Surprise proposed updates to the provider taxes have implications across Medicaid

In July 2025, Avalere Health analyzed how the provider tax provisions in the One Big Beautiful Bill Act (OBBBA) could affect state Medicaid financing, health plans, providers, and beneficiaries. The analysis focused on the law’s reduction of the indirect hold harmless threshold, often called the provider tax “safe harbor.” Under the OBBBA, the law will lower the safe harbor percentage, from the current 6% to 5.5% beginning in fiscal year (FY) 2028 and 3.5% in FY 2032.

In July 2026, the Centers for Medicare & Medicaid Services (CMS) released a Notice of Proposed Rulemaking (NPRM) titled “Medicaid Program; Amending the Indirect Hold Harmless Threshold of Health Care-Related Taxes” (CMS-2452-P). The proposed rule implements Section 71115 of the OBBBA, which it refers to as the Working Families Tax Cut legislation.

Not only does the NPRM confirm the phasedown described in Avalere Health’s 2025 analysis, but it provides important additional details. Most notably, it would:

• Replace the generally applicable 6% threshold with state- and provider class-specific thresholds based on taxes enacted and imposed as of July 4, 2025 (the date OBBBA was signed into law)
• Establish a zero-percent threshold for a permissible class for which a state or locality did not have a qualifying tax enacted and imposed as of July 4, 2025
• Limit the phasedown to expansion states and exempt nursing facility and intermediate care facility for individuals with intellectual disabilities taxes from that phasedown
• Eliminate the existing “75/75” pathway for taxes that exceed the applicable threshold
• Add “services of health insurers” as a new permissible tax class
• Require states to submit detailed tax, net patient revenue, legislative, waiver, and use-of-funds information to CMS

The CMS Office of the Actuary estimates the proposed rule would reduce federal Medicaid expenditures by $246 billion over the span of approximately 10 years, significantly exceeding the Congressional Budget Office’s original estimate of $183 billion in deficit reduction from the OBBBA’s provider tax provisions.

Comments on the proposed rule are due September 21, 2026.

What does the 2026 NPRM tell us that the OBBBA doesn’t?

The proposed rule translates the OBBBA’s statutory changes into a detailed regulatory framework. It builds on, and in several key areas departs from, CMS’s November 2025, “Dear Colleague Letter” that provided preliminary implementation guidance. The most significant proposals are:

Replacement of the uniform 6% threshold with class-specific “applicable percent” standards: The NPRM would replace the current two-prong indirect hold harmless test with a single “applicable percent” standard calculated on a statewide basis for each permissible provider tax class. For FY 2027, the applicable percentage would be set at the level of net patient revenue attributable to taxes a state had both enacted and imposed as of July 4, 2025. Critically, if a state had not enacted and imposed a provider tax on a particular class by that date, the applicable percentage for that class would be zero, effectively barring new provider taxes.

Phasedown for Medicaid expansion states: States that expanded Medicaid under the ACA face an additional statutory limitation. Beginning in FY 2028, expansion states must comply with the lower of the revised class-specific threshold or a statutory percentage that steps down by 0.5 percentage points annually—from 6% in FY 2027 to 3.55% in FY 2032. This phasedown applies to all provider tax classes except nursing facilities and intermediate care facilities for individuals with intellectual disabilities.

Revised interpretation of “enacted” and “imposed: One of the most notable departures from CMS’s November 2025 guidance involves the definitions of “enacted” and “imposed.” The NPRM adopts a more flexible approach:

• Enacted would mean the state or locality completed the legislative process to authorize the tax structure in effect on July 4, 2025
• Imposed would mean the tax was in effect on July 4, 2025, and any required broad-based or uniformity waiver has been approved with a retroactive effective date of July 4, 2025, or earlier

Importantly, CMS would no longer require that states were actively collecting provider tax revenues as of July 4, 2025, a significant relaxation from the November 2025 guidance that could benefit states with taxes that were authorized but not yet in active collection.

Discontinuation of the 75/75 test: Beginning October 1, 2026, CMS proposes to eliminate the alternative 75/75 indirect hold harmless test, leaving the new class-specific threshold as the sole compliance pathway. CMS reasons that retaining the 75/75 test could allow states to circumvent the newly established statutory limits. States with a CMS-approved threshold above 6% under the 75/75 test as of July 4, 2025, may retain that higher rate, subject to the expansion-state phasedown.

New permissible class: “Services of health insurers”: CMS proposes adding “services of health insurers” as a new permissible provider tax class, distinct from the existing managed care organization (MCO) class. Many states currently impose healthcare-related taxes on health insurers (e.g., premium taxes) without a clear permissible-class basis. This new class would be subject to the same threshold and phasedown framework, with an applicable threshold of zero percent for taxes not enacted and imposed by July 4, 2025.

The new class would bring additional state taxes on health insurers under CMS oversight and the OBBBA’s restrictions for the first time. Health plans that are not classified as MCOs but subject to state premium taxes or similar assessments should evaluate whether those taxes will be reclassified under the new permissible class and whether the applicable threshold would be zero if the tax was not enacted and imposed by July 4, 2025.

Enhanced reporting requirements: The NPRM introduces significant new reporting obligations for states:

• Interim reporting (due December 31, 2026): Tax and net patient revenue data for the state fiscal year containing July 4, 2025, using best-available or estimated data
• Final reporting (due June 30, 2028): Actual data for the same period
• Quarterly ongoing reporting (beginning October 1, 2026): Data on tax amounts collected, use of tax revenue, and whether public providers are exempted—designed to help CMS detect potential hold harmless arrangements involving intergovernmental transfers

Illustrative hypothetical scenario

To understand the impacts of these provisions, if finalized, we have developed a hypothetical (but likely) scenario involving a diversified health insurance company that models state operations before and after rule implementation.

Let’s say “Health Plan A” generates $200 million in net premium revenue ($100 million from commercial lines of business and $100 million from Medicaid Managed Care contracts). The state imposes a broad 8% tax on all insurance premiums to maximize federal matching for Medicaid. It also historically uses the 75/75 test to bypass the standard 6% federal cap. Health Plan A is currently paying $16 million in tax to the state (divided equally) from both lines of business.

Under the current 75/75 rule, State A may use the $16 million to draw down federal matching dollars and in turn channel it back to Health Plan A through inflated capitation rates. To offset losses, Health Plan A can raise premiums for employer-sponsored insurance plans.

Under the proposed rule, this scenario would not operate the same. If the 75/75 rule is eliminated and the “services of health insurers” proposal is adopted as a regulated class, a new legal baseline would emerge. States would be capped at 3.5% across all classes, also affecting the insurance company’s net financial impact on commercial lines of business. Additionally, federal oversight and increased administrative and compliance costs would apply to all health insurance lines.

Impact on key stakeholders

If finalized as proposed, the rule would have cascading effects across the Medicaid ecosystem. Impacts will vary based on factors such as expansion status, the number and level of provider taxes currently in place, and the degree to which the state relies on provider tax revenue to fund their Medicaid program.

States will have fewer tools to replace lost federal Medicaid dollars. Potential responses include increased reliance on general revenues, other state revenue sources, reductions in Medicaid spending, or changes to provider payment and program design.

Health systems and providers that historically benefited from tax and supplemental payment arrangements could face pressure as states lose the ability to sustain or expand those financing mechanisms. This could affect Medicaid reimbursement, supplemental payments, state-directed payments, and ultimately provider economics.

Health plans will have unanticipated financial impact. Previously, stakeholders anticipated shifts in Medicaid funding and state financial strategies. The proposed rule could effectively eliminate a major financing strategy affecting commercial lines of business, which was not anticipated. Historically, when states levied general insurance taxes, commercial payers assumed the cost, which were passed on to consumers and employers via higher premiums. If adopted as proposed, this dynamic would change.

The elimination of the 75/75 provision removes a financing pathway, while the creation of “Services of Health Insurers” expands federal oversight. These proposed policy changes warrant organizational redirection. All insurers, even those who do not have a Medicaid line of business, should move from monitoring to active financial and regulatory scenario planning. This requires a methodical approach that includes an inventory of existing assessments, evaluation of exposure, establishing a baseline, preparing state level responses and finally, modeling downstream Medicaid impacts.

Avalere Health partners with health plans and providers to help them successfully navigate the shift in Medicaid financing policies and develop strategic responses to the evolving regulatory environment. For more information about how the provider tax NPRM may impact your line of business, patient access, or state-specific Medicaid financing, please connect with us.