New federal policy changes are set to significantly alter Medicaid financing, with the Centers for Medicare and Medicaid Services (CMS) projecting a $510 billion reduction in federal spending between 2026 and 2035. These measures, stemming from the 2025 reconciliation law, place strict new caps on State Directed Payments (SDPs) and aim to align Medicaid reimbursement rates more closely with Medicare benchmarks, moving away from previous reliance on higher average commercial rates.
What are State Directed Payments?
State Directed Payments (SDPs) are mechanisms that allow state Medicaid programs to mandate how managed care organizations (MCOs) pay healthcare providers. According to the Kaiser Family Foundation (KFF), CMS introduced these in 2016 to help states bolster provider participation and improve access to care. States typically use them to set minimum payment rates or provide uniform supplemental payments that function similarly to fee-for-service (FFS) arrangements. Because these payments were often pegged to average commercial rates—which are generally higher than Medicare rates—they became a primary tool for states to increase provider revenue without adjusting base capitation rates.
How the 2025 Reconciliation Law Changes Reimbursement
The 2025 reconciliation law fundamentally shifts the financial landscape by capping SDPs at or near Medicare payment levels. Under these new rules, total payment amounts for inpatient and outpatient hospital services, nursing facility services, and professional services at academic medical centers are restricted to 100% of the Medicare rate in expansion states and 110% in non-expansion states.
This represents a pivot from the previous regulatory environment. As reported by the Congressional Budget Office (CBO), these legislative caps were designed to curb the rapid growth in federal Medicaid spending. While some existing SDPs are "grandfathered," the law mandates a 10-percentage-point annual reduction starting in 2028 until they comply with the new Medicare-linked ceilings.
Why CMS Estimates Differ from CBO Projections
There is a notable discrepancy between the $510 billion savings estimate released by CMS in May 2026 and the earlier $149 billion estimate provided by the CBO. This difference stems from two primary factors:
- Timeline and Data: The CMS projection covers through 2035, adding a year of impact compared to the CBO’s 2034 window. Additionally, CMS incorporated data from a surge of new SDP proposals submitted by states in 2025, which were not available when the CBO conducted its initial analysis.
- Expanded Scope: The CMS proposed rule extends payment limits to all services—not just the four categories identified in the reconciliation law—and applies these restrictions to U.S. territories, which were previously excluded.
Potential Impacts on Healthcare Providers
The reduction in supplemental revenue creates financial uncertainty for safety-net providers. According to Medicaid and CHIP Payment and Access Commission (MACPAC) analyses, providers that serve primarily Medicaid enrollees often operate on thinner margins than those with diverse payer mixes.
If states cannot offset these losses—potentially limited by restrictions on provider taxes and tighter fiscal conditions—some facilities may face pressure to curtail services. However, some researchers note that because average commercial rates have historically been significantly higher than Medicare, certain providers may be able to absorb these changes without immediate impacts on quality or patient access. The long-term effect remains dependent on how states choose to restructure their base payment rates in response to the loss of supplemental funding.
Frequently Asked Questions
What happens to existing SDPs?
Existing payments are subject to a phase-down. Starting January 1, 2028, grandfathered SDPs will see their total approved payment amounts reduced by 10% annually until they reach the new Medicare-based limits.
Do these rules apply to all Medicaid payment models?
The new limits target SDPs in managed care and certain targeted fee-for-service payments. They do not apply to payments already governed by other federal upper payment limit (UPL) rules.
Will this affect access to care?
The impact on access is a point of debate. While proponents of the law argue it brings transparency and fiscal sustainability to the program, provider advocates warn that safety-net facilities relying heavily on supplemental payments may struggle to maintain current service levels as revenue streams tighten.