EHR Incentive Impacts

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The Fiscal and Economic Impacts of the Medi-Cal EHR Incentives

Prepared for

The California HealthCare Foundation

Prepared by

The Blue Sky Consulting Group

May 10, 2012



Fiscal Impact of EHR Incentives

Prepared by the Blue Sky Consulting Group Page 2

Executive Summary

In 2009, as part of the American Recovery and Reinvestment Act (ARRA), the federal governmentapproved $18 billion in federal funds to incent the use of Electronic Health Record (EHR) systems. InCalifornia, the Medi-Cal EHR incentive program will provide an estimated $1.4 billion to $2 billion in

federally funded EHR incentives to eligible providers. In order to assist states in meeting the

administrative and oversight requirements of the incentive program, the federal government will alsopay 90 percent of the administrative costs, leaving 10 percent of these costs as a state responsibility.

In this report, we demonstrate that using state funds to draw down the federal administration grantand incentive payments would result in a substantial net benefit to the state’s General Fund due to the

economic and fiscal effects of the additional federal funds flowing to California. Specifically, we

estimate that, by spending $5.2 million for administrative costs, the state would experience anincrease in sales, income and corporation taxes of $109 million. Moreover, the state wouldexperience $2.3 billion in increased economic output and almost 16,000 new jobs as a result of the

influx of federal funds.

Measuring the Benefits of the Administrative Grant and Incentive PaymentsFederal funds from the administrative grant and incentive payments will increase the level of economic

output in the state, and, ultimately, the amount of tax revenue collected by the General Fund.

Although the EHR Incentive program may also provide fiscal benefits to the Medi-Cal programthrough an increase in efficiency and/or a reduction in health care costs, the much more immediatefiscal benefit stems from the economic effects of the large amount of new federal money that will be

spent in the state. This money will be used by the state to pay state employees and contractors as wellas by health care providers to purchase and maintain EHR systems. In turn, these public and private

employees will spend their wages as private businesses will purchase supplies; the result will be an

increase in economic activity, which in turn will increase state revenues.

In order to estimate the net General Fund impact of the program, we modeled the effect of both thefederal administration grant and the EHR incentives from 2012-13 until the scheduled end of the

program in July 2021. To do so, we first estimated the amount of money coming into California; thenwe mapped where these funds would go. Specifically, we estimated how much payrolls wouldincrease, and which services and goods would be purchased by the recipients of the new federal

funds. Each of these economic activities will in turn generate tax revenues for the General Fund.

To model the flow of federal funds through the state’s economy, we used the IMPLAN model. Toestimate the fiscal impact stemming from the direct economic effects (i.e. the impact of the initial

expenditures of administration and incentive payments), we identified the wages, profits, and supplier

purchases that are taxable and then applied effective tax rates to them. To estimate the fiscal effect

stemming from the indirect economic benefits (from expenditures by employees, health care providers,and EHR vendors and contractors), we estimated the increase in total state economic output and thenthe resulting increase in state revenue from sales, corporation, and income taxes resulting from thisincrease in output.

The EHR Incentive Program Is Good for the California Economy

We estimate that the large amount of federal funds flowing into the California economy through theEHR Incentive program will produce $2.3 billion in additional economic output and spur the creation of





16,000 jobs. The largest amount of job growth (almost 6,000 jobs) is estimated to be in the computer

industry that supplies and supports EHR systems, with substantial growth in the health care industry aswell.

The State’s General Fund is a Net Winner

The net effect for the state’s General Fund of the EHR program is highly positive. From 2012-13 untilthe scheduled end of the program in 2021, the estimated cost to the General Fund is equal to theamount of the 10 percent administration match, or $5.2 million. Meanwhile, the fiscal benefits from

increased personal income, corporation, and sales taxes are $109 million. Thus, the net benefit to the

General Fund is $103 million. Put another way, for every dollar spent by the state, we estimate that$240 of federal money will enter the state and produce $21 of new General Fund revenue.

Table 1: Net Fiscal Benefits of the

Medi-Cal EHR Incentive Program

Fiscal Impact

Administration Grant Benefits 4,165,000$

EHR Incentive Benefits 104,483,000$Cost to State (5,204,000)$

Net Benefit 103,444,000$





Introduction

In 2009, as part of the American Recovery and Reinvestment Act (ARRA), the federal governmentapproved $18 billion in federal funds to incent the use of Electronic Health Record (EHR) systems. Partof this funding is for Medicare incentives, but states may also opt to create a Medi-Cal incentive

program in order to draw down additional federal funds. In California, the Medi-Cal incentive

program will provide between $1.4 billion and $2 billion in federally funded EHR incentives toeligible providers. In order to assist states in meeting the administrative and oversight requirements ofthe incentive program, the federal government will also pay 90 percent of the administrative costs of

the program.

Despite the generous federal matching for the EHR incentive program, the California Legislature

remained concerned about potential budget impacts and passed enabling legislation in 2011 thatforbade the use of state General Fund money for the program.1 As a result, private money is beingused to draw down the 90 percent federal administrative match for the 2011-12 fiscal year,

enabling the payment of incentives to California providers. With these funds, the Department of

Health Care Services (DHCS) created and launched the EHR incentive program; eligible hospitals have

already been awarded $114 million in incentive funds.

The question has arisen whether it is cost beneficial for the state to pay the 10 percent share of

administrative costs. In this report, we estimate the fiscal impact of the federal funds coming intoCalifornia through the Medi-Cal EHR incentive program. This analysis demonstrates that using statefunds to draw down the federal match and incentive payments would result in a substantial net benefit

to the General Fund due to the economic and fiscal effects of the additional federal funds flowing toCalifornia.

The EHR Incentive Program

The Medi-Cal EHR Incentives are meant to support the purchase, initial implementation, and upgradeof certified EHR technology, including support services and training, as well as operating and

maintaining systems selected by qualified providers. Qualified providers include acute care and

children’s hospitals as well as physicians, nurse practitioners, certified nurse-midwives, and physicianassistants in physician-assistant led FQHCs and RHCs.2,3

The amount of the incentive is based on the average cost of implementing and maintaining EHR

systems as calculated by the Centers for Medicare and Medicaid Services (CMS). Thus, the incentivepayments are not directly related to the actual cost of the system or services purchased by qualifiedproviders. Individual providers can get a maximum of $63,750 over six years, with a $21,250

maximum payment in the first year and $8,500 maximum payments for the next five years. Hospitalpayments will be in a range around a $2 million starting point, adjusted for the overall size of the

hospital and Medi-Cal discharges. Aggregate hospital incentive payment will be distributed over four

years with 50 percent paid in the first year, 30 percent in the second year, and 10 percent in thethird and fourth years. In order to continue receiving incentive payments after implementation,

1Chapter 433, Statutes of 2011 (SB 945)

2 Dentists and optometrists may also eventually be eligible, but are not currently. 3 For acute care hospitals, at least 10 percent of their patients must be Medi-Cal clients in order to participate;individual providers must generally have a minimum 30 percent Medi-Cal patient volume.





providers will have to demonstrate “meaningful use” of their EHR systems by reporting on a number of

required functional and clinical objectives established by CMS.

The initial DHCS review of the EHR provider landscape estimated that 250 hospitals and 10,000

providers in California would be able to claim incentive payments for a total of approximately $1.2

billion. An update of the original assessment indicates that the provider number may be as high as20,000, which would increase total incentive payments to the state to around $2 billion.4

The Connection Between the Incentive Payments and the Administrative Grant

In exchange for 100 percent federal funding for the Medi-Cal EHR incentive payments, CMS requires

administrative oversight by the Department of Health Care Services. Specifically, DHCS must verify

eligibility and disburse payments to eligible providers, have a system capable of coordinating with anational database to verify information in order to coordinate and/or make payments, fight fraudand abuse, recoup monies if overpayments or erroneous payments are found to have been paid, and

provide an appeals process for eligibility, payments, and determinations of meaningful use. In

addition, DHCS must submit a quarterly progress report documenting specific implementation and

oversight activities performed. Finally, DHCS must make incentive payments directly to eligibleproviders without any deduction or rebate; in other words, DHCS cannot use any of the incentive

money to cover administrative costs.

However, the federal government will also provide 90 percent Federal Financial Participation (FFP)for California’s administrative expenses as long as it meets three requirements:

1. Uses the funds to administer Medi-Cal incentive payments for certified EHR technology,

including tracking of meaningful use by Medi-Cal EPs and eligible hospitals;

2. Conducts oversight of the Medi-Cal EHR incentive program, including routine tracking ofmeaningful use attestations and reporting mechanisms; and

3. Pursues initiatives to encourage the adoption of certified EHR technology for the promotion ofhealth care quality and the exchange of health care information.

Because the administrative grant requires initiatives designed to promote the meaningful use of EHRs,California will also receive 90 percent FFP for the administrative work done to bolster the meaningful

use of EHRs, as well as to administer the incentive payments. For example, providers will be required

to use their EHR systems to report to a statewide immunization registry. This statewide immunizationregistry does not yet exist in California, but DHCS can utilize 90 percent FFP to create it.

The rules do not require that California pay the 10 percent match for the administration grant in order

to receive the federal incentive money. However, as described above, they do require that the

program be administered to CMS specifications. The administrative grant covers all incentive-relatedadministrative costs, but also requires some additional promotional activities. The extent of thesepromotional activities is determined by DHCS. Therefore, practically speaking, the state can eitherpay the 10 percent match for the administrative grant, pay 100 percent of incentive-related

administration costs, or forego the federal incentive payments.

4 Results of a UCSF and California Medical Board landscape assessment commissioned by DHCS as communicatedby the Office of Health Information Technology.





In other words, by paying 10 percent of the administration costs, the state will receive federal fundsequal to 90 percent of the administration costs, plus the EHR incentive payments themselves. If thestate should choose not to make this 10 percent payment, it would not be able to put in place the

administrative requirements necessary for receipt of the federal EHR incentives to eligible providers

(and consequently would not receive these federal payments).

The Fiscal Effects of the EHR Incentive Program

Because the EHR incentive program has such a large federal funding component (100 percent of theincentive payments themselves and a 90 percent match for program administration), it will have an

immediate fiscal benefit stemming from the large amount of new federal money coming to the state.

This money is used by the state to pay state employees, contractors, and suppliers, and by health careproviders to purchase and maintain EHR systems. In turn, these public and private employees spendtheir wages, and private businesses purchase supplies, generating economic activity, which in turn

increases state revenues.

In addition, many government programs reap long-term fiscal benefits as a direct result ofaccomplishing program goals, such as decreased costs from changes in behavior (e.g., health care

costs fall as a result of increased prevention programs or residents commit fewer crimes as a result of

increased crime prevention program activities). In theory, the adoption of EHRs by Medi-Cal providerswill also reduce costs by making health care delivery more efficient.

In this report, we focus only on the benefits of the new federal funds because the effects of infusingadditional funds into the economy are widely understood and almost immediately experienced. Any

efficiency benefits would be in addition to the benefits quantified here.

Estimating the Fiscal Effects

To estimate the net General Fund impact of the state’s funding the 10 percent administrative grant

match, we modeled the fiscal impact of both the federal administration grant and the EHR incentives

from 2012-13 until the scheduled end of the program in July 2021.

To do so, we first estimated the amount of money coming into California beginning in July 2012. Then

we mapped where these funds would go, estimating the extent of increases in payrolls and purchases

of goods and services that would result from the influx of federal funds. When services are purchased,the recipient firms use that income to pay employees, buy supplies, and increase profits. When goodsare purchased, the purchase itself can trigger a sales tax, while the payments to the supplier become

revenue that, once again, goes to pay employees, buy supplies, and increase profits.

We used IMPLAN to model the relationship between increased revenue for the affected industries

(e.g., hospitals and EHR vendors) and employee wages and profits. We also used IMPLAN to estimatethe increased economic output created by these private firms’ employee and supplier spending,known as the multiplier effect.5 Finally, we estimated how extent of additional income, corporation,

and sales tax revenue that would be generated from this increased economic activity. To estimate the

direct effect, we identified the wages, profits, and supplier purchases that are taxable, and applied

5IMPLAN is a widely used economic modeling tool created by MIG.





effective tax rates to them. For the indirect economic benefits, we estimated the change in General

Fund revenues resulting from an increase in state economic output based on the historical relationshipbetween economic activity and state revenues.

Administration Grant

In order to estimate the amount of federal money attached to the administrative grant, we utilizedrecent DHCS administration cost data.6 DHCS has estimated its costs for FY 2012-13 and for the firstquarter of FY 2013-14.7 We used the ratio of DHCS costs to estimated incentive amounts in FY 2011-

12, and assumed that this ratio would apply for the life of the program. In effect, when incentive

payments increase so will administration costs, and vice versa. As such, we estimate that DHCS wouldincur approximately $52 million in administrative costs during the remaining period of the incentive

program (i.e. until July 2021). California would be responsible for 10 percent of this amount, or $5.2million, while the federal government would provide nearly $47 million to DHCS to pay for theseactivities.

Mapping the Flow of MoneyTo measure the fiscal impact of the $47 million in new federal funds, we analyzed recent DHCS coststo map the flow of money. Based on our analysis of this cost data, we estimate that DHCS would use

16 percent of the funds to pay salaries, 58 percent to pay for contracted services, 7 percent for

benefits, and 19 percent for other activities, such as training, operating expenses and equipment, andoutreach costs.

Identifying Taxable Amounts

The three main components of direct fiscal benefits from DHCS spending will be state employeewages, the purchase of contractor services, and other state spending on supplies or miscellaneous

purchases. The state employee wages will be subject to income taxes while contractor revenue that isflows to employee wages and profits would also be subject to taxation. In addition, the department’sspending on other activities as well as the indirect spending by employees and suppliers would create

taxable economic activity.

We estimate that DHCS employees will receive $7.7 million in wages over the next nine years fromthe federal share of administrative grant payments. In addition, we estimate that contractors will

receive payments of $27 million in the same time period.8 Using IMPLAN, which utilizes empirically

derived estimates of economic relationships to model the percent of new industry revenue that wouldgo to employee compensation and proprietor income, we estimate that these contractors will pay out$16 million in employee wages and earn $2.4 million in taxable profit.9 Finally, the $9 million in state

spending on other inputs and supplies will similarly generate increases in personal income, corporate

income, and taxable purchases.

6 Office of Health Information Technology, Department of Health Care Services, Health Information Technology

Implementation – Advanced Planning Document Update, March 2012. 7 DHCS labeled its contractor costs from January 2012 to September 2013 as “To Be Determined.” Based on thedescription of the ongoing and new contractor projects to be undertaken during that time, we assumed that thesecosts were equal to the known contractor costs from January 2011 to January 2012.8 We note that only some of these contractors are for-profit, and therefore subject to corporation or personal incometaxes.9 We assume the current split between for-profit (52 percent) and non-profit (48 percent) continues throughout thelife of the incentive program. Given the various ways in which these for-profit contractors could be organized(partnerships, LLCs, C-corps, etc.), we make the simplifying assumption that all profits are taxed as corporate taxes.





In addition, the money earned by employees and contractors would then be used to buy goods andservices. Using IMPLAN, we modeled the flow of the employee compensation, contractor payments,and supplier payments through the California economy, estimating that these expenditures would

create another $56 million in indirect and induced economic activity.

Estimating Tax RevenueUtilizing personal income tax data from 2005 to 2009, we estimated an average effective income

tax rate of 4.5 percent.10 We applied this rate to the $7.7 million in state wages and $16 million in

contractor wages. In total, we estimate that this $24 million in wages will generate $1.1 million inadditional personal income tax revenue. Utilizing corporation tax statistics from 2005 to 2009, we

estimated an average effective corporation tax rate of 5.3 percent.11 Thus, the $2.4 million inincreased profits will generate $126,000 in corporation tax revenue.

To estimate the fiscal benefit of both the $9 million in other state spending and the $56 million in

indirect economic activity, we measured the average annual amount of sales, income, and corporationtax revenue collected by the General Fund for every dollar of economic output. Accordingly, weestimate that 4.4 percent of the $9 million in other state spending and the $56 million in additional

indirect output would come back to the General Fund as $3 million in new tax revenue.

Table 2: Direct and Indirect Effects of the Administration Grant

In total, the General Fund would experience a $4.2 million increase in tax revenue from direct and

indirect economic activity spurred by the administration grant, as shown in Table 2 (above).

EHR Incentives

The amount of EHR incentives that will be paid out between 2012-13 and 2021 depends largely on

the number of providers that apply and the amounts for which they are eligible. The “minimumscenario” planned for by DHCS involved 250 hospitals and 10,000 providers, while the “maximum

scenario” includes 20,000 providers. The analysis presented below is based on a “middle scenario”where 250 hospitals and 15,000 providers will qualify for $1.7 billion over the lifetime of the

incentive program. Using DHCS-provided information, we assume that 154 hospitals and 10,000providers will have qualified for $434 million in Year 1 incentives payments in 2011-12, and thus

10Based on the relationship between adjusted gross income and total tax liability in the Franchise Tax Board’s TableB-2. 11 The corporate tax rate was estimated using the ratio of tax assessed to income for corporations reporting netincome from the Franchise Tax Board’s Exhibit B-2(https://www.ftb.ca.gov/aboutFTB/Tax_Statistics/Rev_Est_Exhibits_0511.pdf).

Taxable Economic

Activity

Effective

Tax Rate

General Fund

Revenue

Personal Income 23,901,000$ 4.5% 1,081,000$

Corporate Profit 2,379,000$ 5.3% 126,000$

Other State Spending 8,700,000$ 4.6% 400,000$

Indirect and Induced Output 56,230,000$ 4.6% 2,560,000$

Total - - 4,167,000$





these payments are not counted in our calculation of the fiscal impact of the EHR incentive payments.12

Thus, our analysis is based on the remaining $1.2 billion in incentive payments to be made during ourperiod of interest.13

It is important to note that additional factors can influence how much incentive money actually goes to

providers. For one, providers may not be eligible for maintenance year payments due to theirinability to meet “meaningful use” criteria. The extent of this potential ineligibility is unknown and willdepend on several factors including the amount of technical assistance given to providers during the

meaningful use years. On the other hand, many new providers may become qualified for the program

(beyond what is projected in our analysis) as a result of Medi-Cal expansion resulting from theAffordable Care Act. Once again, the exact magnitude of this additional provider pool is unknown.

Our analysis does not explicitly account for these two, potentially offsetting, impacts, but insteadpresents results based on the likely participation rate as determined by DHCS.

Mapping the Flow of Money

The fiscal benefit of the EHR incentives comes from direct payments to medical providers inCalifornia.14 The $1.2 billion in incentive funds first gets distributed to hospitals (39 percent) andproviders (61 percent). The next step is to determine what the money will be spent on. An analysis

conducted by CMS determined that spending will be used for two purposes: implementation costs and

maintenance costs. The incentive disbursement itself is structured so that 50 percent of the hospitalmoney and 67 percent of the provider money is disbursed after the first year, or what would betypically considered the “maintenance” years. We assume that the first-year payments are directed

toward implementation costs and subsequent payments are directed toward maintenance.15,16 Because

a large proportion of the total applicants have received their implementation payment in 2011-12,we assume that these applicants will receive only maintenance payments from this point forward. Thus,

12 To determine how much in incentives will have been given out before the beginning of 2012-13, we utilized DHCS-

provided information. Currently, 116 hospitals have qualified for an average first year payment of $1.4 million. Weassume that they will make this average incentive payment to all 154 hospitals that applied for funding this year fora total of almost $222 million. In addition, DHCS has a goal of providing payment to 10,000 providers. Because theprovider application window is still open, we do not have an estimate of the average payment. Instead, we utilize themaximum first year payment of $21,250 in order to estimate that another $212 million in incentives will have beenpaid out to providers by the end of the fiscal year.13 The $1.7 billion in total payments for this middle scenario is calculated using the same methodology as was used tocalculate the amount of payment dispersed in 2011-12 and the minimum and maximum amounts; that is, utilizing theaverage cost in first year payments experience by hospitals and maximum costs possible for providers to estimatetheir total payments. See footnote #9 for additional information. 14 Although the incentive payments are not obligated to be spent on the purchase of EHR systems, the receipt of theincentive is contingent upon the purchase and meaningful use of these systems. Thus, we model the flow of incentivemoney through the purchase, implementation, and maintenance of EHR systems. 15 CMS, citing published studies on the cost of EHR systems, assumes yearly maintenance costs are 20 percent of theinitial implementation costs for both hospitals and providers. Because hospitals receive “maintenance” payments for 3years and providers receive them for 5 years, the maintenance payments would be 38 percent and 48 percent,respectively, of the total spending in that time period. See footnote #14 for additional information on the literature. 16 Incentive payments do not match up exactly with costs in either period; they will be less than the estimated cost ofEHR systems in both implementation and maintenance years. CMS estimates that the costs for a provider would be$54,000 per physician FTE for implementation and $10,000 per physician FTE per year for maintenance. Forhospitals, they estimate the costs to be $5 million for implementation and $1 million per year for maintenance. Incomparison, the incentives would be less than $22,000 in the first year for providers and are averaging $1.4 millionfor hospitals. For maintenance, providers receive a maximum of $8,500 per year and hospitals would be getting$848,000 in the second year and $283,000 in both year 3 and 4. Thus, the incentive payments are substantially lessthan total anticipated costs.





for hospitals we estimate that 27 percent of the incentive payments will go to implementation costs

and 73 percent to maintenance; for individual providers we estimate that 14 percent and 86 percentof payments will go to implementation and maintenance, respectively.

We then used published studies on the cost of EHR systems to allocate funding within implementation

and maintenance. Costs for implementation are categorized as those for hardware (e.g., computersand printers), software, training, and internal staff’s time.17 Utilizing three studies that presented costsfor all four categories, we estimated the percent allocated to each category.18 The same process was

used to divide maintenance costs between hardware maintenance and software maintenance

(including license fees, maintenance, and upgrades), some of which is provided by office staff.19,20 Although hospitals and providers may differ on the division of costs, the literature provides detailed

breakdowns only for clinics and provider offices. Thus we assume that hospitals mimic providerspending for purposes of this analysis. Table 3 maps this flow of funds in more detail, indicating thepercent and amount of total incentive funds that are allocated to and within implementation and

maintenance costs.

17 The EHR system cost literature includes the five studies of EHR implementation costs considered by CMS, plus six

other studies identified through our own literature search. These are: Gallego, Ana Isabel, Marie-Pierre Gagnon, andMarie Desmartis, “Assessing the Cost of Electronic Health Records: A Review of Cost Indicators,” Telemedicine and e-

Health, 16, no. 9 (2010): 963-972; Fleming, Neil S and Steven D Culler et al, “The Financial and Nonfinancial Costsof Implementing Electronic Health Records in PrimChriary Care Practices,” Health Affairs, 30, no. 3 (2011) 481-489;Miller, Robert H and Christopher E West, “The Value of Electronic Health Records in Community Health Centers: PolicyImplications,” Health Affairs, 26, no.1 (2007): 206-214; Gans, David, John and John Krawlewski et al., “MedicalGroups’ Adoption of Electronic Health Records and Information Systems,” Health Affairs, 24, no. 5 (2005): 1323-1333; Kibbe, David and Steven Waldren, Partners for Patients Electronic Health Record Market Survey, (Center forHealth Information Technology, 2005); Kashal, Rainu and Ashish K Jha et al., “Return on Investment for aComputerized Physician Order Entry System,” Technology Evaluation, 13, no. 3 (2006):261-266; Girosi, Federico,Robin Meili, and Richard Scoville, Extrapolating Evidence of Health Information Technology Savings and Costs, (RANDCorporation, 2005); Gans, David N., “Off to a slow start…,” MGMA Connexion, 5, no. 9 (2005): 42-46; Miller,Robert H and Christopher West et al., “The Value of Electronic Health Records in Solo or Small Group Practices,”Health Affairs, 24, no. 5 (2005): 1127-1137; Wang, Samuel J and Blackford Middleton et al., “A Cost-BenefitAnalysis of Electronic Medical Records in Primary Care,” American Journal of Medicine, 114 (2003): 397-403. 18 Miller, Robert H and Christopher E West (2007); Miller, Robert H and Christopher West et al (2005); Wang,Samuel J and Blackford Middleton et al (2003). 19 Miller, Robert H and Christopher E West (2007); Miller, Robert H and Christopher West et al (2005); 20 Although a portion of the maintenance costs will be spent internally, the literature was not clear on the percent ofthe maintenance costs that was spent on in-house technical staff. In addition, the use of in-house technical staff willlikely vary by practice. Thus, for purposes of this analysis, we assume that all the maintenance money goes to the EHRvendors for eventual use and, as such, is subject to taxation. Given the non-profit nature of many hospitals and cl inicsand the for-profit structure of EHR vendors, this may overstate the tax benefits of the maintenance spending.However, we also assume that none of these software maintenance costs have sales tax applied to them, which has acounterbalancing effect on the estimates.





Table 3: Implementation and Maintenance Costs

* See footnote 21

Because incentives are also provided to applicants for upgrading to certified EHR systems, we assumethese “updaters” spend similarly to “implementers,” except that the costs that would otherwise go to

hardware purchases for new implementers go instead to the provider’s general revenue.21 Theseassumptions provide a means of accounting for the fact that hospitals have been more active inimplementing EHRs, yet plan to be very active in obtaining incentive payments and that updaters willlikely experience lower upfront costs.

Identifying Taxable Amounts

Once we’ve modeled the spending path of the incentive money, we have to determine which

transactions incur state taxes. The three main causes of direct benefits are the purchases of taxablesoftware and hardware, the increased revenue for the suppliers for goods and services (EHR vendorsand hardware suppliers), and the increased revenue for providers. In general, the purchase of

hardware will be subject to sales tax while the purchase of the EHR software will be taxed only under

certain circumstances. The increased revenue for EHR vendors and hardware suppliers that goes toprofits will be subject to corporation tax while the portion that goes to employee wages will besubject to personal income taxes.22 Portions of the increased revenue for hospitals and providers will

also go to profits and employee wages, with the attendant corporation and personal income tax

impacts. Finally, the indirect spending by EHR system suppliers and employees and suppliers tohospitals and providers would also create taxable economic activity.

We estimate that $357 million in software and hardware sales will be subject to the sales tax over

the next nine years. This includes $345 million of initial hardware purchases and ongoing equipment

21 $10 million ($7 million for hospitals and $2.9 million for providers) of the hardware costs are assumed to go togeneral revenue of providers that are updating instead of implementing new systems. The percent that are updatingis based on the percent of each provider type that have implemented some type of EHR system times the percent thatwould be apply for an incentive, as determined by provider surveys. For hospitals, 17 percent are assumed to beupdating; for providers, 9 percent are assumed to be updating. 22 Here we note that some EHR vendors might not be corporations. As a result, profits from these vendors would besubject to personal income taxes rather than corporation taxes. For simplicity, however, we assume that all profits aresubject to corporation taxes.

Cost Category Percent Hospitals Providers Total

Purchase & Implementation $131,483,000 $106,250,000 $237,733,000

Hardware purchase* 31% $40,400,000 $32,647,000 $73,047,000

Software purchase 26% $34,352,000 $27,760,000 $62,112,000

Training and support 16% $21,693,000 $17,530,000 $39,223,000

Internal Staff's Time 27% $35,037,000 $28,313,000 $63,350,000

Maintenance $353,448,000 $637,500,000 $990,948,000

Ongoing Equipment Costs 28% $100,490,000 $181,249,000 $281,739,000

Ongoing Service Costs 72% $252,958,000 $456,251,000 $709,209,000

Total 100% $484,931,000 $743,750,000 $1,228,681,000





spending and $12 million in software purchases.23 Our assumption is that 100 percent of hardware

and ongoing equipment costs are taxable and that software sales to newly implementing hospitalsincur sales taxes 25 percent of the time, to updating hospitals 15 percent of the time, and to providerpractices 15 percent of the time.24 We assume that none of the ongoing EHR service costs are subject

to sales tax.25

Next, we estimated the additional revenue going to the EHR system suppliers and medical providers.Hardware purchases and ongoing equipment services total $345 million.26 All software purchases,

training and support, and ongoing service costs increase revenues for EHR vendors by $811

million.27,28 Then, we estimated the additional revenue being kept by medical providers in part toaccount for the amount of time that their staff will have to spend implementing and/or learning the

new EHR system. This amount is estimated to be $73 million.29 Once again, we utilize IMPLAN toestimate the amount of the increased revenue that goes to employee compensation and profit (in for-profit companies), which is $532 million and $145 million, respectively.30

23 $345 million is the sum of hardware purchase ($73 million) and ongoing equipment costs ($282 million) in Table 3.$12 million is the amount of the software purchase figure of $62 million in Table 3 that has sales tax applied to itbased on the assumptions described in the same paragraph. 24 Only pre-written EHR software that is transferred to the hospitals and providers via a tangible medium such as aCD or a piece of computer hardware is subject to sales tax. EHR software that is mostly custom built, installed by thevendors at the practice site, hosted on servers off-site, downloaded via the Internet, or accessed “in the cloud” is notsubject to sales tax. Discussions with EHR vendors revealed the popularity of the vendor installation and remoteelectronic installation method, especially for larger practices, and the growing use of Internet applications for smaller,less complex practices. In addition, the fact that providers must purchase pre-certified systems means that custombuilds are not the market norm, even though the system capabilities can be mixed and matched by the practices.These market characteristics form the basis of our software sales tax assumptions. 25 For EHR updates that are installed by practices using a tangible medium, sales tax would be paid. However,

updates that are downloaded via the Internet or installed by the vendors would not be taxed. For EHR systems thatincur license fees, these ongoing costs are taxed only if the original installation was taxed. Conservatively, weestimate that none of these software maintenance costs are taxed. This also has the effect of offsetting the fact thatwe do not apportion any of the maintenance costs to the hospital and providers. See footnote #17. 26 $345 million is the sum of hardware purchase ($73 million) and ongoing equipment costs ($282 million) in Table 3. 27 EHR vendors are classified as custom computer programming services when using IMPLAN. 28 $811 million is the sum of software purchase ($62 million), training and support ($39 million) and ongoing servicecosts ($709 million) in Table 3. 29 $73 million is the sum of internal staff’s time and the $10 million of the hardware purchase amount shown in Table3 that is assumed to go to general revenue of providers that are updating instead of implementing new systems. 30 The original divisions between provider types become more nuanced for this part of the analysis. Hospitals areclassified as non-profit and for-profit based on the average representation of each type in the acute care hospitallandscape and in the Disproportionate Share Hospital (DHS) hospital sector as found in the 2010 Office of StatewideHealth Planning and Development (OSHPD) Hospital Annual Financial data. Thus, we assume 28 percent of hospitalsare for-profit. In addition, individual providers are classified as individual offices, for-profit medical groups, and non-profit medical groups. Based on DHCS data that 85 percent of individual provider incentive recipients arereassigning their payments to medical groups, we assume 85 percent of incentive recipients are medical groups andthat the other 15 percent are individual practices. Of the medical groups, we assume that 15 percent are for-profitbased on the percent of the eligible group landscape of non-profit clinics, public hospitals, and medical groups thatare for-profit. Of these, we make the simplifying assumption that all groups are organized as corporations and aresubject to the corporate income tax instead of the individual income tax (as experienced by offices operated byindividuals or under partnerships). For-profit status of medical groups are based on an analysis of the medical groupdatabase maintained by Cattaneo & Stroud. When using IMPLAN, all hospitals are classified as private hospitals,individual providers are classified as offices of physicians, dentists and other health providers, and medical groupsare classified as medical and diagnostic labs and outpatient and other ambulatory care services.





Finally, the money earned by employees, EHR system suppliers, and medical providers would then be

used to buy goods and services throughout the state’s economy. Using IMPLAN, we modeled the flowof this money through the California economy, estimating that the amount of indirect and inducedeconomic activity would be $1.3 billion.

Estimating Tax RevenueThe last step then is to apply effective tax rates to these taxable amounts using the same approachwe applied to the administration grant revenue.31 Applying these rates to our taxable amounts, we

estimate that incentive payments to California would generate $46 million from direct expenditure of

the incentive payments ($14 million in additional sales tax revenue, $24 million in personal income taxrevenue, and $8 million in corporation tax revenue). In addition, $59 million in increased sales,

income, and corporation tax revenue would be generated from the indirect economic effectsassociated with these expenditures. In total, California would experience $104 million in GeneralFund fiscal benefit, as shown in Table 4 below.

Table 4: Direct and Indirect Effects of the EHR Incentives

The Net Benefit to the General Fund

With these estimates in hand it is possible to calculate the expected net impact on the General Fund.

From 2012-13 until the scheduled end of the program in July 2021, the estimated cost to the General

Fund is the 10 percent match, or $5.2 million. The benefits are $4.2 million resulting from theadministration grant and $104 million from the incentives for a total benefit of $109 million. Thus, the

net benefit to the General Fund is $103 million. Even excluding any indirect benefits from the

multiplier effect, the state would experience a $47 million net benefit just from the initial expenditure

of the federal funds in California. Put another way, for every dollar spent by the state, $240 offederal money enters California to produce $21 of new General Fund revenue.

Our overall finding of net General Fund benefits is not sensitive to changes in the input assumptions.For example, if we model the effects of a “minimum scenario” (rather than the “medium scenario”

presented) with just 10,000 providers participating and assumptions that none of the EHR softwaresold is taxable and that 5 percent of providers “drop-out” every year, the net benefit would still be

$69 million (as shown in Table 5). Similarly, the overall finding is not sensitive to assumptions abouthow the EHR money is spent (i.e. what fraction is spent on employees, supplies, equipment, etc.).

Moreover, even if administration costs are doubled in every year but the level of provider enrollment

remains at 15,000, the net fiscal benefit is still over $100 million.

31 Information from the Board of Equalization indicates a statewide effective sales tax rate of 8.1 percent, of whichonly 3.9625 percent goes to the General Fund. This rate was used to estimate sales tax effects resulting from theincentive payments.

Taxable EconomicActivity

EffectiveTax Rate

General FundRevenue

Taxable purchases 357,117,000$ 4.0% 14,151,000$

Personal Income 532,437,000$ 4.5% 24,084,000$

Corporate Profit 145,188,000$ 5.3% 7,708,000$

Indirect and Induced Output 1,285,989,000$ 4.6% 58,540,000$

Total - - 104,483,000$





Table 5: 2012-13 to 2021 Net Benefits,

Middle and Minimum Scenario

In addition, we modeled the yearly fiscal effects of the program in order to see if the results werepositive in each fiscal year (as well as overall). To do so, we assumed the remaining eligible providers

were evenly dispersed throughout the remaining initial grant period and then estimated the amount of

incentives that would be handed out in each year.32 Then we estimated the direct and indirect benefits

that would be experienced in each year from both the administration grant and incentive payments.As such, we find that each year is likely to produce a net fiscal benefit to the state General Fund. AsTable 6 shows, we anticipate that the state will experience the largest net benefit, $23.4 million, in

2012-13, and the smallest net benefit, $900,000, in 2020-21. Moreover, even if we model a oneyear lag between the expenditure of General Fund money and subsequent changes in direct and

indirect economic activity, the yearly net benefits are positive throughout the program period.

Table 6: Estimated Yearly Net Benefits

The Economic Benefits of the EHR Incentive Program

The fiscal benefits presented above stem from the increased economic activity that the EHR incentiveprogram would create. We estimate that the infusion of $47 million in federal administrative grantfunds to the Department of Health Care Services will generate $92 million in increased economic

activity in the state and an additional 700 jobs. Meanwhile, we estimate that the $1.2 billion in

federal incentive payments given to providers will generate $2.2 billion in increased economic activityand over 15,000 new jobs. In total, as shown in Table 7, we estimate that the EHR incentive programincreases state economic output by $2.3 billion and creates 16,000 new jobs.

Table 7: Estimated Total Economic Benefits

As shown in Table 8, the bulk of these new jobs (5,770) is estimated to be in the EHR industry, or those

firms that will provide systems and support to medical providers. In addition, 1150 jobs are estimated

32Although the program runs through FY 2020-21, providers are only eligible to begin receiving payments until

2015-16. After that year, only maintenance payments to remaining providers will be handed out.

Middle Scenario Minimum Scenario

Administration Grant Benefits 4,165,000$ 3,224,000$

EHR Incentive Benefits 104,483,000$ 69,806,000$Cost to State (5,204,000)$ (4,028,000)$

Net Benefit 103,444,000$ 69,002,000$

2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21

State Cost -$1,176,000 -$928,000 -$1,001,000 -$886,000 -$679,000 -$236,000 -$163,000 -$90,000 -$45,000

Fiscal Benefits $24,500,000 $19,400,000 $20,900,000 $18,500,000 $14,200,000 $4,900,000 $3,400,000 $1,900,000 $900,000

Net Benefit $23,300,000 $18,500,000 $19,900,000 $17,600,000 $13,500,000 $4,700,000 $3,200,000 $1,800,000 $900,000

Employment Output

Administrative Grant Benefits 700 $92,000,000

EHR Incentive Benefits 15,300 $2,230,000,000

Total 16,000 $2,322,000,000





for the health care industries (i.e., hospitals, physician offices, and group practices). Another 580 jobs

are expected in the wholesale trade industry, spurred in part by increased computer equipmentpurchases. Finally, service industries that provide food, labor, and real estate to employees and firmsare also poised to see additional growth.

Table 8: Employment Effects by Industry,Top 10 Areas of Job Growth

Conclusion

Given the very large amounts of federal money coming into California through the Medi-Cal incentive

program, it’s reasonable that the fiscal benefits of these incentives and the federal share of the

program’s administrative costs should produce a net benefit for the state’s General Fund. In our modelof the fiscal benefits of the program, we find that $1.2 billion in federal funds due to enter the state

between 2012-13 and July 2021 will generate $109 million in new General Fund revenue (if thestate expends $5.2 million from the General Fund on administration costs). Moreover, the state would

experience $2.3 billion in increased economic output and almost 16,000 new jobs. In other words, forevery dollar spent by the state, $240 of federal money enters the state to produce $21 of new

General Fund revenue. Moreover, these benefits do not include other incentive-related federalspending on Regional Extension Centers and community college workforce training or potential

efficiency gains from the use of EHR systems in the treatment of Medi-Cal patients.

Industry Employment

Custom computer programming services 5,770

Food services and drinking places 810

Real estate establishments 710

Employment services 660

Wholesale trade businesses 580

Private hospitals 510

Offices of physicians, dentists, and other health practitioners 380

Securities, commodity contracts, investments, and related activities 270Medical and diagnostic labs and outpatient and other ambulatory care services 260

Services to buildings and dwellings 230





Appendix A: Yearly Federal Spending Detail

Table 9 details the level on federal spending expected in California in each fiscal year via both the

administration grant and EHR incentive payments.

Table 9: Yearly Federal Spending in California

2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21Administration Grant $10,600,000 $8,400,000 $9,000,000 $8,000,000 $6,100,000 $2,100,000 $1,500,000 $800,000 $400,000

Incentive Payments $277,600,000 $219,200,000 $236,400,000 $209,200,000 $160,400,000 $55,600,000 $38,400,000 $21,300,000 $10,600,000

Total Federal Spending $288,200,000 $227,600,000 $245,400,000 $217,200,000 $166,500,000 $57,700,000 $39,900,000 $22,100,000 $11,000,000





Appendix B: Flow of Federal Funds

Figure 1 diagrams the flow of federal funds through the state’s economy via the administration grant

and EHR incentives. First, federal administration grant funds are used to pay employee wages,contractors, and other suppliers of the Department of Health Care Services, who then create

additional indirect and induced economic activity. These payments and purchases next make their way

to the state’s General Fund via sales, corporation, and personal income taxes. Similarly, the federalEHR incentive payments are given to hospitals and providers, who use most of this money to purchaseEHR software and computer hardware from vendors. In addition, some of this provider money is used

to pay employee wages and suppliers and to keep as profit, which then creates additional indirect

and induced economic activity. This provider-based economic activity funnels some of the federalmoney to the state General Fund via sales, corporation, and personal income taxes. Finally, the

software and hardware vendors use the money to pay employee wages and suppliers and to keep asprofit, creating additional indirect and induced economic activity. Some of this money also makes its

way to the state’s General Fund via sales, corporation, and personal income taxes.

Figure 1: The Flow of Federal Funds through the State Economy

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EHR Incentive Impacts

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