Full opinion text
MEMORANDUM OPINION AND ORDER EISELE, District Judge. The Plaintiffs — three individual hospitals, four national hospital associations and seven state hospital associations — filed this action, along with a motion for preliminary and permanent injunction, against the Secretary of the Department of Health and Human Services (“the Secretary”) on March 7, 2002. Cross motions for summary judgment have now been filed. Plaintiffs ask the Court to bar implementation and enforcement of new Medicaid regulations scheduled to take effect on May 14, 2002. These regulations — codified at 42 C.F.R. §§ 447.272 and 42 C.F.R. 447.321 — are known collectively as the 2002 Upper Payment Limit Rule. The challenged regulation reduces the upper limit on what states may reimburse locally-owned public hospitals for services to Medicaid beneficiaries and still receive federal matching funds. The Plaintiffs contend that the 2002 UPL will drastically impact states’ abilities to channel much needed payments to locally-owned public hospitals, which treat large numbers of Medicaid, uninsured, and underinsured patients. In contrast, the Secretary contends that the challenged regulation closes a flagrant regulatory loophole that essentially allows states to improperly obtain excess federal matching funds through “Mckback” procedures (described below) and then use such excess for non-Medicaid purposes. After a careful review of the entire administrative record, the supplemental materials submitted by the parties, the excellent briefs submitted by counsel and their impressive oral arguments, the Court has concluded that the Plaintiffs’ motion for summary judgment must be denied and that the Defendant’s motion for summary judgment should be granted. I. BACKGROUND: MEDICAID OVERVIEW Medicaid is an entitlement program administered by the states but jointly financed by the federal and state governments. The Medicaid program was created in 1965 and is designed to furnish medical assistance to persons “whose income and resources are insufficient to meet the costs of necessary medical services.” 42 U.S.C. § 1396. As the nation’s largest means-tested health care financing program, its importance to the nation’s health care system cannot be overstated. However, despite the program’s singular position in American health policy — and perhaps in part because of it — the Medicaid legislation is a morass of arcane, vague, and incoherent rules and regulations, which in some cases provide little in the way of helpful guidance. Its complexity becomes readily apparent in a case such as this one, where the intricacies of the Medicaid system appear to allow different states to use a particular regulation for vastly different ends. Here, for instance, some states rely on the regulation to fund critical care for underserved communities, while others use the same regulation to artificially inflate the amount of federal Medicaid reimbursement to which they are entitled with no guarantee that such excess federal funds will be used for Medicaid purposes. The Medicaid program is administered by the states under Medicaid state plans approved by the Secretary of the Department of Health and Human Services (HHS). Each state is required to establish a medical assistance plan (known as the “State Plan”) which must describe eligibility standards, the scope of benefits, reimbursement methodologies and certain other details of that state’s Medicaid program. With regard to reimbursement, the State Plan must describe the methodology used to pay providers, but it need not list amounts to be paid to specific individual providers. HHS reviews the various State plans and all subsequent amendments to ensure compliance with broad federal requirements outlined in the Medicaid statute and accompanying regulations. Most notably, State Medicaid plans must assure that payments to health-care providers “are consistent with efficiency, economy, and quality of care.” 42 U.S.C. § 1396a(a)(30)(A). The plans must also be “sufficient to enlist enough providers so that care and services are available under the plan at least to the extent that such care and services are available to the general population in the geographic area.” Id. In other words, Medicaid reimbursement must take into account the market-driven nature of our nation’s health care system while balancing the need to safeguard against inappropriate and wasteful expenditures. As noted, the Medicaid system is jointly ^financed by the federal and state governments, and, thus, differs from Medicare, which is financed solely by the federal government. Essentially, the federal government reimburses the states for their Medicaid expenditures on the basis of a formula tied to the per-capita income in each state. The federal share of Medicaid expenditures, otherwise known as “federal financial participation,” or “FFP,” varies from a minimum of 50 percent to as much as 83 percent of a State’s total Medicaid expenditures. Athough the non-federal share of a state’s Medicaid expenditures is frequently referred to as the “State share,” it is important to note that the Medicaid statute requires only that each State plan “provide for financial participation by the State equal to not less than 40 per centum of the non-Federal share.” 42 U.S.C. § 1396a(a)(2). In other words, the portion of a State’s Medicaid expenditures not covered by federal matching funds is properly referred to as the “non-federal share.” And, sixty percent of the non-federal share of a State’s Medicaid expenditures may be funded by sources other than the State. It is this provision-— 42 U.S.C. § 1396a(a)(2) — combined with certain regulations discussed below — that has given States room to create the abusive financing schemes of which the Secretary complains. II. SAFETY NET HOSPITALS As noted, Plaintiffs challenge a regulation known as the 2002 Upper Payment Limit Rule (“2002 UPL Rule” or “2002 Rule”). The 2002 UPL Rule reduces the maximum amount of Medicaid reimbursement that states can give to locally owned public health care providers and still receive federal matching funds. Plaintiffs contend that the 2002 UPL Rule, by reducing Medicaid reimbursement rates, drastically limits the states’ ability to target supplemental payments to such locally owned hospitals, which comprise a significant percentage of the nation’s “safety net hospitals” the loose term which generally refers to those hospitals that treat all patients without regard to their health status or them ability to pay. The premise is that these hospitals must make up for large amounts of uncompensated services in order to stay operational. In addition to high levels of uncompensated care, these hospitals typically have low private caseloads and, thus, are less able to shift the cost of uncompensated care to privately insured patients. States have taken advantage of numerous statutory and regulatory provisions in order to direct supplemental payments to safety net hospitals. One method of targeting such payments to safety net hospitals involves supplemental payments under Medicaid Upper Payment Limits— the type of payments that are at issue in the instant litigation. Another method involves payments under a separate Medicaid statute to “disproportionate share hospitals,” or “DSH” payments. The Secretary contends that the history of DSH payments is particularly relevant to this litigation because HHS has been forced to correct abuses within the DSH program that are similar in operation to the abuses which in large measure precipitated both the 2001 UPL Rule and the 2002 UPL Rule. Thus, the Court will briefly discuss the DSH program. III. THE DSH PAYMENT ADJUSTMENT Since 1981, the Medicaid statute has directed States to set Medicaid payments rates that take into account “the situation of hospitals which serve a disproportionate number of low-income patients with special needs.” 42 U.S.C. § 1396a(a)(13)(A)(iv). This requirement is commonly referred to as the Medicaid disproportionate share hospital (DSH) payment adjustment. As noted, DSH payments are designed to assist safety net hospitals in making up for high levels of uncompensated care. The DSH payments that States make to safety net hospitals also draw federal matching funds. Because the states are responsible for funding a share of DSH payments, Congress assumed their generosity to DSH hospitals would be tempered by fiscal realities. Thus, DSH payments originally had no ceiling and were not subject to the “upper payment limits” that applied to other Medicaid payments. See 42 C.F.R. 447.272(c)(2)(stating that upper payment limits do not apply to DSH payments). This flexibility, however, resulted in what has been referred to as a “loophole” in the DSH Program that allowed states to increase their receipt of federal matching funds without a corresponding increase in state expenditures. The loophole typically operated as follows. A state would pay an excessively high DSH payment to a hospital. This would fix the amount of the federal matching contribution. But the hospital would then transfer back a portion of the DSH payment to the state through “donations,” “taxes,” or some type of intergovernmental transfer. The result was that the state could draw additional federal matching funds without having to contribute additional state money towards the DSH payments. Thus, states could make virtually unlimited DSH payments and, in the process, earn FFP dollars while requiring DSH hospitals to transfer back to the states most of the DSH payments that the state had provided. Many states were initially slow to act on their ability to make DSH payments to hospitals in need of special assistance. However, as states became increasingly aware of their ability to leverage additional federal matching funds through excessive DSH payments, the number of states with DSH programs increased rapidly during the late 1980s and early 1990s. According to the Defendant, the states’ use of inflated DSH payments and resulting kickbacks grew significantly between 1989 and 1992 with the result that federal spending for DSH payments grew from $400 million to $16.5 billion during that time period. In 1991, Congress passed legislation aimed at stopping states from so inflating DSH payments. This legislation was the Medicaid Voluntary Contributions and Provider-Specific Tax Amendments of 1991, Pub.L. No. 101-284, 105 Stat. 1793 (1991). This legislation (A) essentially banned provider “donation” programs; (B) reduced federal matching funds for any state with existing provider taxes that exceeded 25% of its Medicaid expenditures; (C) imposed criteria on allowable provider taxes that required that they be “broad based” and that the provider not be “held harmless” financially; and (D) capped DSH payments at roughly their 1992 levels under a new formula. Interestingly, although the 1991 legislation curtailed DSH payment growth, it actually allowed states that had been making excessive DSH payments to make significantly higher DSH payments subsequent to the 1991 legislation than states that had not established DSH programs prior to the legislation. IV. SUPPLEMENTAL PAYMENTS UNDER UPPER PAYMENT LIMITS States also have found ways to use the Medicaid “upper payment limits,” or UPLs, to create additional supplemental payments to safety net hospitals. These limits apply to payments for the services of inpatient hospitals, nursing facilities and intermediate-care facilities for the mentally retarded, and to payments for the services of outpatient hospitals and clinics. 42 C.F.R. §§ 447.272, 447.321. UPLs set a maximum amount that a state may pay to Medicaid providers and still receive federal matching funds. In other words, a state could conceivably make payments to providers in excess of the UPLs but it could not legitimately receive any federal matching contributions towards the excess amount. A. Medicaid UPL Prior to 1987: 100% Rule Applied Across All Types of Hospitals Prior to 1987, the UPL regulations required a state to assure “that its estimated average proposed payment rate” for inpatient or long-term care services was “reasonably expected” not to exceed in the aggregate the amount that the agency “reasonably estimat[ed] would be paid for the services under the Medicare principles of reimbursement.” 42 C.F.R. § 447.253(b)(2) (1984) (emphasis added). The UPL applied in the aggregate to the three categories of health care facilities— that is, state-owned, locally-owned, and privately-owned. In other words, so long as a state’s aggregate Medicaid payments did not exceed 100 percent of what would be paid for the same services pursuant to Medicare, the states were free to allocate payments among specific facilities, and/or specific categories of facilities, as they chose. States could, for instance, make higher payments to all government-owned hospitals at the expense of private hospitals, so long as the aggregate payments across all types of hospitals did not exceed 100 percent of Medicare payment principles. Similarly, a State could make higher payments to government-owned long-term care facilities (i.e., government-owned nursing homes) at the expense of private long-term facilities, so long as the aggregate payments across all types of long-term facilities did not exceed 100 percent of Medicare payment principles. B. 1987 Revision: Separate UPL for State-Owned Hospitals and Long-Term Care Facilities In 1987, HHS revised the UPLs for inpatient hospital and long-term care facility services into a two-tiered structure. One tier involved state-operated facilities, while the second tier included all three categories of facilities — state-owned, locally-owned, and privately-owned — combined. See 51 Fed.Reg. 5728 (February 18, 1986); 52 Fed.Reg. 28141, 28145 (July 28, 1987). More specifically, under the regime instituted in 1987, states were required to limit aggregate payments to state-operated facilities to 100 percent of Medicare principles. And states also were required to limit aggregate payments to all three categories of facilities combined to 100 percent of Medicare principles. This change was effectuated because there were no incentives for State-operated facilities to self-impose cost-constraining methodologies. In other words, because states were obligated to pay for the expenses of state-operated facilities, states had an incentive to increase Medicaid payments to these facilities at the expense of non-state facilities subject to the pre-1987 single aggregate limit. The 1987 regulations reduced the ability of states to overpay their own hospitals and long-term care facilities at the expense of privately-owned or locally-owned facilities. But it left intact the ability of states to shift Medicaid payments to locally-owned (i.e., county- or city-owned) hospitals and long-term care facilities at the expense of private facilities so long as the aggregate 100 percent limit was respected. Accordingly, some states soon found a way to make intergovernmental transfers (IGTs) work for them in a way that closely resembled the donation and provider-tax DSH loopholes of the late 1980s and early 1990s. In particular, some states began to pay locally-owned facilities at rates exceeding their cost of serving Medicaid beneficiaries. These states would claim federal matching funds based on these “inflated” amounts, and the local facilities would then funnel some or all of the additional money back to the states through IGTs. In some instances, the money that was funneled back to the states through IGTs was used to increase care to underserved populations — not necessarily Medicaid populations — -or to otherwise improve healthcare in these states. In other instances, however, states were using this money for purposes completely unrelated to health care. C. 2001 Regulations: 150 Percent Rule for Locally-Owned Hospitals The continued flexibility that states had to abuse IGTs under the UPLs prompted HHS to consider additional changes to the UPL regulations. Specifically, HHS proposed regulatory changes on October 10, 2000, that were finalized on January 12, 2001, and became effective March 13, 2001. An understanding of these regulatory changes, collectively referred to as the 2001 UPL Rule, is particularly crucial to the instant litigation. Thus, the Court will discuss them in detail. 1. CMS Describes Potential for Abuse in Letter to States In the Summer of 2000, HHS notified States of its growing concern about abusive IGTs. Specifically, the changes effectuated in the 2001 150 percent rule were foreshadowed in a letter to state Medicaid Directors from the Director of the Centers for Medicare & Medicaid Services (“CMS”), the agency responsible for administering Medicaid. See Administrative Record of Rule Promulgated at 65 Fed. Reg. 3148 (2001 UPL Rule), Volume 1, at 41-44. This letter, dated July 26, 2000, reads, in relevant part as follows: It has come to our attention that some States are using the flexibility in setting the maximum rates that can be paid under the Medicaid program (the so-called “upper payment limits”) to pay government-owned facilities at a rate far exceeding their cost of serving Medicaid beneficiaries so that the States can gain Federal Medicaid matching payments without new State contributions. I am writing to say that we intend to address this problem, and to outline our concerns and the process for addressing them. Background As you know, under current Federal regulations, States have great flexibility in setting the Medicaid rates that they pay to nursing homes and hospitals. These regulations do establish an overall maximum payment; States may pay facilities a total amount up to the level that Medicare would pay for the same services. However, it appears that some States are: □ calculating the maximum amount that, in theory, could be paid to each Medicaid facility (referred to as the “upper payment limit” or “UPL”); □ adding these amounts together to create excessive payment rates to a few county or municipal facilities; □ claiming Federal matching dollars based on these excessive payment rates; and then □ directing these county or municipal facilities to transfer large portions of the excessive payments back to the State government. It appears that many States allow their county-owned providers to keep only a small fraction of the Federal funds (less than five percent) that are used to provide these excessive “reimbursements.” The practical outcome is that the States using this financing mechanism actually gain Federal matching payments without any new State financial contribution. This practice is not consistent with the intent of the Medicaid statute that -specifies that provider payments must be economic and efficient. If a State requires facilities to refund its own Medicaid contribution, the practice also effectively undermines the requirement that a State share in the funding for its Medicaid program. Moreover, this practice appears to be creating rapid increases in Federal Medicaid spending, with no commensurate increase in Medicaid coverage, quality, or amount of services provided. There is preliminary evidence that this current practice has contributed to a spike in Federal Medicaid spending. The States’ estimates of Federal Medicaid spending for FY 2000 have already increased by $3.4 billion over earlier projections. We believe the $1.9 billion of this increase is likely due to the circulation of funds through the UPL loophole. The five-year cost of this growing State practice would be at least $12 billion, and there is an influx of new State proposals. Currently, 17 States have approved plan amendments and another 11 have submitted amendments. This could have the long-term effect of undermining the core mission and the broad-based support for Medicaid, which guarantees critical health services to our most vulnerable populations, low-income children and families, people with disabilities, and the elderly. Id. at 41-42. The CMS Director noted that “[t]he excess Federal Medicaid payments that are shared with State and local governments- are put to any number of uses — both health and non-health related.” Id. at 42. More particularly, the Director noted that some states appeared to use part of the excess' funds to pay for uncompensated care and to finance “other health programs.” Id. The Director stated that this resulted in “Medicaid funding being used for otherwise laudable health care purposes ... but for people and/or services not eligible for Medicaid coverage.” Id. In addition, the Director noted that “reports suggest that some States have gone so far as to use — or intend to use— the UPL arrangement for non-health purposes” such as filling budget gaps, reducing state debt, financing tax cuts, and financing education programs. The Director’s letter also informed States that the HHS Office of Inspector General was “conducting á review of UPL practices in a number of States and [would be] reporting on them soon.” Id. at 43. In addition, the letter notified States that HHS was then developing a- regulatory change intended to halt the abusive practices described in his letter and that a Notice of Published Rulemaking would be published forthwith. Id. 2. HHS Proposes and Finalizes 150 Percent Rule for Locally Owned Public Hospitals As noted, the 2001 Rule was proposed October 10, 2000, and finalized on January 12, 2001 (“2001 Rule”). The Summary of the 2001 Rule as published in the Federal Register reads as follows: SUMMARY: This final rule modifies the Medicaid upper payment limits for inpatient hospital services, outpatient hospital services, nursing facility services, intermediate care facility services for the mentally retarded, and clinic services. For each type of Medicaid inpatient service, existing regulations place an upper limit on overall aggregate payments to all facilities and a separate aggregate upper limit on payments made to State-operated facilities. This final rule establishes an aggregate upper limit that applies to payments made to government facilities that are not State government-owned or operated, and a separate aggregate upper limit on payments made to privately-owned and operated facilities. This rule also eliminates the overall aggregate upper limit that had applied to these services. With respect to outpatient hospital and clinic services, this final rule establishes an aggregate upper limit on payments made to State government-owned or operated facilities, an aggregate upper limit on payments made to government facilities that are not State government-owned or operated, and an aggregate upper limit on payments made to privately-owned and operated facilities. These separate upper limits are necessary to ensure State Medicaid payment systems promote economy and efficiency. We are allowing a higher upper limit for payment to non-State public hospitals to recognize the higher costs of inpatient and outpatient services in public hospitals. In addition, to ensure continued beneficiary access to care and the ability of States to adjust to the changes in the upper payment limits, the final rule includes a transition period for States with approved rate enhancement State plan amendments. 66 Fed.Reg. 3148 (Jan. 12, 2001). The 2001 Rule effectuated the following UPL revisions. With regard to inpatient and long-term care services, the new regulation eliminated the aggregate UPL for all categories of facilities combined and replaced it with separate UPLs for each of the three categories of facilities. The UPL for state-owned facilities remained at a reasonable estimate of what would have been paid for those services under Medicare payment principles, i.e. at 100 percent. Likewise, the new UPL for private facilities was set at a reasonable estimate of what would have been paid for those services under Medicare payment principles, or 100 percent. Finally, the UPL for locally-owned public facilities also was set at 100 percent, with the following crucial exception — the UPL for locally-owned public hospitals was set at 150 percent. In addition, the 2001 Rule effectuated a parallel set of limits for outpatient services. (a) Transition Periods The 2001 Rule also established transition periods for States that had previously implemented UPL supplemental payment plans. Specifically, States that had previously obtained HHS approval of their supplemental payment plans were eligible for one of three transition periods, depending on the date of HHS approval. States that had implemented plans on or after October 1, 1999, were given until September 30, 2002, to comply with the new regulation. States that had implemented supplemental payment plans between October 1, 1992 and October 1, 1999 were subject to a five-year transition period mandating specific but gradual payment reductions. And, finally, states that had implemented supplemental payment plans before October 1, 1992, were subject to an eight-year transition period which also mandated gradual payment reductions. As noted in the Federal Register, these transition periods were designed “to ensure continued beneficiary access to care and the ability of States to adjust to the changes in the upper payment limits.” 66 Fed.Reg. 3148 (Jan. 12, 2001). (b) Reporting Requirements The 2001 UPL Rule also contained new reporting requirements designed to aid the Secretary in ensuring proper use of the 150 percent rule by States. The reporting requirements obligated States with supplemental payment programs to identify (1) the total Medicaid payments made to each locally-owed hospital and (2) the reasonable estimate of the amount that would be paid for the services furnished by each hospital under Medicare payment principles. As noted in the Federal Register, “[t]he purpose of this requirement was to ensure the higher payments are appropriate and are being fully retained by hospitals.” 66 Fed.Reg. 3158. The then Secretary described the reporting requirements as “a necessary administrative tool to ensure the proper administration of the Medicaid program.” Id. Unfortunately, there was no follow-through to actually establish an effective reporting system. See infra. 3. The Motivations and Concerns Behind the 2001 Rule Interestingly, the rule-making record reveals that the 150 percent rule for locally-owned hospitals was the product of con-Aiding concerns. First, as noted, HHS believed that the then-UPLs allowed too much potential for abusive IGTs — that is, IGTs designed to inflate a state’s federal matching rate thereby freeing up state funds for other purposes. Indeed, in proposing the 2001 Rule, HHS set forth the following description of the potential for abuse: It has become apparent that the current regulation creates a financial incentive for States to overpay non-State-operated government facilities because States, counties, cities and/or public providers can, through this practice, lower current State or local spending and/or gain extra Federal matching payments. This practice is not consistent with [the] Medicaid statute and has contributed to rapidly growing Medicaid spending. The incentive and ability for States to pay excessive rates to non-State government-owned or operated Medicaid providers can be explained as follows. As stated previously, the current aggregate upper payment limit is applied to both private and non-State government-owned or operated facilities. By developing a payment methodology that sets rates for proprietary and nonprofit facilities at lower levels, States can set rates for county or city facilities at substantially higher levels and still comply with the current aggregate upper, payment limit. The Federal government matches these higher payment rates to public facilities. Because these facilities are public facilities, funds to cover the State share may be transferred from those facilities (or the local government units that operate them) to the State, thus generating increased Federal funding with no net increase in State expenditures. This is not consistent with the intent of statutory requirements that Medicaid payments be economical and efficient. 65 Fed.Reg. 60152 (Oct. 10, 2000). At the same time, HHS recognized the value of public hospitals’ services to Medicaid and the financial pressures facing public hospitals due to their large indigent patient base. Again, the Court notes the following excerpt from the October 10, 2000, Notice of Proposed Rulemaking (“NPRM”): We are proposing a higher upper payment limit for services in non-State-owned or operated public hospitals operated by governmental entities other than the State itself because we believe that allowing higher Medicaid payments will fully reflect the value of public hospitals’ services to Medicaid and the populations it serves. Public hospitals are established to ensure access to needed care in underserved areas, and often provide a range of care not readily available in the community, including expensive specialized services, such as trauma and burn care and outpatient tuberculosis services. They also provide a significant proportion of the uncompensated care in the nation. The size and scale of public hospitals create extreme stresses and uncertainties, especially given their dependence on public funding sources. We are concerned that these stresses may threaten the ability of these public hospitals to fulfill their mission and fully serve the Medicaid population. As such, we are proposing a higher UPL for these facilities. Specifically, this higher aggregate UPL would allow States to pay non-State-owned or operated public hospitals up to 150 percent of the amount that would have been paid for inpatient and outpatient services using Medicare payment principles. 65 Fed.Reg. 60151, 60153 (Oct. 10, 2000) (emphasis added). Thus, the 150 percent rule for locally-owned hospitals reflected the fragile financial position of many of these hospitals as well as their importance to the communities they serve. Importantly, however, the NPRM also recognized a potential for continued abuse under the 150 percent rule. We also recognize that, in some instances, these public hospitals may be required by State or local governments to transfer back a portion of payments that they receive under Medicaid. This practice raises serious concerns about whether the purposes of the higher payment limits being proposed for public hospitals will be met. To ensure that higher payment levels will assist in ensuring the stability of public hospitals as a vital link in the resources available for care to Medicaid beneficiaries, we intend to require in our final rule that payments made to public hospitals under this provision be separately identified and reported to [CMS]. We request comment on the most suitable ways of reporting and accounting for these payments. In addition, we are soliciting comments on whether the 150 percent limit is appropriate. Id. (emphasis added). Defendant refers to the 150 percent rule as a “controversial compromise in which the previous Secretary recognized that significant potential for abusive governmental transfers remained.” 4. Findings of the OIG Audits The most crucial aspect of the 2001 rule-making record was the collective findings of the HHS Inspector General (OIG). The publication of the finalized 2001 Rule included the following reference to said findings: As of December 22, 2000, the OIG had completed six substantial reviews in five States. Although the specifics of the enhanced payment programs and associated financing mechanisms differed somewhat in each State reviewed, the OIG found that payment programs share some common characteristics. These similarities are included below. • In general, enhanced payments to city and county government owned providers were not based on the actual cost of providing services to Medicaid beneficiaries, or directly related to increasing the quality of care provided by the public facilities that received the enhanced payments. • Enhanced payments to public nursing facilities were not being retained by the facilities to provide services to Medicaid beneficiaries. Instead, the majority of the enhanced payment was returned by the providers to the States through intergovernmental transfers (IGT). The States then used the funds for other purposes, some of which were unrelated to the Medicaid program. • Unlike the nursing facilities, public hospital providers retained the majority of the Medicaid enhanced payments. However, the portion of the funds that hospitals returned to the States through IGTs resulted in millions of dollars available to the States for other uses. • While the public hospital providers served a large number of Medicaid beneficiaries and uninsured patients, the hospitals either (1) did not receive Medicaid disproportionate share hospital (DSH) payments from the States, or (2) returned the majority of the Medicaid DSH payments to the States through IGTs. It appears, for these providers, that States used enhanced payments in the place of DSH payments, although Medicaid DSH payments are designed to help hospitals that provide care to a large number of Medicaid beneficiaries and uninsured patients. 66 Fed.Reg. 3148, 3150. In particular, the 2001 rule-making record included the following draft reports from the HHS Inspector General: (1) Draft Report [ A-XX-XX-XXXXX ], Review of the Commonwealth of Pennsylvania’s Use of Intergovernmental Transfers to Finance Medicaid Supplementation Payments to County Nursing Facilities, (August 2000); (2) Draft Report [ A-XX-XX-XXXXX ], Review of Medicaid Enhanced Payments to Public Providers and the Use of Intergovernmental Transfers by the Alabama State Medicaid Agency (August 2000); (3) Draft Report [ A-XX-XX-XXXX ], Review of Medicaid Enhanced Payments to Public Providers and the Use of Intergovernmental Transfers by the State of Nebraska (August 2000); (4) Draft Report [ A-XX-XX-XXXXX ], review of Medicaid Supplemental Payments to Public Hospital District Nursing Facilities and the Use of Intergovernmental Transfers by Washington State (September 2000); (5) Draft Report [ A-XX-XX-XXXXX ], Review of Illinois’ Use of Intergovernmental Transfers to Finance Enhanced Medicaid Payments to Cook County for Hospitals Services (November 2000); (6)Draft Report [ A-XX-XX-XXXXX ], Review of Medicaid Enhanced Payments to Public Hospital Providers and the use of Intergovernmental Transfers by the Alabama State Medicaid Agency (November 2000). The Court notes some of the OIG’s conclusions contained in these Draft Reports: • The use of IGTs as part of Pennsylvania’s nursing home supplementation payment program “is a financing mechanism designed solely to maximize Federal Medicaid reimbursements, thus effectively avoiding the Federal/State matching requirements.” Since State Fiscal Year 1992, Pennsylvania’s Department of Public Welfare received $3.1 billion in Federal matching funds based on a reported $5.5 billion in supplemental payments to county nursing facilities. The reported supplementation payments were never directly made to the county nursing facilities that were supposedly to receive these payments, but, instead, never left the bank that processed the supplemental payment transactions. In State Fiscal Years 1997-1999, about 21 percent of the FFP generated by the IGT transactions was not budgeted for Medicaid purposes and another 29 percent was unbudgeted and available to Pennsylvania for non-Medicaid related use. • Alabama’s use of supplemental payments to “rural government owned” nursing homes were “not based on their actual cost of providing services to Medicaid beneficiaries or directly related to increasing the quality of care provided by public facilities.” In addition, the nursing homes transferred 96.5 percent of the supplemental payments back to Alabama’s Medicaid agency. The payments returned to the State agency were deposited into a special revenue fund — the main fund of three funds used by the State to pay Medicaid expenses. Upon deposit, the enhanced payment funds lost their identity. Thus, the OIG was unable to determine exactly how Alabama spent the enhanced payments, but it “is clear that in effect the use of the enhanced payments resulted in Federal funds being used to obtain additional Federal funds.” • For Fiscal Years 1998 through 2000, Nebraska made enhanced payments to locally-owned nursing facilities totaling $227 million, generating about $139 million in Federal financial participation. Of the $227 million, providers retained about $1.5 million and about $225.5 million was returned to the State for other uses. For the funds transferred back to the State, the State share of the enhanced payments, totaling about $88 million, was returned to the Nebraska General Funds and the remaining $137.5 million in Federal matching funds was designated for the Nebraska Health Care Trust Fund. • During State Fiscal Year 2000, Washington State distributed supplemental payments of $147 million to “Public Hospital District (PHD) nursing facilities meeting certain eligibility criteria.” These supplemental payments generated $76.2 million in federal matching funds. Of the $147 million distributed, $127 million was returned to the State by the PHD nursing facilities in the form of an IGT. The remaining $20 million was shared “among 14 eligible PHD nursing facilities and other health-related organizations.” The funds returned to the State were deposited in “the State’s health services account” which is used for “(i) maintaining and expanding access for low-income residents to health care services; (ii) maintaining and improving the capacity of the health care system (iii) containing health care costs; and (iv) regulating, planning, and administering the health care system.” Thus, although the PHD nursing facilities retained only a small portion of the supplemental payments, “most of the [supplemental] funds was either designated or used for State health care needs, regardless of a person’s Medicaid eligibility.” • Illinois paid enhanced payments to three hospitals administered by Cook County — Cook County Hospital, Oak Forest Hospital, and Provident Hospital — and associated clinics administered by Cook County. During the period from July 1,1991 through June 30, 2000, the Illinois Department of Public Aid (IDPA) made about $5.9 billion of enhanced payments to Cook County for inpatient, outpatient, and clinic services under the Medicaid program. About $3.0 billion of the $5.9 billion represented a payback of funds that were initially transferred as IGTs from Cook County to IDPA. The remaining $2.9 billion represented the Federal share of the payments. About $866.6 million of the $2.9 billion was returned by Cook County to IDPA and deposited to the State’s General Revenue Fund. The IDPA contended that it used the returned funds for health-related services, but the OIG was unable to confirm this contention. • The State of Alabama made inpatient hospital enhancement payments to both State owned and local government owned facilities totaling approximately $465 million for the period from October 1, 1996 through July 31, 2000. OIG audited about $432 million of this total, of which the Federal share was about $302 million. Of the Federal share, the hospitals retained about $216 million, and about $86 million was returned to the State agency. The funds returned to the State were deposited into a special revenue fund that was used to pay Medicaid expenses. V. THE CHALLENGED REGULATION: The 2002 One Hundred Percent Rule Of course, this case pertains to the most recent revision to the UPL regulations— the 2002 UPL Rule. The 2002 UPL Rule eliminates the 150 percent limit applicable to locally-owned hospitals that was adopted as part of the 2001 Rule and replaces it with the same 100 percent rule applicable to all other facilities. The 2002 UPL Rule was proposed on November 23, 2001 — roughly eight months after the 2001 Rule became effective. It was finalized on January 18, 2002. The summary of the finalized rule as published in the Federal Register reads as follows: This final rule modifies the Medicaid upper payment limit (UPL) provisions to remove the 150 percent UPL for inpatient hospital services and outpatient hospital services furnished by non-State government-owned or operated hospitals. This final rule is part of this Administration’s efforts to restore fiscal integrity to the Medicaid program and reduce the opportunity for abusive funding practices. based on payments unrelated to actual covered Medicaid services. 67 FecLReg. 2602-03 (Jan. 18, 2002) (emphasis added). A. HHS’ Stated Rationale For 2002 UPL Rule In its Notice of the finalized rule, HHS briefly revisited the changes implemented by the 2001 Rule and, in particular, the 150 percent limit for locally-owned public hospitals. The Court notes the following excerpt: In a final rule published on January 12, 2001, in the Federal Register (66 E.R. 3148). we revised the Medicaid UPL for inpatient and outpatient hospitals to require separate UPLs for State-owned or operated facilities, non-State government-owned or operated facilities, and privately owned and operated facilities. In that final rule, we also created an exception for payments to non-State government-owned or operated hospitals. That exception provided that the aggregate Medicaid payments to those hospitals may not exceed 150 percent of a reasonable estimate of the amount that would be paid for the services furnished by these hospitals under Medicare payment principles. At that time, we believed that payments to these public hospitals needed a higher UPL because of their important role in serving the Medicaid population. Based on farther analysis, we do not believe that a higher UPL is necessary to achieve the objective of assuring access for Medicaid patients to the services of public hospitals. 67 Fed.Reg. 2602, 2603 (Jan. 18, 2002) (emphasis added). HHS listed the following factors in support of its conclusion that the 150 percent rule was not needed: • We believe that the 100 percent UPL is more than sufficient to ensure adequate access to services for Medicaid beneficiaries at public hospitals. Under this limit, States may pay public providers up to 100 percent of a reasonable estimate of what Medicare would have paid for services provided to Medicaid beneficiaries. States also retain some flexibility to make enhanced payments to selected public hospitals under the aggregate limit. • We do not believe that the higher payments are necessarily being used to further the mission of these hospitals or their role in serving Medicaid patients. The OIG has issued several reports demonstrating that a portion of the enhanced payments made as part of the UPL process are being transferred directly back to the State via intergovernmental transfers and used for other purposes (which may include funding the State share of other Medicaid expenditures). In cases for which hospitals did retain UPL-related enhanced payments, the OIG found that these same hospitals either did not receive disproportionate share hospital (DSH) payments or if they did, typically returned the DSH payments directly back to the State through intergovernmental transfers. We believe that Medicaid provisions permitting enhanced payments to disproportionate share hospitals should be ■ sufficient to ensure that Medicaid beneficiaries have access to the services of these hospitals. • Many of the public safety net hospitals affected by this rule qualify as DSH hospitals. The Medicare, Medicaid, and SCHIP Benefits Improvement and Protection. Act of 2000 (BIPA), enacted on December 21, 2000, provides additional funding to public hospitals by increasing the hospital-specific DSH limits originally set under the Omnibus Budget Reconciliation Act of 1993. States will have the ability to make Medicaid DSH payments to public hospitals up to 175 percent of a hospital’s reasonable costs of treating the uninsured and Medicaid beneficiaries for a period of two State fiscal years beginning after September 30, 2002. • We wish to restore payment equity among hospital providers and across other provider types. Id. at 2603. B. OIG’s September 11, 2001 Report As with the 2001 Rule, a most crucial aspect of the 2002 UPL rule-making record was the collective studies and analyses of the OIG. On September 11, 2001, the Principal Deputy Inspector General released a final report titled Review of Medicaid Enhanced Payments to Local Public Providers and the Use of Intergovernmental Transfers. The report consolidated the results of seven OIG audits, conducted in six States, of Medicaid enhanced payments to locally-owned facilities and the use ofIGTs. The Court notes the following language included in the memorandum transmitted with said report: In Federal Fiscal Year 2000, 28 States made or planned to make at least $10.3 billion in Medicaid enhanced payments which included $5.8 billion in Federal matching funds. Prior to 1999, only 12 States had enhanced payment programs. If not brought under control, the rapid growth of these enhanced payment programs threaten the financial stability of the Medicaid program. Our audits of seven enhanced payment programs in six States found that the enhanced payments to local government-owned providers were not based on the actual cost of providing services to Medicaid beneficiaries, nor did we find a direct relationship in the use of these funds to increase the quality of care provided by these public facilities. We also found that a large portion of the enhanced payments were not retained by the nursing facilities to provide services to resident Medicaid beneficiaries. Instead, some or most of the funds were transferred back to the States for other uses. Some of the funds transferred back to the State governments were earmarked for use in health care related service areas but not necessarily for Medicaid covered services approved in the State plans. In contrast to nursing facilities, hospital providers kept a large portion of the enhanced payments. However, the hospitals either did not receive Medicaid disproportionate share hospital (DSH) payments from their State, or returned the majority of the Medicaid DSH payments to their State through IGTs. It appears, for these providers, that States have used enhanced payments in place of DSH payments, although Medicaid DSH payments are intended to help hospitals that provide care to a large num-' ber of Medicaid beneficiaries and uninsured patients. For the portion of the enhanced payments that was returned to the States, it appears that the States did not incur a health care expenditure for which Federal matching funds were claimed. This condition draws into question whether the amounts returned to the State agencies constitute a refund required to be reported as other collections, and consequently offset against expenditures reported to [CMS]. As is, State agencies have developed mechanisms to obtain Federal Medicaid funds without committing the States’ share of required matching funds. Our review concluded that the States’ use of the IGT as part of the enhanced payment program was a financing mechanism designed to maximize Federal Medicaid reimbursements, thus effectively avoiding the Federal/State matching requirements. The States were clear winners because they were able to reduce their share of Medicaid costs and cause the Federal Government to pay significantly more than it should for the same volume and level of Medicaid services. Memorandum from Michael F. Mangano, Principal Deputy Inspector General, dated September 11, 2001, at 1-2. The OIG then detailed the changes implemented in the 2001 Rule and noted that these changes were projected to “save $55 billion in Federal Medicaid funds over the next 10 years.” Id. at 3. However, the OIG emphasized that the 2001 Rule “will only limit, not eliminate, the amount of financial manipulation of the Medicaid program the States can perform because the regulation did not require that the enhanced funds be retained by the targeted facilities to provide medical services to Medicaid beneficiaries.” Id. The OIG further noted that “we do not believe the higher payment limit for non-State-owned government hospitals has been adequately supported through an analysis of these hospitals’ financial operations.” Id. The OIG then recommended that CMS take the following actions: 1.Annually audit the accuracy of the States’ upper payment limit calculation and enhanced payments to ensure that the expected savings of $55 billion are realized. 2. Provide States with definitive guidance on calculating the upper payment limit so that there is a uniform standard applicable to all States. We believe this should include using facility-specific upper payment limits that are based on actual cost report data. 3. Require that, for States to seek Federal financial participation (FFP) to match State enhanced payments, they must demonstrate that the enhanced payments were actually made available to the facilities and the facilities used the funds to furnish Medicaid approved services to Medicaid eligible beneficiaries. 4. Require that the return of Medicaid payments by a county or local government to the State be declared a refund of those payments and thus be used to offset the FFP generated by the original payment. 5. Reconsider Capping the aggregate upper payment limit at 100 percent for all facilities rather than the 150 percent allowance for non-State-owned government hospitals. 6. Seek authority to eliminate or reduce the transition periods included in the new upper payment limit regulations. Id. In sum, the OIG’s final report concluded that “[t]he States’ use of the IGT as part of the enhanced payment program is a financing mechanism designed to maximize Federal Medicaid reimbursements, thus effectively avoiding the Federal/State matching requirements. The combination of enhanced payments and IGTs has become a financial windfall for States.” The GIG further concluded that the changes implemented pursuant to the 2001 UPL Rule “do not go far enough in protecting the financial integrity of the Medicaid program.” C. Transition Periods Contained in 2002 Rule: More Dramatic Drop-offs The 2002 UPL Rule adopted the same transition periods that were adopted pursuant to the 2001 Rule. 67 Fed.Reg. 2603-04. However, whereas the 2001 Rule required states entitled to transition periods to be in full compliance with the 150 percent rule at the end of said periods, the 2002 Rule requires states to be in full compliance with the 100 percent rule at the end of their respective transition periods. Id. In other words, the 2002 UPL Rule imposes a steeper, or more dramatic, drop-off. VI. THE PARTIES’ ARGUMENTS As noted, the Plaintiffs , ask the Court to bar implementation of the 2002 UPL Rule. Essentially, the Plaintiffs make the following arguments: (1) the 2002 UPL Rule does not include a concise , statement of basis and purpose as mandated by the Administrative Procedure Act; (2) the 2002 UPL Rule is arbitrary, capricious and an abuse of the Secretary’s discretion, and, thus, it must be overturned pursuant to the Administrative Procedure Act; and (3) the 2002 UPL Rule violates the Regulatory Flexibility Act and the Social Security Act. In response, the Secretary contends that the 2002 UPL Rule corrects deficiencies in the 2001 Rule and, in the process, eliminates a. gaping loophole in the Medicaid funding system. The Secretary argues that the 2002 Rule will limit the ability of States to abuse the Medicaid system through the creative financing schemes described in the CMS letter of July 26, 2000 and the OIG’s reports and, thus, the 2002 Rule will thereby strengthen the integrity of the Medicaid system and protect the federal fisc. More specifically, the Defendant makes the following arguments: (1) the 2002 UPL Rule is a product of reasoned rule-making and is a rational response to the 2001 Rule, which left too much potential for abuse on the part of the states; (2) the 2002 UPL Rule contains an adequate statement of basis and purpose; and (3) the Defendant conducted both an initial and a final regulatory flexibility analysis in compliance with the Regulatory Flexibility Act. A. Standard of Review The Court will discuss the parties’ arguments in turn, but first the Court will note the applicable standard of review. Because the 2002 UPL Rule was promulgated pursuant to the informal rulemaking procedures of section 553 of the Administrative Procedures Act, the Court must determine if the Rule is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. § 706(2)(A). The rescission or modification of a rule is subject to this standard. Motor Vehicle Manufacturers Ass’n. v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 77 L.Ed.2d 443 (1983). Indeed, “an agency-changing its course by rescinding a rule is obligated to supply a reasoned analysis for the change beyond that which may be required when an agency does not act in the first instance.” Id. at 42, 103 S.Ct. 2856. However, Congress has conferred on the Secretary exceptionally broad authority to prescribe standards under the Medicaid statute. See Schweiker v. Gray Panthers, 453 U.S. 34, 43, 101 S.Ct. 2633, 69 L.Ed.2d 460 (1981). The breadth of his discretion must be recognized by courts including in situations where an agency has changed its position from one taken by an earlier administration. See Barnhart v. Walton, — U.S. -, 122 S.Ct. 1265, 1274, 152 L.Ed.2d 330 (2002) (Scalia, J., concurring). The Supreme Court has advised that “the scope of review under the ‘arbitrary and capricious’ standard is narrow and a court is not to substitute its judgment for that of the agency.” Motor Vehicle, 463 U.S. at 43, 103 S.Ct. 2856. However, before an agency finalizes a rule it “must examine the relevant data and articulate a satisfactory explanation for its action including a ‘rational connection between the facts found and the choice made.’ ” Id. (quoting Burlington Truck Lines, Inc. v. United States, 371 U.S. 156, 168, 83 S.Ct. 239, 9 L.Ed.2d 207 (1962)). Indeed, the Supreme Court has indicated that an agency rule is normally arbitrary and capricious under the following circumstances: (1) the agency relied on factors which Congress has not intended it to consider; (2) the agency entirely failed to consider an important aspect of the problem; (3) the agency offered an explanation for its decision that runs counter to the evidence before the agency; or (4) the agency offered an explanation for its decision that is so implausible that it could not be ascribed to a difference in view or the product of agency expertise. Id. B. The Statement of Basis and Purpose All final agency rules must contain “a concise general statement of their basis and purpose” pursuant to 5 U.S.C. § 553(c). The basis and purpose statement must identify “what major issues of policy were ventilated by the informal proceedings and why the agency reacted to them as it did.” St. James Hospital v. Heckler, 760 F.2d 1460, 1469 (7th Cir.1985) (citing Automotive Parts & Accessories Ass’n v. Boyd, 407 F.2d 330, 338 (D.C.Cir.1968)); see also Boswell Memorial Hospital v. Heckler, 749 F.2d 788, 794 (D.C.Cir.1984). It need not, however, respond to every fact or contention in the comments submitted. Id. The Plaintiffs contend that the basis and purpose statement contained in the 2002 UPL Rule is legally insufficient because it (1) does not address the substantive, quantitative assessments of likely harm to hospitals submitted by numerous commentators; and (2) does not explain how those assessments of harm affected the new regulation. The Plaintiffs also contend that the basis and purpose statement is deficient due to the Secretary’s “willful mis-characterization of the comment letters.” Specifically, Plaintiffs emphasize that the statement of basis and purpose employs the identical term — “several”—to describe the numbers of comment letters in support and opposed to the 2002 UPL Rule. See 67 Fed.Reg. 2602, 2604 (January 18, 2002). In actuality, only two of the approximately 240 Comments in response to the 2002 UPL Rule expressed support for the Rule; the remainder were opposed to it. See Administrative Record for 2002 Rule, Volume II. 1. The Comments in Response to the Proposed 100 Percent Rule Before determining if the Secretary adequately addressed the Comments submitted, it is important to review these Comments in some detail. It also is important to analyze these comments because the agency’s analysis thereof is the central focus of the Plaintiffs’ argument concerning the Rule’s basis and purpose statement. Thus, the Court has reviewed all of the Comments offered in response to the 2002 UPL Rule. The commenters include persons working in a variety of positions related to patient care, including physicians and hospital administrators, as well as union representatives and elected officials from the county, state and federal levels. As noted, all but two of the Comments were strongly opposed to the change from the 150 percent UPL to the 100 percent UPL. In general, the commentators labeled the 100 percent rule as a direct assault on the ability of hospitals to provide essential health care to the uninsured and underinsured, and commenters also predicted that safety net hospitals in several states would have to cut services or close altogether as a result of the rule. Several commenters included predictions as to the specific amount of financial losses that particular states and/or counties will incur once the 2002 UPL Rule becomes effective. For instance, certain commentators stated that the 2002 Rule would result in the following losses: (1) an estimated $1 billion dollar loss to California over that state’s eight-year transition period and an estimated $300 million annual loss to California once the 2002 Rule is fully implemented; (2) a loss of $14-15 million per budget year to county health services in Alameda County, California; (3) a loss of $28 million to Santa Clara Valley Medical Center, located in Santa Clara, California; (4) an estimated $8 million annual loss to Hennepin County Medical Center, Minnesota’s largest safety-net hospital; (5) an estimated $48 million ail-nual loss to the University of California academic medical centers; (6) an estimated $125 million annual loss to the Los Angeles County Public Health System; (7) an estimated $25-30 million loss to California children’s hospitals; (8) an estimated loss $400 million loss to New York hospitals; (9) an estimated $200 million loss to Florida hospitals, including a $34 million loss to Jackson Memorial Hospital, the designated trauma/burn center in cases of state or federal emergencies for South Florida; (10) an estimated $10 million annual loss to San Francisco General Hospital Medical Center, the only designated trauma center for the City and County of San Francisco; (11) an estimated $12 million annual loss to Oregon Health & Sciences University Hospitals & Clinics; and (12) an estimated $59 million loss to the University of Medicine and Dentistry of New Jersey teaching hospital. Several commentators emphasized that their states did not shift supplemental payments to areas unrelated to the care of Medicaid beneficiaries and indigent patients but, rather, used supplemental payments to make up for Medicaid shortfalls and uncompensated care. These commentators further emphasized that IGTs play an irreplaceable role in this process due to shortfalls in state general funds and the large number of uninsured residents. These commentators suggested that HHS, in a rush to correct abuses in only some State programs, overlooked the crucial role that IGTs play in states that properly use supplemental payments to maintain hospital o