OBBB Medicaid Reform: Lower Health Care Prices on Top of Sizeable Taxpayer Savings

 The One Big Beautiful Bill (OBBB) contained significant Medicaid financing reforms to address state schemes that have shifted hundreds of billions of dollars in Medicaid costs to federal taxpayers. A new report from the Assistant Secretary for Planning and Evaluation (ASPE) at HHS shows that the benefits extend well beyond the substantial taxpayer savings. By reducing provider taxes and excessive state-directed payments (SDPs), the reforms are projected to lower prices and increase access to care for Americans outside Medicaid. ASPE estimates those benefits at between $502 billion and $875 billion from 2025 through 2034.

States Shifting Medicaid Costs to Washington

The federal government provides an open-ended reimbursement of state Medicaid expenditures. States have large incentives to structure their programs to maximize federal payments while minimizing their own contributions. Provider taxes and SDPs became increasingly important tools for doing this. States tax hospitals and other providers and use the revenue to finance the state’s share of Medicaid. The federal government then matches that spending. SDPs then direct Medicaid managed care plans to make additional payments to providers. According to ASPE, in 2022 about two-thirds of the nonfederal share of SDP funding was financed through provider taxes or intergovernmental transfers, through which government providers transfer funds to state Medicaid agencies to draw down federal matching funds. These arrangements shift costs from states to Washington and, as HHS puts it, “reduce states’ incentives to be prudent purchasers of services.”

SDP Spending Exploded Despite Unproven Benefits for Patients

The number of services receiving approved SDPs increased from only 34 in 2017 to 1,667 in 2025, while annual SDP spending more than tripled in four years, from $43 billion in 2021 to $144 billion in 2025. This growth far exceeded earlier expectations, and CMS actuaries projected SDP spending would reach $316 billion annually without reform. Yet ASPE finds “no evidence that the dramatic increase in SDP spending has been associated with any commensurate improvement in quality of care.”

Medicaid Managed Care Became an End Run Around Payment Limits

Federal rules have long limited aggregate Medicaid fee-for-service payments to what Medicare would have paid for equivalent services. But states increasingly used managed care SDPs to get around those limits. The Biden administration’s 2024 managed care rule clarified that certain SDPs could reach average commercial rates (ACR). ASPE finds that among states with approved SDPs using the ACR benchmark, base Medicaid payments averaged 96 percent of Medicare rates. After SDPs were included, payments averaged 186 percent of Medicare rates. CMS approved some SDPs reaching 350 percent of Medicare rates.

Higher Commercial Prices Could Generate Still More Medicaid Money

Tying SDPs to commercial prices created an especially damaging incentive. ASPE explains that “by linking SDPs to the ACR, hospitals have an added incentive to negotiate higher commercial rates, increasing costs to commercial insurance beneficiaries as well.” Higher commercial prices permit higher Medicaid payments and therefore more federal matching dollars. Importantly, ASPE does not include this incentive in its model, suggesting its estimates likely understate the benefits of reform.

OBBB Attacks Both Sides of the Financing Scheme

For major categories of SDPs, Medicaid expansion states will generally be limited to 100 percent of Medicare rates, while non-expansion states will be limited to 110 percent. The law also restricts states’ ability to create or expand provider taxes and gradually lowers the provider-tax safe-harbor threshold in expansion states from 6 percent to 3.5 percent. The reforms reduce states’ ability to manufacture their share of Medicaid spending through provider taxes while also limiting the excessive payments used to draw down additional federal dollars. The OBBB appropriately distinguished between expansion and non-expansion states since states can generate $9 in federal funds with $1 of state financing gimmicks for expansion enrollees—seven times more than the amount they can generate on average for traditional enrollees.

Lower Provider Taxes Mean Lower Prices for American Families

Provider taxes increase the cost of supplying health care, and providers pass some of that cost on to commercial payers. ASPE estimates that OBBB will reduce non-Medicaid prices by as much as 3.5 percent in markets with provider taxes. This finding is consistent with a Paragon study by Liam Sigaud and Eric Sun that found that a California hospital tax was associated with a 4 percent increase in prices. ASPE estimates that each one-percentage-point reduction in provider tax rates reduces prices paid by non-Medicaid payers by 0.72 percent through this effect.

Reducing Excessive Medicaid Payments Frees Resources for Other Patients

Excessive Medicaid payments make treating Medicaid patients more financially attractive relative to other patients. Reducing provider taxes and excessive SDPs frees health care resources for patients with Medicare and commercial coverage. ASPE estimates that this effect reduces non-Medicaid prices by another 0.69 percent for each one-percentage-point reduction in provider taxes. Combined with the direct effect of lower provider taxes, non-Medicaid prices fall by about 1.4 percent for each percentage-point reduction in provider tax rates.

Up to $875 Billion in Benefits for Non-Medicaid Consumers

ASPE estimates that OBBB’s provider-tax and related Medicaid financing reforms will generate $502 billion to $875 billion in benefits for non-Medicaid consumers over the 2025–2034 period. When fully phased in, the reforms will reduce total federal health spending by an average of 2.9 to 5.1 percent, according to ASPE’s calculations. Roughly 60 percent of the benefit comes from lower health care prices, with the other 40 percent reflecting the value of additional care that consumers purchase as prices fall.

Taxpayers Benefit Several Times Over

These gains are on top of OBBB’s direct savings to taxpayers from lowering Medicaid spending. Lower commercial health care prices produce additional federal savings by reducing Medicare costs and the tax expenditure for employer-sponsored health insurance. ASPE also finds that the reforms should reduce inflationary pressures. The direct federal savings also produce broader economic benefits by reducing the need for taxation or borrowing and the associated economic losses. CBO’s score of OBBB did not fully account for these dynamics, while ASPE’s more expansive analysis estimates larger federal savings.

There Is No Free Medicaid Money

Provider taxes, IGTs, and excessive SDPs do not create free resources for health care. They shift costs to federal taxpayers, weaken states’ incentives to obtain value, distort providers’ behavior, and raise costs for Americans outside Medicaid. OBBB’s reforms are much-needed improvements to the status quo. Federal taxpayers save from lower Medicaid spending, while workers and families benefit from lower health care prices and greater access to care. ASPE’s analysis shows that the economic benefits of Medicaid financing reform are substantially larger than the federal budget savings alone.

Brian Blase, Ph.D., is the President of Paragon Health Institute. Brian was Special Assistant to the President for Economic Policy at the White House’s National Economic Council (NEC) from 2017-2019

https://paragoninstitute.org/paragon-prognosis/the-massive-win-of-obbbs-medicaid-financing-reforms-hhs-economists-find-lower-health-care-prices-on-top-of-sizeable-taxpayer-savings/