Forty States Face Medicaid Payment Cuts as CMS Caps State-Directed Payments

Forty states and the District of Columbia, which collectively receive $93 billion annually in federal Medicaid spending through state-directed payments (SDPs), could face significant budget reductions due to new payment limits, according to a KFF analysis. The changes, part of a 2025 reconciliation law, cap SDP rates at Medicare levels rather than average commercial rates, potentially reducing federal Medicaid spending by $510 billion between 2026 and 2035, as estimated by the Centers for Medicare and Medicaid Services (CMS).

What Are State-Directed Payments (SDPs)?

SDPs, established in 2016, allow states to set payment rates for managed care organizations, often benchmarked to commercial (private) rates. These payments primarily cover hospital services, which accounted for 84% of federal SDP spending in 2023, totaling $78 billion, according to KFF. Professional services at academic medical centers ($3.2 billion) and nursing facility services ($2.1 billion) make up the next largest shares.

How Will the New Limits Affect Hospitals?

The 2025 reconciliation law reduces SDP payment rates to Medicare levels, a shift expected to disproportionately impact hospitals, which dominate SDP spending. CMS estimates the changes will cut federal Medicaid spending by $510 billion over the next decade, with effects intensifying yearly. Hospitals, particularly safety-net providers serving Medicaid enrollees, could face financial strain, risking service reductions or closures if uncompensated care rises, as noted by KFF.

Why Did CMS Shift to Medicare Rates?

CMS began approving SDPs tied to commercial rates in 2018 to expand provider networks and improve access. However, the 2024 Medicaid managed care rule formalized a cap at average commercial rates, prompting increased SDP spending. The 2025 law reversed this, aligning rates with Medicare, which are significantly lower. A proposed CMS rule in May 2025 aims to further broaden these limits, according to KFF’s policy analysis.

What Are the Broader Implications?

States face limited options to offset federal cuts due to other Medicaid financing restrictions in the reconciliation law. Hospitals already struggling with financial instability may see reduced services, particularly in rural or low-income areas. The American Hospital Association has warned that safety-net hospitals, which serve a high proportion of Medicaid patients, could be “under extraordinary financial pressure,” as reported by Reuters.

How Are States Responding?

The response remains uncertain, with states grappling with limited tools to mitigate losses. Some may seek alternative funding sources, while others could face difficult decisions about service cuts. CMS has not yet finalized its proposed rule, but the policy shift underscores growing scrutiny of Medicaid spending and its impact on healthcare access, according to Health Affairs.