Medicaid state-directed payments for hospitals face cuts across 37 states under OBBBA

Hospital state-directed payments (SDPs) in at least 37 states are set to be reduced as part of Medicaid cutbacks in the One Big Beautiful Bill Act (OBBBA), according to a new analysis.

Roughly $60 billion in current federal spending on hospital SDPs will come in above the OBBBA’s limits, set at 110% of the Medicare rate in Medicaid non-expansion states and 100% of Medicare in expansion states.

Under current regulatory guidance, SDPs as used to supplement a Medicaid claim can boost payment to the average commercial rate for the healthcare item or service. The phase-down to the new limits is set to take place in 10-percentage-point annual increments starting in 2028.

The impact projects to be highly concentrated, according to the new analysis by KFF, with eight states accounting for more than half of the surfeit relative to the upcoming limits.

California has $7.4 billion in excess federal SDP spending, followed by Illinois ($4 billion), Kentucky ($3.9 billion), Texas ($3.5 billion), North Carolina ($3.4 billion), Louisiana ($3.3 billion), Arizona ($3 billion) and Michigan ($2.6 billion). The amounts do not reflect which states face the biggest impact relative to current Medicaid spending.

Caveats include the use of SDP preprints as the data source, leaving KFF to impute payment rates for half of the hospital spending ($39.1 billion out of $78 billion) in the analysis. In addition, the analysis assumes the new limits are fully effective against current payment policies, whereas in fact they are being phased in, giving states time to adapt.

In May, CMS issued a proposed rule implementing the SDP reductions. The rule has drawn pushback from provider advocates such as the American Hospital Association.

Hospital financial effects will vary by market and payer mix

The net impact on hospitals can be expected to deviate from the reductions in SDP spending. That’s in part because of overlap between the new limits on SDPs and rollbacks on Medicaid provider taxes, as required by the OBBBA and implemented in another CMS proposed rule. Provider taxes are a key funding source for SDPs.

For example, of the projected $510 billion in reduced federal Medicaid spending over 10 years, as tallied by CMS in the SDP proposed rule, $155 billion intersects with the tax-reduction impact.

Furthermore, in states with lower Medicaid base payment rates, a larger portion of SDPs may fit below the upcoming caps. A lesser share of an SDP thus would be exposed to the cutbacks.

Still, the estimates in the report may be conservative because the analysis does not examine the state-financed share of hospital SDPs. Much of the state funding comes from provider taxes.

Even within a state, the impact would vary among hospitals because SDPs may not be available to all hospitals, and among those that receive the payments, Medicaid volumes determine the amounts.

The ability to absorb the cutbacks will depend on overall financial health, KFF wrote.

“For hospitals with relatively high operating margins (such as for-profit hospitals and those serving relatively large shares of commercial patients), changes to SDP revenues might be more easily absorbed,” the report states. “On the other hand, hospitals with relatively low operating margins (like rural hospitals and those serving relatively large shares of Medicaid patients) may adapt in ways that affect Medicaid enrollees’ access to care, such as by cutting service lines or closing.”

ASPE projects broader effects on commercial healthcare prices

HHS’s Office of the Assistant Secretary for Planning and Evaluation (ASPE) released its own report on provider taxes and SDPs, reflecting the Trump administration’s criticism of current Medicaid spending.

The report used economic modeling to describe how the cuts in the OBBBA (referred to as the Working Families Tax Cut legislation, or WFTC) could tamp down healthcare prices.

“Reforms to provider taxes and SDPs are projected to reduce non-Medicaid prices by up to 3.5%, relative to a no-policy baseline,” the report states.

ASPE further estimates that the provisions will generate between $502 billion and $875 billion in benefits for non-Medicaid payers (including consumers) from 2025 through 2034. Of that benefit, roughly 60% would be from reduced spending and 40% from the value of the additional healthcare services being used due to the lower prices.

For the federal government, the reduction to Medicaid provider taxes and SDPs is expected to save between 2.9% and 5.1% of baseline healthcare spending.

“With lower prices faced by non-Medicaid payers likely leading to premium reductions in these markets, a potential additional benefit of the policy change is increased take-up of non-Medicaid coverage, specifically employer and [Affordable Care Act] Marketplace coverage, as these coverage options become more affordable than they would be without the WFTC legislation,” the report posits.

How the decreased non-Medicaid prices would come about

The 3.5% potential price reduction stems from non-empirical modeling pertaining to the OBBBA’s required decrease in the safe-harbor rate for provider taxes. The maximum rate will be reduced from 6% to 3.5% of net patient revenue over a five-year period starting in FY28 in expansion states, and frozen at 6% in non-expansion states.

ASPE’s projection of a corresponding fall in non-Medicaid prices is based in part on the supposition that some provider-tax costs are passed through to prices paid by non-Medicaid payers.

Another assumed driver of the decrease is that lower Medicaid payments would give providers incentive to shift care resources to other payer segments. With more care directed toward commercial patients, the resulting higher volumes would allow prices to drop in that segment.

The 3.5% number is presented as a market-wide price effect rather than an indicator of what individual hospitals will experience. Nor does the report delve into the possibility that hospitals will have to roll back healthcare services or seek to increase their commercial prices in response to the lower Medicaid revenue.

Government’s report also addresses the SDP impact

Although it does not factor into the 3.5% estimated decrease, another part of the report’s reasoning that the OBBBA changes will reduce non-Medicaid prices is the current ability for states to link SDPs to the average commercial rate.

“Because higher commercial rates would, in the baseline, allow for a higher absolute limit on SDPs, states in the baseline are additionally incentivized to support policies that increase commercial rates in order to draw additional federal [matching] funds,” the authors wrote.

In addition, the report hypothesizes that because SDPs disproportionately flow to hospitals, higher SDP rates motivate more hospitals to acquire independent physician practices. Such transactions can raise commercial payments by shifting care toward hospital-owned settings.

The report states that in 2025, the average healthcare service covered by an SDP was compensated at 186% of the Medicare rate, significantly higher than the looming OBBBA caps.