Stakeholders were watching closely when Secretary of Health and Human Services (HHS) Robert F. Kennedy Jr. testified on Capitol Hill on May 14. In back-to-back hearings before the House Appropriations Subcommittee on Labor, Health and Human Services, and Education and the Senate Committee on Health, Education, Labor, and Pensions, Kennedy outlined the administration’s priorities in appearances marked by a combination of collegial exchanges and pointed scrutiny.
For those focused on rural healthcare delivery, a key signal came early in the first hearing when Subcommittee Chair Robert Aderholt (R-AL) described the Centers for Medicare & Medicaid Services (CMS’s) area wage index (AWI) as “one of the most significant challenges facing rural hospitals.” Aderholt contended that the wage index had “the perverse result of preventing low-wage hospitals—many of which are in rural areas and underserved communities—from paying higher wages.”
Accepting Aderholt’s premise and echoing language from recent federal court decisions, Kennedy sais that CMS “has no power to redress this disparity.” He pledged to work with Aderholt and Congress to pursue reform, emphasizing that meaningful change “has to be statutory.” Kennedy added that HHS would provide “technical support, including the kind of studies that [Aderholt] just mentioned that show how badly this disparity is wounding” rural providers.
Background
Since 1983, Medicare has reimbursed hospitals for inpatient care through a prospective payment system. These payments are determined using formulas established by Congress and administered by HHS.
The reimbursement formula includes several fixed-rate components: one covering labor costs, another covering non-labor costs, and a third adjusting for the type of care based on the patient’s diagnosis. Together, these components aim to approximate the cost of treating a patient with a particular condition at an efficiently run hospital in a given region.
Because labor costs vary widely across the country, Congress included a wage index to account for regional wage differences. Under 42 U.S.C. § 1395ww(d)(3)(E)(i), CMS compares local wages to the national average and assigns each hospital a wage index value. The national average is set at 1.0. Hospitals in higher-wage areas receive a value above 1.0—and therefore higher payments—while hospitals in lower-wage regions receive a value below 1.0 and lower payments. Hospital labor market areas are defined using Core-Based Statistical Areas (CBSAs) designated by the Office of Management and Budget (OMB).
Congress also required that changes to the wage index be budget-neutral. If payments increase in one area due to wage growth, they must be offset by corresponding reductions in other areas. Additionally, under 42 U.S.C. § 1395ww(d)(5)(I)(i), CMS is authorized to make “adjustments” to the reimbursement formula when necessary.
During the first Trump administration, CMS attempted to address wage index disparities through the Fiscal Year (FY) 2020 Inpatient Prospective Payment System (IPPS) final rule, issued in August 2019. Invoking its authority to make “exceptions and adjustments,” CMS implemented a policy to support hospitals with persistently low wage index values. The agency cited structural limitations in the wage index methodology—particularly the lag between wage increases and their reflection in reimbursement rates—as a barrier to raising compensation in low-wage markets.
To mitigate these effects, CMS boosted the wage index values for hospitals in the lowest quartile, thereby increasing their Medicare payments. Because adjustments had to remain budget-neutral, this increase was offset by a 0.2016% reduction in payments to other hospitals. The policy drew sharp criticism from higher-wage hospitals, several of which filed legal challenges. One of the most consequential was Bridgeport Hospital v. Becerra.
In Bridgeport, the plaintiffs argued that the Low Wage Index Hospital Policy violated both the Medicare Act and the Administrative Procedure Act. They contended that CMS had exceeded its statutory authority by altering the wage index formula in a way that redistributed payments. The plaintiffs emphasized that the Social Security Act already prescribes a detailed methodology for calculating the wage index and that CMS’s reallocation exceeded the bounds of permissible agency discretion.
Defending the policy under Secretary Xavier Becerra, HHS argued that CMS had acted within its authority to make “exceptions and adjustments” under 42 U.S.C. § 1395ww(d)(5)(I)(i). The agency maintained that the policy addressed long-standing disparities in the wage index and was a reasonable effort to support financially vulnerable hospitals in underserved areas.
The U.S. Court of Appeals for the D.C. Circuit disagreed. In a decision issued in July 2024, the court held that the Medicare statute prescribes the inpatient reimbursement formula with “remarkable specificity,” leaving no ambiguity about how the wage index must be calculated. It found that CMS had unlawfully used its adjustment authority to “pick winners and losers” by inflating payments for certain hospitals while suppressing them for others. The court ordered the policy to be vacated.
The Bridgeport decision had operational consequences. Although CMS initially continued the policy in its FY 2025 final rule, it reversed course shortly before the new fiscal year began. In a September 2024 interim final rule, CMS removed the policy from the FY 2025 IPPS payment calculations, citing the D.C. Circuit’s ruling. To limit financial disruption, the agency capped wage index losses at 5 percent for hospitals affected by the repeal—without applying offsetting reductions elsewhere.
The legal consensus was reinforced in December 2024 when the U.S. Court of Appeals for the Ninth Circuit issued a separate decision in a parallel case. Affirming a district court ruling, the Ninth Circuit held that HHS lacked authority to implement the low-wage index hospital policy under either the Wage Index Provision or the Exceptions and Adjustments Provision. The panel criticized the agency for having “tinkered” with the statutory formula. It emphasized that “under our system of separation of powers, neither good intentions nor pressing policy problems can substitute for an agency’s lack of statutory authority to act.” Notably, one judge dissented, observing that “unnecessary rejection of the Secretary’s policy will have drastic repercussions for vulnerable communities.”
The D.C. and Ninth Circuit decisions and Kennedy’s testimony indicate that permanent changes to the wage index will need to come from Congress. As stakeholders consider the future of rural hospital financing and broader wage index reform, attention will turn to whether the administration and Congress can agree on a statutory fix.