The Bay State Boondoggle During a Time of Reform

By Amy Kaufman

On June 13, 2013, Senators Tom Coburn (R-OK) and Claire McCaskill (D-MO) sent letters to more than fifty senators urging them to support legislation to repeal Section 3141 of the Affordable Care Act (ACA). Under Section 3141, budget neutrality adjustments made to the Medicare hospital wage index based on the “rural floor” must be applied on a national, instead of a state-specific, basis. Established under the Balanced Budget Act of 1997 (BBA), the rural floor requires that the wage index for a hospital in an urban area of a State not be less than the wage index determined for that State’s rural area. The Hospital Payment Fairness Act of 2013, which Senators Coburn and McCaskill introduced in January, would restore the application of the “rural floor” adjustment to one that is state-specific.  State hospital associations have also called for the repeal of Section 3141. Most recently, twenty state hospital associations, along with the Rural Hospital Association, wrote a letter to President Barack Obama claiming that this provision creates an unacceptable windfall for Massachusetts hospitals at the expense of hospitals in other states and requested a reversal in policy.

The debate about the rural floor is not new. Rather, the discussion spawns from a long history of legislative action that has attempted to reform the broader hospital wage index adjustment under the Medicare inpatient prospective payment system (IPPS). The Secretary of the Department of Health and Human Services (HHS), the Medicare Payment Advisory Commission (MedPAC), and the Institute of Medicine (IOM), among others, have weighed in on the issue and, while many agree that change is necessary, few can confidently advocate for a specific plan for reform. This article examines how the debate about the rural floor, particularly about the application of budget neutrality, has progressed and has shifted over time, and predicts how Congress might address the issue, if at all, in the near future.

A.      History of the Rural Floor

The purpose of the hospital wage index under the IPPS is to adjust the IPPS standardized payment to reflect variations in wage levels in different labor market areas. This system is intended to help “hospitals which are disadvantaged by their current geographic classification because they compete with hospitals that are located in the geographic area to which they seek to be reclassified.”[i] Geographic classification was created under section 1886(d)(1) of the Social Security Act (the Act) (42 U.S.C. 1395ww(d)).

Section 4410(a) of the BBA provides that, for discharges on or after October 1, 1997, the area wage index applicable to any hospital that is located in an urban area of a State may not be less than the area wage index applicable to hospitals located in rural areas in that State.[ii] This provision is referred to as the “rural floor.” Section 4410(b) of the BBA established a budget neutrality requirement by providing that the Secretary shall “adjust the area wage index referred to in subsection (a) for hospitals not described in such subsection in a manner which assures that the aggregate payments under section 1886(d) of the Social Security Act in a fiscal year for the operating costs of inpatient hospital services are not greater or less than those which would have been made in the year if this section did not apply.”[iii] The Secretary initially applied this budget neutrality requirement on a nationwide basis. As a result, rural hospitals and other urban hospitals that do not benefit from their state’s rural floor received reduced wage index adjustments.

In the FY 2009 IPPS Proposed Rule, the Centers for Medicare and Medicaid Services (CMS) proposed (and later finalized its proposal) to apply the budget neutrality requirement on a state-by-state basis and, as such, redistribute wage index adjustments within the borders of each state.[iv] CMS noted that the rural floor benefits a minority of states and negatively impacts a majority of states—primarily rural ones– when budget neutrality is applied on a national scale.[v]  Moreover, CMS reasoned that since one purpose of the wage index is to help hospitals in the same geographic area to compete, it seemed appropriate to make budget neutrality state specific. Under this new policy, hospitals in states without a rural floor wage index would no longer be negatively affected by the budget neutrality adjustment.[vi] At the same time, hospitals in states with a rural floor would in essence be responsible for funding the rural floor adjustment within the borders of their own state.

CMS anticipated that states with the majority of their hospitals in urban settings would be disadvantaged by this this new policy and that states with few urban hospitals would benefit.[vii] In states such as Connecticut and California, for example, CMS expected adjustments to go from 2.1 and .7 under the national adjustment status quo to -2.2 and -.8, respectively. In Wisconsin, currently one of the biggest proponents of returning to the state-specific system, CMS expected the adjustment to remain steady at -.1.[viii] Surprisingly, CMS expected the adjustment for Massachusetts, the state that is now being accused of reaping benefits from the application of a national adjustment, to increase from -.2 to .3.[ix] But, as explained below, that was before Nantucket Cottage Hospital converted from  a critical access hospital (CAH) to an IPPS facility, which dramatically changed the circumstances in the Commonwealth.

The ACA restored the budget neutrality adjustment to a uniform, national adjustment, beginning in FY 2011. During the Senate Finance Committee’s mark-up of the Affordable Care Act in December 2009, Senators Robert Menendez (D-NJ) and John Kerry (D-MA) proposed to amend CMS’s new application of state-specific budget neutrality and return to the previous , national policy.[x] According to a letter sent by the Massachusetts delegation to President Obama on January 31, 2012, the American Hospital Association urged House Speaker Nancy Pelosi and Majority Leader Harry Reid to keep in place the Kerry-Menendez amendment.[xi] Moreover, none of the more than 1,000 amendments offered during the markup period sought to stop the Kerry-Menendez amendment from being passed.[xii] As such, the amendment passed both the House and the Senate and was signed into law as Section 3141 of ACA on March 23, 2010.

B.       Lobbying for Change

The application of the national rural floor budget neutrality adjustment has been the topic of heated debate since CMS issued its first set of regulations implementing Section 3141 in July 2011. Much of the controversy has centered on the fact that Massachusetts hospitals have benefited greatly from returning to the pre-2009 policy, collectively earning between a $275 million and $367 million annual bonus as a result of the national adjustment.[xiii] While hospitals in Alaska, California, Colorado, Connecticut, New Hampshire, and New Jersey have also benefited from the new policy, Massachusetts has been by far the largest beneficiary of the policy (California, the second largest recipient, received half as much as Bay State).[xiv]  

Given that CMS had expected Massachusetts to benefit from the earlier shift from the national application of budget neutrality to the state-specific application in 2008, it is perhaps surprising that the state would be the biggest winner of all when the policy was reversed only a few years later.   A seemingly minor change in circumstances, however, caused this major shift to occur.

Nantucket Cottage Hospital, a fifteen-bed hospital located in Nantucket, Massachusetts that serves approximately 150 Medicare patients each year, was previously classified as a critical access hospital (CAH) (a provider that is paid based on reasonable costs, rather than on the IPPS system). In October 2011, the hospital obtained IPPS status (becoming the only rural hospital In Massachusetts with IPPS status) and, as such, “triggered” the rural floor exception for urban hospitals in the state of Massachusetts.[xv] Because wages at Nantucket Cottage Hospital are high (due to its remote location and high cost of living), the inclusion of Nantucket in the IPPS resulted in a boost in wages for urban hospitals in the Commonwealth. Due to the national adjustment in place under the ACA, hospitals across the nation, rather than only Massachusetts hospitals, footed this bill.

In response to the Massachusetts windfall, state hospital associations, primarily from states with more rural areas, have lobbied for change. For example, on January 18, 2012, a group of state hospital associations from around the country asked the Obama administration to examine the rural floor provision, alleging that this provision would allow Massachusetts hospitals to earn an additional $275 million or more per year in Medicare reimbursements. According to that letter, the change is “unfairly favoring one state’s hospitals and Medicare beneficiaries to the detriment of others.”[xvi] The letter also stated that:

If left uncorrected, hospitals in 49 states will experience reduced funding of more than $3.5 billion over the next ten years as a direct result of this manipulation of Medicare’s hospital wage index.  Hospitals nationwide are already struggling with reduced government payments and the potential for cuts through the federal deficient reduction discussions and health care reform. Scarce Medicare funding should reward value and efficiency in health care, not be diverted based on an artful manipulation of obscure payment formulas.[xvii]

On June 25, 2012, the Wisconsin Hospital Association sent a letter to Acting Administrator of CMS Marilynn Tavenner opposing the “continued application of a nationwide rural floor budget neutrality adjustment….”[xviii] The association asserted that hospitals in many states lose significant money to offset the Medicare payments in Massachusetts and requested that CMS implement wage index provisions in an equitable manner in FY 2013. The association highlighted that the Agency itself had expressed concerns about this issue in the CY 2012 Outpatient Prospective Payment System (OPPS) final rule (CMS-1525-FC), when it stated that “[i]n recent years, we have become concerned that hospitals converting their status significantly inflate wage indices across a State….Our concern is that the manipulation of the rural floor is of sufficient magnitude that it requires all hospitals wage indices to be reduced.” [xix]

On January 16, 2013, twenty state hospital associations, along with the National Rural Hospital Association, wrote a letter to President Obama, requesting that he include language in his FY 2014 budget to address Section 3141.[xx] Former administrator of CMS Donald Berwick is quoted therein as stating that “the entire way the payment…has become so complex and so susceptible to gaming and manipulation…what Massachusetts gets comes from everybody else.” [xxi] This letter brought the debate about the rural floor back to the national stage.

A select group of congressmen also became involved in this discussion. First and foremost, former senator John Kerry has continuously defended the national application of the budget neutrality adjustment and the fact that Massachusetts is one of the beneficiaries. In a letter dated January 31, 2012, Senator Kerry and the rest of the Massachusetts delegation urged President Obama to ignore requests from state hospital associations to revert back to the state-specific adjustment.[xxii] They explained that:

rural floor budget neutrality has historically been applied at the national level, just like all other Medicare budget neutrality provisions. Near the end of the Bush Administration in 2008, [CMS] for the first time, in unprecedented rule-making, reversed long standing policy and changed rural floor budget neutrality to apply on a within-state basis. It meant that though all other budget neutral provisions in the Medicare program would continue to be on a national basis, the rural floor would be singled out for a different approach. The rule conflicted with statutory intent, destabilized the wage index, and produced inequity among providers. It was, in effect, a manipulation of long standing Medicare reimbursement policy.[xxiii]

The delegation also adamantly asserted that there was no manipulation by the Commonwealth or its hospitals, and pointed out that nine of twenty-seven state associations that had signed onto a letter urging President Obama to support the state-specific adjustment had in fact lobbied against changing to the state-specific adjustment at an earlier time.[xxiv]

Senator Coburn is also very much involved in this discussion. During a U.S. Senate Finance Committee Hearing on the President’s Budget for FY 2013, on February 15, 2012, he asked Secretary Kathleen Sebelius why she permitted the “nice little trick that enhances [reimbursement for] Massachusetts to the tune of $3.5 billion over the next ten years at the expense of 49 other states….” [xxv] He later explained that he was most concerned about HHS’s decision to grant IPPS status to Nantucket Cottage Hospital since that move ultimately triggered the significant shift in reimbursement dollars around the country.

Earlier this year, Senator Coburn and Senator McCaskill introduced the Hospital Payment Fairness Act of 2013 (S.183), which would sunset section 3141 of the ACA. In a statement about the bill, Senator Coburn said that “[t]his policy is effectively a payment earmark inserted in a law without the American people’s knowledge or consent. No state should have a special exemption while others bear the costs for a provision designed to advance a special interest.”[xxvi] The bill has been referred to the Senate Finance Committee for consideration and, as of the date of this publication, the bill had sixteen Republican and nine Democratic co-sponsors. Although the senators are adamantly seeking additional support, it appears unlikely that the bill will move beyond the committee anytime soon.   

C.      The Bigger Picture: Wage Index Reform

The debate about the rural floor adjustment is only a narrow piece of the ongoing discussion about more comprehensive wage index reform. Congress began a review of the Medicare wage index system through Section 106(b)(1) of the Medicare Improvements and Extension Act, Division B of the Tax Relief and Health Care Act of 2006.[xxvii] This act required MedPAC to submit to Congress a report describing the wage index system applied in the IPPS and any alternatives methods for computing the wage index. MedPAC set forth its recommendations for reforming the wage index in its June 2007 report titled “Report to Congress: Promoting Greater Efficiency in Medicare.” The Report recommended the creation of a new hospital compensation index that:

  • uses wage data from all employers and industry-specific occupational weights;
  • is adjusted for geographic differences in the ratio of benefits to wages;
  • is adjusted at the county level and smooth large differences between counties; and
  • is implemented so that the large changes in wage index values are phased in over a transition period.[xxviii]

In addition, the Institute of Medicine (IOM) issued a report in 2011 that called for a new system based on the Bureau of Labor Statistics data “with a method for smoothing differences in wage indexes across adjacent payment areas. This new system “is intended to replace the system of geographic reclassifications that is currently in place.”[xxix]

The Secretary of HHS released its own “Report to Congress: Plan to Reform the Medicare Wage Index,” as required by section 3137(b) of the ACA, on April 11, 2012.[xxx] Section 3137(b) requires the Secretary’s report to include a plan to reform the Medicare wage index applied under section 1886(6) of the Social Security Act relating to the IPPS. Congress directed the Secretary to consider the goals that MedPAC described in its 2007 Report to Congress and to consult with relevant affected parties when it developed its plan.

The Secretary’s report analyzes recent efforts to reform the wage index system and describes the concept of a Community Based Wage Index (CBWI), which “takes into account hospital hiring patterns in calculating the wage index by using commuting data to establish a labor market area and wage index for each hospital (as opposed to labor market areas).” The CBWI would focus more on individual hospitals and is intended to create a system that is more accurate and less distorted.[xxxi]  The report also notes the pros and cons of transitioning to this type of system.

D.       Conclusion

At this time, it is not clear whether Congress will resolve the debate about the wage index this year. It only appears unlikely that the Hospital Payment Fairness Act will be the vehicle of choice.  Perhaps the introduction of a bill in the House of Representatives could be the next best move for proponents of the repeal of Section 3141. Until a resolution is reached, however, regardless of who makes the next move in the debate, this issue will continue to have a significant impact on hospital reimbursement nationwide.


Amy E. Kaufman represents clients in the health care industry on a wide range of fraud and abuse, regulatory, and reimbursement matters. She has in-depth experience advising clients on compliance with federal and state fraud and abuse laws, including the Stark law and Anti-kickback Statute, licensing matters, and pharmacy regulations.

Ms. Kaufman also counsels private equity clients on acquisitions of health care providers and suppliers. For instance, she assists clients by identifying strategic ways to structure acquisitions, conducting due diligence, drafting regulatory sections of purchase agreements, and keeping federal and state agencies informed of acquisitions as required by law. 


[i]  Medicare Program; Proposed Changes to the Hospital Inpatient Prospective Payment Systems and FY 2009 Rates; 73 Fed. Reg. 23528, 23618 (April 30, 2008).

[ii]  Balanced Budget Act of 1997, Pub. L. No. 105-33, §4410(a), 111 Stat. 251 (1997).

[iii] Id. at §4410(b).

[iv] 73 Fed. Reg. 23620.

[v] Id.

[vi] Id.

[vii] Id.

[viii] Id. at 23621.

[ix] Id. at 23621.

[x] See Letter from Mass. Delegation to President Barack Obama (Jan. 31, 2012) (on file with author), available at

[xi] Id.

[xii] See id.

[xiii] See Overly, Jeff, “Sens. Aim to Curb Medicare ‘Earmarks’ for Mass. Hospitals,” Law360 (Jan. 31, 2013), available at

[xiv] Cheung-Larivee, Karen, “Mass. to Win $275M through Medicare Loophole, States Outraged,” Fierce Healthcare (Aug. 4, 2011), available at

[xv] Letter from MedPAC to Donald M. Berwick, M.D., Jan. 17, 2011 (on file with author), available at

[xvi] Letter from State Hospital Assn’s to President Barack Obama, Jan. 18, 2012 (on file with author), available at

[xvii]  Id.

[xviii] Letter from Wis. Hospital Assn., Inc. to Acting CMS Administrator Marilyn Tavenner  (June 25, 2012) (on file with author), available at

[xix] Id.

[xx] Letter from State Hospital Assn’s to President Barack Obama (Jan. 16, 2013) (on file with author).

[xxi] Id.

[xxii] Letter from Mass. Delegation to the President, Jan. 31, 2012 (on file with author), available at

[xxiii] Id.

[xxiv] Id.

[xxv] The President’s Budget for 2013: Hearing Before the Committee on Finance, United State Senate, 112th Cong. (2012),

[xxvii] Tax Relief and Health Care Act of 2006, Pub. L. 109-432, §106(b)(1) Div. B, 122 Stat. 2922 (2006).

[xxviii] Letter from MedPAC to Donald M. Berwick, M.D., Jan. 17, 2011 (on file with author), available at

[xxix] Institute of Medicine, 2011. Geographic Adjustment in Medicare Payment: Phase I: Improving Accuracy. The National Academy Press, Washington, DC.

[xxx]   Secretary of Health and Human Services, Report to Congress: Plan to Reform the Medicare Wage Index (Apr. 11, 2012).

[xxxi]   Id. 


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