limit.13

CMS interprets the statutory phrase “total amount” to mean the approved total dollar amount listed in Item 4 of the SDP preprint, and it proposes using that original approved amount as the fixed baseline for all future annual reductions.

These reductions are not compounded annually. Instead, each year’s required reduction is based on the original grandfathered amount. For example, if a grandfathered SDP had an approved total amount of $1 billion, the state would have to reduce spending by at least $100 million per year beginning in 2028 until the SDP payment rate falls to the applicable Medicare-based cap.

Those who interpret this differently cite legislative history. They argue that Congress intended a 10-year glidepath and that the 10 percent reduction would only be of the excess payment above the cap, not of the total payment itself.14

But this interpretation ignores that Congress’s intent is best identified in the text they passed, not in CBO’s misreading or assumptions some lawmakers held.15 Here, the language of the text is unequivocal. Section 71116(b) uses the phrase “total amount of such payment.”16 It does not say “the amount of the payment that exceeds the cap.” Therefore, CMS’s decision to calculate the reduction based on the total payment amount is the only way to faithfully implement the statute. The agency should finalize this phasedown as proposed.
IV. CMS’s Phasedown Interpretation Gives Greater Effect to Congress’s Intention of Reducing Wasteful Spending.

This proposed rule also better effectuates Congress’s intent to reduce wasteful spending. Originally, Congress encouraged Medicaid managed care because capitated payments were expected to reduce unnecessary utilization and better align incentives than FFS reimbursement. SDPs substantially weaken those incentives by shifting financial risk away from plans and encouraging higher spending rather than more efficient care.

SDPs turn the purported theory of Medicaid managed care—as promoting value-based care and limiting improper utilization—on its head. SDPs are constructed to increase spending. SDPs offload a portion of the financial risk from insurers and push them to spend more. CMS notes that “there is often little or no risk for the plans related to the directed payment.”17 This dynamic “can result in shifting utilization to providers in ways that are not consistent with Medicaid program goals.”18

Although SDPs are often described as simply flowing through insurers to providers, the current framework allows insurers to profit from these arrangements. We urge CMS to account for that reality in finalizing this rule. Most significantly, because directed payments are treated as incurred claims in the numerator of the medical loss ratio calculation under 42 C.F.R. 438.8, their large, near-pass-through dollar volumes raise a plan’s MLR toward the required floor—enabling insurers to retain underlying margin on their core business that they would otherwise owe back to the state as a remittance.

As SDPs are increasingly embedded in the capitation rate rather than structured as separate payment terms, insurers also bear and are compensated for the associated risk, and the grossed-up premium can carry administrative and margin loads unless those amounts are expressly carved out. Insurers further benefit from the timing float on directed-payment dollars held between receipt of capitation and payment to providers, and, where a plan and the receiving providers share common ownership, directed payments and the federal match financing them remain within the consolidated enterprise.

These mechanisms mean that a meaningful share of directed-payment spending does not reach patient care as intended, reinforcing the need for the payment limits, transparency requirements, and structural safeguards in the proposed rule.

Congress reformed SDPs in response to widespread concerns that such payments were wasteful. As previously mentioned, these schemes have long been the subject of bipartisan skepticism. While Congress is usually reticent to reduce payments in health care, its actions here were to address clear waste and corporate welfare. Thus, by phasing these payments down as quickly as possible, CMS gives greater effect to Congress’s intent.
Recommendations

The proposed rule represents one of the most significant Medicaid program integrity reforms in decades. While CMS’s proposal faithfully implements the OBBB in most respects, the agency can further strengthen the rule by limiting opportunities for states to delay implementation or shift wasteful financing arrangements into other areas of Medicaid. We therefore respectfully offer the following recommendations.
I. CMS Should Accelerate the Phasedown of the State-Directed Payments So That Medicaid Payments Through Managed Care Do Not Exceed the Statutory Limits (110 Percent of Medicare in Non-Medicaid Expansion States and 100 Percent of Medicare in Medicaid Expansion States).

Congress required grandfathered SDPs to be phased down because it recognized that these arrangements produce many of the same distortions as newly approved SDPs. While CMS’s proposed phasedown appropriately implements the statutory minimum, the agency should evaluate whether it possesses existing regulatory authority to accelerate the transition where doing so would better carry out Congress’s objectives and remain consistent with reliance interests.

Every additional year that grandfathered SDPs remain above the statutory payment limits perpetuates the very financing arrangements that Congress sought to curtail. To the extent legally permissible, CMS should move existing SDPs into compliance with the statutory payment limits as quickly as practicable.
II. CMS Should Make the Grandfathering Window 180 Calendar Days, Not Business Days.

CMS should interpret the statute’s reference to “180 days” according to its ordinary meaning—180 calendar days—not 180 business days.

Section 71116’s grandfathering applies to certain SDPs for rating periods occurring “within 180 days” of enactment. CMS’s proposed rule interprets “days” to mean “business days,” rather than “calendar days.”

Reading “days” to mean “business days” adds a limiting word that Congress did not include. The ordinary meaning of “days” is calendar days, not business days.19 When Congress intends to refer to business days, it knows how to say so expressly. It routinely uses the term “business days” in federal statutes when weekends and holidays are meant to be excluded.20 By contrast, Section 71116 uses the unqualified term “days.”

The agency here justifies its approach by saying “this interpretation is appropriate because activity on SDP preprints, including our review and approval, occurs on business days and not on weekends or Federal holidays.”21

The fact business normally happens on business days does not justify expanding the definition of a word beyond its plain meaning. Congress routinely imposes statutory deadlines in calendar days even when the required action involves agency review or approval.22 In this case, the justification for “business days” is even weaker than other statutes because the 180-day cutoff does not require any affirmative action by the agency or by the state.

This expanded definition materially changes the statutory deadline and results in more SDPs being grandfathered than what the law allows. A 180-business-day window effectively expands the time frame by 45 days. While 180 calendar days after July 25, 2025 would have been January 21, 2026, CMS’s “business days” interpretation extends that time to 252 calendar days, or April 3, 2026.

Congress’s intent in phasing down SDPs was to reduce their wasteful effect. Allowing more SDPs to be grandfathered by expanding the definition of “days” would result in more SDPs being grandfathered than the law allows.
III. CMS Should Implement Its New Cap on FFS Payments Sooner.

In addition to its caps on SDPs, CMS is also proposing important reforms to FFS supplemental payments in 2029. CMS should accelerate implementation of the FFS supplemental payment limits to reduce opportunities for regulatory arbitrage.

CMS should implement these caps sooner than 2029 because FFS supplemental payments are much smaller than SDP payments and therefore don’t implicate the same level of reliance interests that justify a phasedown or delay. CMS estimates that FFS supplemental payments for physicians and other practitioners totaled approximately $2.64 billion in fiscal year (FY) 2024.23 By contrast, CMS estimates that SDPs alone will total approximately $143.8 billion in FY 2025.24

Capping the FFS payments sooner would also prevent states from using FFS supplemental payments to get around the SDP restrictions. Many states increased provider taxes and SDPs in anticipation of the new legal limits. And some states are increasingly seeking to fund their SDPs through IGTs rather than provider taxes.

Such gaming by states is predictable. By capping FFS payment sooner than 2029, CMS would prevent states from temporarily using FFS payments as a stopgap for more wasteful spending.
IV. CMS Should Closely Scrutinize Financing Arrangements That Rely on Intergovernmental Transfers and Prohibit Higher Payments for Public Providers.

We support CMS’s recognition that states may attempt to respond to these reforms by shifting among financing mechanisms rather than reducing wasteful spending. Intergovernmental transfers (IGTs) have increasingly become a vehicle for financing SDPs while allowing states to maximize federal matching funds with limited state fiscal responsibility.

Although intergovernmental transfers can serve legitimate purposes, they should not be used to recycle federal matching funds back to government-owned providers in ways that distort competition, harm patients, and undermine Congress’s reforms.25

The final rule should ensure that payment limits apply equally regardless of the financing source and should prohibit arrangements that result in government-owned providers receiving higher reimbursement than similarly situated private providers. Such arrangements distort competition between public and private providers, may harm patients by allocating resources toward providers based on ownership rather than quality, and undermine Congress’s goal of restoring fiscal discipline to Medicaid.
V. CMS Should Evaluate Total Medicaid Payments Rather Than Individual Payment Streams.

CMS should evaluate providers’ total Medicaid reimbursement—not individual payment streams—to ensure that states cannot comply with individual payment limits while achieving substantially higher reimbursement through overlapping payment mechanisms. CMS should evaluate the aggregate Medicaid reimbursement received by providers—including base Medicaid payments, SDPs, FFS supplemental payments, and any other Medicaid payment streams—to ensure that government-owned providers are not receiving materially higher total reimbursement than comparable private providers for furnishing the same services. Evaluating aggregate reimbursement would better prevent states from complying with the letter of the rule while frustrating its purpose through multiple overlapping payment mechanisms.
VI. CMS Should Strengthen Transparency and Ongoing Oversight of State-Directed Payments.

We support CMS’s effort to reduce unnecessary administrative burden by eliminating prospective approval requirements for certain minimum-fee-schedule and maximum-fee-schedule SDPs tied directly to Medicare or Medicaid State Plan rates. As CMS explains, these payment methodologies are inherently easier to monitor, audit, and validate than more customized Average Commercial Rate (ACR)-based or uniform-percentage-increase SDPs. The agency estimates that this change will eliminate approximately 272 SDP preprints annually across 42 states, reducing state administrative burden by approximately 2,720 hours and lowering annual administrative costs by roughly $283,000. We support this effort to streamline oversight where payment methodologies are objective and readily verifiable.

However, reducing prospective review should not reduce transparency. As states adapt to the new payment limits, they will likely modify payment methodologies and financing arrangements. Robust public reporting will therefore become increasingly important to ensuring Congress’s reforms remain effective.

Accordingly, CMS should require annual public reporting demonstrating that each SDP remained within the applicable payment limits throughout the rating period. Such reporting should include total payments made, participating providers, financing sources—including provider taxes, intergovernmental transfers, certified public expenditures, and other financing mechanisms—and any material modifications to the approved payment methodology. Similar reporting should also be required for standardized Medicare- and Medicaid-based fee schedule SDPs that no longer require prospective preprint approval. Although these arrangements may not require advance approval, they still involve substantial federal expenditures and remain susceptible to restructuring in ways that frustrate Congress’s objectives.
VII. CMS Should Post Addenda for Existing and Future SDP Payments and Machine-Readable Claim-Payment Methodology.

CMS should also publicly post every approved SDP preprint addendum alongside the corresponding approved preprint. Currently, CMS posts approved preprints but generally does not post the accompanying addenda. In many cases, states submit these addenda as separate spreadsheets that are not posted with the approved preprint. This separation substantially limits meaningful public oversight of SDP financing arrangements. CMS should also publish existing approved addenda so that researchers, Congress, and the public have a complete historical record of SDP financing arrangements. In particular, the addenda often contain the most detailed information regarding the financing structure supporting SDPs. Their absence makes it difficult to evaluate the extent to which states rely on intergovernmental transfers, provider taxes, and other financing mechanisms to maximize federal matching funds.

We also encourage CMS to improve implementation of the claim-payment methodology by publishing a machine-readable file containing the Medicare payment rates used for compliance purposes. Some stakeholders have argued that the existing Medicare payment tools are difficult to apply consistently and may produce different results across users. Providing the underlying payment data directly would improve consistency, reduce administrative burden, facilitate compliance, and strengthen CMS’s preferred claim-payment methodology without weakening the statutory payment limits. Together, these transparency measures would improve public accountability, facilitate independent research, and help CMS identify emerging efforts by states to circumvent Congress’s reforms by shifting payment methodologies or financing arrangements.
VIII. CMS Should Reserve Authority to Reopen or Modify Approved State-Directed Payments.

CMS should expressly reserve the authority to reopen, modify, or terminate previously approved SDPs if subsequent information demonstrates material inaccuracies, changed financing arrangements, or evidence that states have restructured payment methodologies in ways that undermine the purposes of this rule. Without this authority, states would have incentives to modify financing arrangements after approval in ways that technically comply with CMS requirements while undermining Congress’s objectives.
IX. CMS Should Monitor State Evasion Strategies.

Congress has repeatedly acted to curtail Medicaid financing arrangements that maximize federal matching funds without corresponding state financial responsibility. History suggests that states often respond to such reforms by developing alternative financing mechanisms rather than reducing spending. CMS should therefore commit to annually reviewing state financing arrangements and, where necessary, proposing additional regulatory or legislative reforms to address emerging avoidance strategies. Ongoing oversight will be essential to ensuring that the objectives of this rule continue to be achieved over time.
X. CMS Should Bolster Its Regulatory Impact Analysis to Discuss the Excess Burden of Taxation.

The agency should account for the proposed rule’s reduction in the excess burden of taxation as part of the final regulatory impact analysis. CMS estimates that the rule would reduce total Medicaid spending by approximately $774.8 billion between 2026 and 2035, including $510.1 billion in federal savings and $264.4 billion in state savings. These budgetary reductions would generate benefits beyond the direct transfer effects identified in the proposal. By reducing the taxes or federal borrowing otherwise required to finance government spending, the rule would reduce the extent to which households and businesses limit productive activity to reduce their tax exposure. This deadweight loss is a real social cost, and as mentioned earlier, its consideration is consistent with the economic principle of opportunity cost as reflected in OMB Circulars A-4 and A-94 and in HHS guidance for preparing regulatory impact analyses.

Accordingly, the agency should quantify these benefits using an appropriate marginal excess burden coefficient and present the results as a distinct category of benefits in the final analysis. Applying coefficients ranging from 0.25, as recommended in OMB Circular A-94, to 0.50, as estimated by the Council of Economic Advisers, to the rule’s projected spending reductions suggests that the rule could reduce the excess burden of taxation by approximately $192 billion to $385 billion over the next decade. The agency should also discuss related fiscal benefits, including reduced federal borrowing needs, lower future debt-service costs and inflationary pressures, while clearly identifying the assumptions used and avoiding double counting. Recognizing these effects would provide a more complete assessment of the rule’s societal benefits and further support the Department’s designation of the rule as a deregulatory action under Executive Order 14192.
Conclusion

Taken together, these recommendations would strengthen an already strong proposed rule by reducing opportunities for regulatory arbitrage, improving transparency, accelerating implementation, ensuring that states cannot preserve wasteful financing arrangements through alternative payment mechanisms, and improving social welfare. We commend Congress for enacting important Medicaid reforms in the OBBB and CMS for faithfully proposing to implement them while appropriately expanding upon them. We encourage CMS to finalize this rule as proposed while incorporating the recommendations outlined above.

Sincerely,

Brian Blase, PhD
Niklas Kleinworth
Gabrielle Minarik
Kip Piper
Christopher Jones




https://paragoninstitute.org/medicaid/public-comment-medicaid-program-medicaid-managed-care-state-directed-payments-and-medicaid-fee-for-service-targeted-medicaid-practitioner-payments/