In a report being released Thursday, the Government Accountability Office says Medicaid payments to doctors, hospitals and other providers aren't technically considered federal funds, since they're funneled through state health care programs.
Because of that glitch, the IRS can't just shut off the payment spigot to collect tax debts. Investigators only looked at three states, so the full extent of the losses is even greater.
One dentist who received more than $100,000 from Medicaid while owing back income taxes was spending money on fine dining, trips, spas, shopping and wine, the report said.
In another case, a medical transport company received more than $1 million from Medicaid while owing millions in unpaid payroll taxes for its employees. Not paying the payroll taxes is a violation of federal law.
Medicaid, a federal-state program that mainly serves low-income people, is the companion to Medicare, which primarily serves seniors.
While the IRS can block Medicare payments to scofflaw providers using something called a "continuous levy," it is precluded by law from using the same strategy to go after Medicaid payments — even though the federal government pays about 60 per cent of the costs of Medicaid.
GAO investigators recommended that the IRS immediately reassess its policies to find more efficient ways of collecting back taxes from Medicaid service providers. Part of the problem seems to be co-ordination with states.
In a formal response to the report, the IRS said it agrees action is needed. Congress has an opportunity to close the loophole during budget deliberations after the elections.
Republican Sen. Tom Coburn of Oklahoma said piles of unpaid taxes ought to raise a red flag about anybody doing business with the government.
"People who cheat on their taxes show a clear disregard for the law, so they might be more likely to defraud Medicaid, or even harm patients," Coburn said in a statement. "GAO's findings raise serious questions about steps that need to be taken to improve the integrity of the Medicaid program."
Unpaid taxes are a persistent problem for the government, a so-called tax gap of about $350 billion a year. Much of the money is considered uncollectable.
GAO investigators scrutinized Medicaid providers, from doctors to hospitals to medical transport companies, in three large states: Texas, New York and Florida.
During 2009, about 7,000 Medicaid providers who were paid a total of $6.6 billion by the program also owed $791 million in unpaid taxes.
They represented nearly 6 per cent of all the Medicaid providers reimbursed by the three states, a fairly large proportion to be found delinquent considering that they were receiving income from a major government program.
Advocates for the poor may complain that a tax crackdown will only drive legitimate providers away from Medicaid. The program already pays much less than Medicare or private insurance. But the GAO said that concern doesn't justify continuing to tolerate the problem.
"Even though Medicaid providers are relied on to deliver significant medical services to those most in need, payment of billions of federal dollars to those who do not pay their fair share of federal taxes raises questions about the integrity and fairness of the tax system," the report said.
"Given that we found over $6 billion of payments made to tax delinquent Medicaid providers in just three states, a more rigorous review ... is warranted," investigators concluded.