CMS proposes $775B cap on Medicaid hospital payments

On May 20, 2026, CMS published a Notice of Proposed Rulemaking, CMS-2449-P, that would cap Medicaid state-directed payments at 100% of Medicare rates in states that expanded Medicaid and at 110% in non-expansion states. CMS announced the rule would generate $775 billion in total 10-year savings — $510 billion federal, $265 billion state — making it one of the largest Medicaid payment changes in program history.

State-directed payments are arrangements in which states require Medicaid managed care organizations to pay providers at rates above standard Medicaid levels. States have used SDPs to bring reimbursements closer to what commercial insurers pay, supporting providers who would otherwise lose money on Medicaid patients.

Section 71116 of the One Big Beautiful Bill Act, signed by President Trump on July 4, 2025, directed CMS to restrict SDPs beginning with rating periods on or after July 4, 2025. The OBBA required CMS to cap certain SDPs — covering inpatient hospital, outpatient hospital, nursing facility, and academic medical center practitioner services — at Medicare rate levels.

CMS's proposed rule goes further than what Congress mandated in Section 71116. The rule would extend rate caps to all SDP service categories beginning January 1, 2029, not just the four service types Congress specified, and would phase out "uniform increase" SDP arrangements entirely.

State-directed payments grew rapidly from just four preprint submissions across two states in 2016 to 366 submissions across 41 states by 2024, driven partly by a 2024 CMS rule that allowed SDPs for certain services up to the Average Commercial Rate. Annual SDP spending reached $107 billion in FY 2024 and was projected to nearly triple to $296 billion by FY 2034 without restriction.

SDPs account for more than a quarter of all Medicaid managed care spending in FY 2025. CMS Administrator Mehmet Oz characterized the growth as misuse of Medicaid dollars, issuing a press release titled "CMS Moves to Rein In Misused Medicaid Dollars and Reward Quality Care."

The proposed rule implements a two-tier payment cap tied to state expansion status under the Affordable Care Act. States that expanded Medicaid under the ACA face a 100% Medicare cap; the 10 non-expansion states face a slightly more generous 110% cap.

This distinction creates a direct financial incentive tied to a decade-old coverage decision. The cap structure also means hospitals in expansion states — which typically have more Medicaid enrollees because more low-income adults are covered — face tighter payment restrictions than hospitals in non-expansion states, even though expansion hospitals often serve larger Medicaid populations.

For states that currently have SDPs exceeding the new Medicare rate caps, the rule proposes a grandfathering provision for certain existing arrangements. Grandfathered SDPs would be phased down by 10 percentage points annually beginning January 1, 2028, until they reach the new payment limit.

SDPs eligible for grandfathering are those with rating periods occurring within 180 business days before OBBA enactment (October 11, 2024 through July 3, 2025) or 180 business days after enactment (July 7, 2025 through May 27, 2026). Arrangements outside those windows don't qualify.

The American Hospital Association said the rule would cut supplemental payments that offset "chronically inadequate base Medicaid payment rates." Ashley Thompson, AHA Senior Vice President for Public Policy Analysis and Development, warned the cuts "will have very real consequences for access to care."

America's Essential Hospitals said CMS's proposed cuts go far beyond what Congress intended, arguing that by cutting SDPs by hundreds of billions more than the Congressional Budget Office projected, CMS would devastate essential hospitals' ability to provide care to patients and communities. The Modern Medicaid Alliance warned the restrictions could put coverage and access at risk for the more than 75 million Americans who depend on Medicaid.

Research from the Georgetown Center for Children and Families found that in 19 of 25 states with publicly available data, total Medicaid payments to hospitals would drop by at least 20 percent under SDP restrictions. Rural hospitals, children's hospitals, and safety-net providers face the heaviest impact because they serve high shares of Medicaid patients and have little commercial revenue to cushion payment losses.

Congress created a $50 billion Rural Health Transformation Fund that will allocate $10 billion to rural providers nationwide each year through 2030, but Georgetown researchers concluded that no state would receive more from the fund than it will lose from OBBA Medicaid cuts. The fund offsets roughly one-third of the $137 billion in cuts rural health systems face.

The proposed rule implements notice-and-comment rulemaking under the Administrative Procedure Act, 5 U.S.C. § 553. CMS opened a 60-day public comment period, with comments due by July 21, 2026. The rule was published as Federal Register document 2026-10292.

The APA notice-and-comment process requires CMS to consider all timely public comments before issuing a final rule. Hospitals, patient advocates, and state Medicaid directors have standing to submit detailed technical comments challenging CMS's legal authority, economic analysis, and implementation timeline — and to file legal challenges after finalization if they believe CMS exceeded its statutory authority under Section 71116.

STAT News reported on May 20, 2026 that Florida hospitals alone received $8 billion in extra Medicaid state-directed payments before the new limits took effect — one illustration of the scale of SDP payments in large states and the financial exposure hospitals face under the proposed caps.

States like California, Texas, and Florida that operate large managed care programs and have approved large SDP preprints face the biggest dollar-value cuts. State Medicaid directors in all 41 states using SDPs must now calculate how much revenue their providers would lose and whether to recommend state budget adjustments, provider rate increases from general funds, or service reductions to compensate.

The rule's legal authority rests on the Social Security Act, sections 1902, 1903, and 1932, which govern federal financial participation in Medicaid and the requirements for managed care contracting. Section 71116 of the OBBA provides the specific Congressional directive. CMS also cited a June 6, 2025 Presidential Memorandum, "Eliminating Waste, Fraud, and Abuse in Medicaid," as additional authorization.

Hospital groups and state Medicaid directors may challenge whether CMS's extension of rate caps to all SDP service categories — beyond the four Congress specified — exceeds the agency's statutory authority under Section 71116. Courts reviewing such challenges apply the major questions doctrine and post-Loper Bright deference standards following the Supreme Court's 2024 ruling that ended Chevron deference to agency interpretations of ambiguous statutes.