As Medicaid assumes an increasingly significant role in the health insurance market, federal and state policymakers are focusing on how to ensure that its payment policies and purchasing strategies create incentives for higher quality, more efficient care. Yet to date, payment reform initiatives have, for the most part, neglected to address a significant component of Medicaid payment policies – supplemental payments. The two most significant forms of supplemental payments are Disproportionate Share Hospital (DSH) Payments and Upper Payment Limit (UPL) payments. Combined, DSH and UPL payments represent more than one-third of Medicaid fee-for-service payments to hospitals, and hospital payments constitute 23 percent of all Medicaid spending.1

DSH and UPL payments historically have been used to subsidize uncompensated care costs and backfill for low reimbursement rates under Medicaid for hospitals serving large numbers of Medicaid and uninsured patients. More recently, supplemental payments are being used to provide additional Medicaid revenue to a wider array of hospitals, often to compensate for budget-driven cuts to base payment rates and to offset provider taxes used to generate the states’ share of Medicaid costs. DSH and UPL payments can be a critical source of revenue to hospitals, especially safety-net hospitals. But supplemental payments are generally disconnected from the specific services provided to specific patients and delinked from the efficiency or quality of the care provided. This paper examines the impact of supplemental payment arrangements for hospitals on efforts to reform Medicaid’s payment and purchasing strategies to ensure that beneficiaries have access to quality, cost-effective care.