This year’s State budget negotiations included significant debate about the renewal of the “Millionaire’s Tax,” a personal income tax surcharge on high-income households which yields up to $4.5 billion annually. Far less attention was given to the extension of the Health Care Reform Act of 1996 (HCRA), which authorizes two taxes that yield more than $4.3 billion annually and a mix of other revenues from health care related sources.[1] Although this revenue is essential to keeping the State’s budget in balance, the case for preferring the two major HCRA taxes over other broad based taxes has eroded over the last 20 years. Initially earmarked for health care programs, these tax revenues are now transferred to the State’s General Fund and used for other purposes. Instead of continuing to renew them the Legislature should think creatively about how to replace them in future budgets.

Background

The HCRA was passed at the initiative of Governor George Pataki to replace the system of State-regulated payments to hospitals with a more competitive strategy that encouraged negotiations between the institutions and insurers and promoted the use of managed care organizations for the Medicaid population. Previously the State Department of Health set the rates at which private insurance companies and Medicaid paid hospitals; under HCRA the insurance companies were free to negotiate the payments to hospitals and the State Medicaid program would pay managed care organizations a per capita rate and they, in turn, would negotiate with hospitals to set the payment rates.

HCRA’s deregulation strategy was intended to allow a competitive market to make hospital costs more reasonable, but under the new system two activities previously financed through regulated payments were no longer to be funded by the new competitive rates: graduate medical education (the training of interns and residents) and services to those ineligible for Medicaid but lacking the ability to pay (uncompensated or indigent care). To support these activities HCRA authorized taxes to fund two pools to be allocated to hospitals by the State Health Department.

The funds for graduate medical education are raised from a tax on commercial health insurance called the Covered Lives Assessment. The tax rate varies among eight regions in the State with the rate set proportional to the allocated cost of graduate medical education at institutions in the region. The rate is highest ($185.33 annually per covered individual) in New York City where most hospitals have extensive graduate medical education programs. The rate is lowest in the Utica/Watertown region ($9.08) where total graduate medical education expenses are far lower.[2] While collected from insurance companies, the tax is ultimately paid through the premiums paid by individuals and employers purchasing the insurance. The tax yields about $1.1 billion annually statewide.

The funds for the Indigent Care Pool are raised from a surcharge on hospital revenues. The rate is 9.63 percent on revenue from private insurance and 7.04 percent on Medicaid revenue (no tax is levied on Medicare revenue). As with the health insurance tax for graduate medical education, the surcharge on commercial insurance revenue is ultimately paid by the purchasers of this insurance through higher premiums. It is estimated HCRA taxes now comprise over 6 percent of the premium cost for health insurance in New York State.[3]

The surcharge on hospital Medicaid revenue is built into the rate the State Medicaid program pays to hospitals. In this sense, the State is taxing itself, but the logic of this arrangement is the State is reimbursed for 50 percent of these payments by the federal government as part of the Medicaid program. Thus, the federal government is financing half of the Medicaid portion of the hospital revenue surcharge, approximately $500 million annually.[4]

The total yield from the hospital revenue surcharge is about $3.2 billion annually. As shown in Table 1, this yield has been growing significantly over the past decade with the projected $3.2 billion in fiscal year 2018 more than 50 percent greater than the revenue in fiscal year 2009.

The yield from the hospital revenue tax now greatly exceeds the amount allocated for the Indigent Care Pool – more than $3.2 billion versus less than $1.0 billion. (See Table 2.) This excess revenue is available for other purposes, and typically is transferred to the State General Fund; although the General Fund supports a variety of State programs, this transfer is identified as intended to offset the General Fund revenue that otherwise would be used to finance the Medicaid program. The Indigent Care Pool spending has also become part of the Medicaid program, with this pool one of the supplementary payments that Medicaid makes available to hospitals serving disproportionately large numbers of indigent patients.

Issues Raised by Renewal

The fiscal year 2018 adopted budget extends the two major HCRA taxes for three years through December 31, 2020. Three-year extenders have become par for the course, with similar extensions adopted in 2008, 2011, and 2014.[5] But these taxes have two serious flaws, and a rethinking of revenue options for the future is appropriate.

First, the direct and indirect taxing of health insurance premiums is a regressive way to pay for health care for the poor. While the tax is hidden from those who ultimately pay because it is collected from insurance companies and hospitals, it falls on all those insured who pay a nearly equal amount regardless of their income. Shifting the financing to broader based taxes such as the income tax or sales tax would lower health insurance premiums and ease the burden on lower wage workers with insurance.

A drawback to changing current arrangements is the potential loss of the $500 million in federal aid generated through Medicaid revenue. Through a unique “D’Amato Provision” won by then-Senator D’Amato in 1997, New York is permitted to impose the hospital surcharge at varying tax rates on commercial insurance and Medicaid.[6] Changing the hospital surcharge could jeopardize the federal funding, but alternative waivers or other special provisions should be explored to retain the federal funding while shifting to a more progressive revenue stream.

Second, the support of graduate medical education is a large commitment funded in an irrational manner. Graduate medical education warrants public subsidies because it is a “public good,” a service that not only benefits the medical education institution and local region, but also a broader constituency.[7] Graduates seek employment in national labor markets for physicians and the research they conduct yields gains for a national and even global community. Because these benefits extend beyond state borders, the activity ought to be funded at the national level; in fact, the federal Medicare program provides significant support for graduate medical education totaling about $10 billion annually nationwide with at least $2.1 billion going to hospitals in New York.[8] New York State’s commitment of nearly $1 billion for this purpose is unusual among states and puts its taxpayers in the position of paying to train physicians who eventually serve residents of other parts of the country. Equally problematic is the way in which the money is raised. The differential tax rates among regions of the State to pay for an activity whose benefits are not limited to those in the area is inherently inequitable. Whatever money the State decides to allocate to graduate medical education should be raised from a tax levied uniformly across the State.

Conclusion

The two major taxes authorized under HCRA are historical anomalies. While they generate $4.3 billion needed to support the state programs, they do so in an inequitable and irrational manner and are no longer entirely linked to the activities initially supported. The Governor and the Legislature should develop a new strategy for raising equivalent revenue in the future that is less burdensome for those who pay for health insurance, and the nature and scale of the State’s commitment to graduate medical education should be re-evaluated.