Kentucky Health Care Provider Tax - Court Decisions
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OLR Research Report OLR Research Report

The Connecticut General Assembly


December 7, 1994 94-R-1062


FROM: John Kasprak, Senior Attorney

RE: Kentucky Health Care Provider Tax - Court Decisions

You asked for information on the Kentucky health care provider tax and related court decisions.


In a 1993 special session, Kentucky legislators enacted a 2% gross revenue tax on physicians, nursing homes, and health maintenance organizations (HMO), as well as a pharmacy tax of 25 cents per prescription, and a 2. 5% gross revenue tax on hospitals.

Last month, the United States Supreme Court, in effect, upheld the validity of the 2% gross revenue tax on physicians by refusing to review a Kentucky Supreme Court decision upholding the tax.

In 1993, a Kentucky trial court ruled the tax "special legislation" prohibited by the state's constitution because it singled out physicians and HMOs to underwrite a program (Medicaid) benefitting the whole state. But the Kentucky Supreme Court later held that the state statute was constitutional even though it taxed some physicians who did not participate in Medicaid.


In May of 1993, the Kentucky Legislature passed HB1, a provider tax measure expected to generate $ 225 million for the state's Medicaid program over the next fiscal year. The legislation included a 2. 5% gross revenue tax on hospitals; a 2% gross revenue tax on individual physicians, nursing homes, and HMOs; and a pharmacy tax of 25 cents per prescription.

The law, which took effect July 1, 1993, had a sunset clause under which the provider taxes expired after the next special legislative session on health care or the end of the 1994 regular session, whichever came first. (Although the provider tax was scheduled to expire in June 1994, health care reform measures that passes both the Kentucky House and Senate continued the tax).

Three lawsuits were filed challenging the law, by individual physicians, the Kentucky Medial Association, and the HMO Association of Kentucky. The circuit court consolidated the lawsuits. (A separate suit was filed by the Kentucky Hospital Association and is not discussed here. ).

The legislation's provider taxes replaced prior taxes invalidated by 1991 amendments to the federal Medicaid statute. The previous taxes applied only to providers who participated in the Medicaid programs. Federal law specified that permissible state provider taxes had to apply uniformly to all health care providers in a class for the state to avoid reductions in federal financial participation. HB1's prescription tax could be passed on to third party payers, but the law prohibited hospitals and physicians from passing along the tax.


State Circuit Decision

In November 1993, a Franklin County circuit Judge held that the legislation which intended to help finance Kentucky's Medicaid program by taxing physician's gross revenues was unconstitutional under the Kentucky Constitution (Smith v. Kentucky Revenue Cabinet, Kentucky Circuit Court (Franklin County), November 23, 1993).

The court ruled that the 2% tax on physicians' gross revenues violated a state constitutional provision prohibiting special legislation that arbitrarily discriminates against classes of persons. The classifications established by HB1, which apply to all physicians and not just the 60% participating in Medicaid "are not based upon reasonable and natural distinctions and are not logically related to the purpose of the legislation to increase Medicaid funding," the court stated. There was no reasonable basis for singling out physicians to pay special taxes to support the Medicaid program, which benefits the state as a whole, according to the court. Instead of complying with a federal mandate, the court said the state was "rewriting the law to avoid loss of the federal funding. "

Judge Roger Crittenden ordered the state to refund within 90 days taxes already paid by physicians and barred further state efforts to collect the taxes. His ruling applied not only to private physicians, but also to physicians employed by HMOs. The court also held that HMO's premium revenues were excluded from the provider tax.

Request for Stay

The state requested a stay of the circuit court's order blocking enforcement of the provider tax and requiring tax refunds to physicians. On December 21, 1993, the Kentucky Supreme Court stayed the lower court's order. In its order, the state Supreme Court commented that the state had a strong possibility of succeeding on its appeal from the lower court decision. Chief Justice Robert Stephens also found that a stay of the lower court injunction was warranted to prevent the state Medicaid program from losing $ 12 million to $ 25 million through reduction of federal matching funds linked to the provider tax. The state Supreme Court's order stayed both the circuit court's refund order and the portion of the order barring the state from collecting the taxes. Affected providers had to continue to remit the taxes pending final resolution of the matter.

Kentucky collected about $ 59 million in the first three months after the tax was implemented. About $ 8. 4 million derived from physician taxes, with $ 3. 6 million representing HMO payments.

Also the state and the HMOs resolved their differences in an agreement reached December 20, 1993.

State Supreme Court Decision

On March 24, 1994, the Kentucky Supreme Court upheld the constitutionality of Kentucky's health care provider tax (Kentucky Revenue Cabinet v. Smith, Kentucky Sup. Ct. No. 93-SC-946-TG). In a 5-2 ruling, the court said the tax did not constitute special legislation as found by the lower court. Just because the legislature chose to fund the state's Medicaid program by taxing doctors and other health providers, rather than all Kentucky residents, did not make the law unconstitutional, according to Justice Reynolds. If it did, as argued by the physicians, then progressive income tax and sales tax exemptions would also be unconstitutional, according to the Justice.

Appeal to U. S. Supreme Court

On November 14, 1994, the United States Supreme Court declined to review the Kentucky Supreme Court's decision upholding the state's health care provider tax. (Smith v. Kentucky Revenue Cabinet, U. S. Sup. Ct. , No. 94-525). Thus, the state court's decision upholding the 2% gross revenue tax on health care providers remains in place.

JK: tjo