United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued November 8, 2010 Decided January 14, 2011
No. 09-5447
CAPE COD HOSPITAL, ET AL.,
APPELLANTS
v.
KATHLEEN SEBELIUS, SECRETARY, UNITED STATES
DEPARTMENT OF HEALTH AND HUMAN SERVICES,
APPELLEE
Appeal from the United States District Court
for the District of Columbia
(No. 1:08-cv-01751)
Paul D. Clement argued the cause for appellants. With
him on the briefs were Christopher L. Keough, Stephanie A.
Webster, Erin E. Murphy, John M. Faust, and John P.
Elwood.
Jeffrey Clair, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief were
Ronald Machen, U.S. Attorney, and Michael S. Raab,
Attorney. R. Craig Lawrence, Assistant U.S. Attorney,
entered an appearance.
2
Before: TATEL, Circuit Judge, and WILLIAMS and
RANDOLPH, Senior Circuit Judges.
Opinion for the Court filed by Circuit Judge TATEL.
TATEL, Circuit Judge: Five hospitals contend that the
Secretary of Health and Human Services improperly
implemented a statutory provision in a way that over the years
has progressively reduced Medicare payments for inpatient
services. In particular, they challenge rules governing
reimbursements for the 2007 and 2008 fiscal years. Because
the Secretary failed to provide a reasoned response to the
hospitals’ comments regarding those rules, we vacate the
district court’s grant of summary judgment in the Secretary’s
favor and remand for further proceedings in light of the
guidance set forth in this opinion.
I.
Established in 1965, Medicare “provides federally funded
health insurance for the elderly and disabled.” Methodist
Hosp. of Sacramento v. Shalala, 38 F.3d 1225, 1226–27 (D.C.
Cir. 1994). The Secretary administers the program through
the Centers for Medicare and Medicaid Services (CMS).
Originally, Medicare reimbursed hospitals based on the
“ ‘reasonable costs’ ” they incurred in providing services to
Medicare patients. Id. at 1227 (quoting 42 U.S.C. § 1395f(b)
(1988)). Concerned that this system created inadequate
incentives for hospitals to control costs, Congress in 1983
required the Secretary to implement a prospective payment
system under which hospitals would receive a fixed payment
for inpatient services. Id. Since hospitals receive the same
payment under this system regardless of their actual costs,
Congress believed that it would encourage efficiency “by
rewarding cost[-]effective hospital practices.” Id. (quoting H.
3
Rep. No. 98-25, at 132 (1983), reprinted in 1983
U.S.C.C.A.N. 219, 351).
In calculating prospective payment rates, CMS begins
with a figure called the “standardized amount,” which roughly
reflects the average cost incurred by hospitals nationwide for
each patient they treat and then discharge. See 42 U.S.C.
§ 1395ww(d)(2); Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2007 Rates, 71
Fed. Reg. 47,870, 48,146 (Aug. 18, 2006) [hereinafter Final
2007 Rule]. Central to the issue before us, CMS does not
calculate the standardized amount from scratch each year.
Instead, following Congress’s directive, it calculated the
standardized amount for a base year and has since carried that
figure forward, updating it annually for inflation. See 42
U.S.C. § 1395ww(b)(3)(B)(i), (d)(2), (d)(3)(A)(iv)(II); 42
C.F.R. § 412.64(c)–(d); Final 2007 Rule, 71 Fed. Reg. at
48,146; see also Prospective Payments for Medicare Inpatient
Hospital Services, 48 Fed. Reg. 39,752, 39,763–64 (Sept. 1,
1983) (explaining how the Health Care Financing
Administration, CMS’s predecessor, developed base-year cost
data at the inception of the inpatient prospective payment
system).
To account for the fact that labor costs vary across the
country, CMS determines the proportion of the standardized
amount attributable to wages and wage-related costs and then
multiplies that labor-related proportion by a “wage index” that
reflects “the relation between the local average of hospital
wages and the national average of hospital wages.”
Appellee’s Br. 5; see also 42 U.S.C. § 1395ww(d)(2)(H),
(d)(3)(E); Se. Ala. Med. Ctr. v. Sebelius, 572 F.3d 912, 914–
15 (D.C. Cir. 2009). Unlike the standardized amount, wage
indexes are calculated anew each year instead of being carried
forward from one year to the next.
4
The standardized amount is also modified to account for
the fact that the costs of treating patients vary based on the
patients’ diagnoses. Medicare patients are classified into
different groups based on their diagnoses, and each of these
“diagnosis-related groups” is assigned a particular “weight”
representing the relationship between the cost of treating
patients within that group and the average cost of treating all
Medicare patients. See 42 U.S.C. § 1395ww(d)(4).
Putting all these components together, CMS determines
how much a hospital should be paid for treating a Medicare
patient by performing the following calculation (where SA =
standardized amount; labor% = the proportion of the
standardized amount attributable to wages and wage-related
costs; non-labor% = the proportion of the standardized
amount not attributable to labor-related costs; WI = wage
index; and DRG Weight = the weight assigned to a particular
diagnosis-related group):
[SA*(non-labor%) + (SA*(labor%)*WI)]*(DRG Weight) =
Payment
In 1997, Congress determined that “[a]n anomaly that
exists with the way area wage indexes are applied has resulted
in some urban hospitals being paid less than the average rural
hospital in their states.” H.R. Rep. No. 105-149, at 1305
(1997). To correct this problem, Congress provided in the
Balanced Budget Act of 1997 (“BBA”) that the wage index
assigned to a hospital in an urban area must be at least as
great as the wage index assigned to rural hospitals within the
same state. Pub. L. No. 105-33, § 4410(a), 111 Stat. 251, 402
(reprinted at 42 U.S.C. § 1395ww note) (“[T]he area wage
index applicable under [42 U.S.C. § 1395ww(d)(3)(E)] to any
hospital which is not located in a rural area . . . may not be
5
less than the area wage index applicable under such section to
hospitals located in rural areas in the State in which the
hospital is located.”). This provision is commonly referred to
as the “rural floor.”
Potentially, the rural floor could affect the total amount
of money Medicare pays hospitals each year. For example, if
CMS increased the wage indexes of urban hospitals to bring
them in line with the wage indexes of rural hospitals in the
same state, payments to those urban hospitals would increase.
All other things being equal, the aggregate amount of
Medicare payments would increase as well. But Congress
required the Secretary to take steps to ensure that all other
things would not be equal. It mandated that the rural floor be
“budget neutral.” In other words, it required the Secretary to
implement the rural floor in a manner that would have no
effect on the annual total of Medicare payments made to all
hospitals throughout the country for inpatient services. Cape
Cod Hosp. v. Sebelius, 677 F. Supp. 2d 18, 22 (D.D.C. 2009).
Congress accomplished this through BBA section 4410(b),
which provides: “The Secretary . . . shall adjust the area wage
index . . . in a manner which assures that . . . aggregate
payments . . . in a fiscal year for the operating costs of
inpatient hospital services are not greater or less than those
which would have been made in the year if [the rural floor]
did not apply.”
The five hospitals that are appellants herein challenge
how the Secretary has implemented this budget-neutrality
provision. Rather than adjusting area wage indexes to achieve
budget neutrality, as the hospitals argue the statute requires,
the Secretary adjusted the standardized amount. Thus, if the
rural floor threatened to increase aggregate payments in a
particular year, she applied a downward adjustment to the
standardized amount to offset the effect of the rural floor. See
6
Final 2007 Rule, 71 Fed. Reg. at 48,147. The Secretary then
carried forward the adjusted standardized amount from year to
year, purportedly making further adjustments only as
necessary to account for incremental changes in each new
year. See id. (explaining that CMS would apply the “budget
neutrality adjustment factor[] . . . to the standardized amount[]
without removing the effect[] of the [prior year’s] budget
neutrality adjustment[]”). The parties contrast this
“cumulative” approach of carrying forward prior adjustments
and making incremental annual changes with a
“noncumulative” approach under which the Secretary would
calculate the full amount of the requisite adjustment anew
each year. Since the cumulative and noncumulative
approaches are simply different methods of making the same
arithmetic computation, they should produce identical results
if performed correctly. The problem, the hospitals contend, is
that the Secretary botched the math, mixing the cumulative
and noncumulative methods in a way that gradually decreased
Medicare payments for inpatient services over time.
To understand the error the hospitals accuse the Secretary
of making, consider the following hypothetical taken from the
hospitals’ briefs. Imagine an employee normally earns $10
per hour. His employer decides to give him a company car,
the value of which equates to compensation of $1 per hour.
To avoid an increase in the employee’s overall
compensation—i.e., to achieve “budget neutrality”—the
employer reduces the employee’s wage to $9 per hour. Now
imagine that next year, the employee receives a nicer car
worth $2 per hour. To calculate what the employee’s wage
should then be to keep his overall compensation at $10 per
hour, the employer could use either a cumulative or
noncumulative approach. Under the cumulative method, the
employer would subtract the $1 incremental increase in the
value of the car from the employee’s current wage of $9 to
7
arrive at a new, budget-neutral wage of $8. Under the
noncumulative approach, the employer would simply subtract
the full value of the car ($2) from the desired total
compensation ($10) to arrive at the same figure—a wage of
$8 per hour. But it would make no sense for the employer to
subtract the full $2 value of the new car from the employee’s
current $9 wage and thus pay him only $7 per hour. Doing so
would not be “budget neutral”—it would reduce the
employee’s total compensation by $1 per hour. Yet this is
essentially what the hospitals accuse CMS of doing in
calculating the annual budget-neutrality adjustment to account
for the rural floor. Specifically, the hospitals argue that CMS
has duplicated prior adjustments by each year calculating the
full amount of the adjustment necessary to counteract the
effect of the rural floor and then applying that adjustment to a
figure that includes adjustments carried over from previous
years.
According to the hospitals, this error first came to light in
a May 2006 email exchange in which a CMS employee
informed a consultant working with the hospitals that CMS
calculated the budget-neutrality factor necessary to account
for the rural floor by comparing projected aggregate payments
for the coming fiscal year with the rural floor applied with the
aggregate payments that would have been made in the current
fiscal year without the rural floor. CMS then reduced the
standardized amount to account for the full difference
between these two figures, “even though the standardized
amount being carried over already included reductions from
prior years’ rural floor budget-neutrality adjustments.”
Appellants’ Opening Br. 12. This email exchange, the
hospitals argue, indicates that CMS illogically combined the
cumulative and noncumulative methods for calculating
budget-neutrality adjustments. Each year, CMS calculated
“the entire payment effect of the rural floor” but applied the
8
corresponding adjustment “to a carried-over figure that
already incorporated previous years’ rural floor budget-
neutrality adjustments,” thereby duplicating prior adjustments
in a manner that progressively reduced aggregate payments
over time. Id. at 12–13.
When CMS failed to respond to an email pointing out
this apparent error, the hospital consultant again attempted to
bring the error to CMS’s attention in a comment letter
regarding the agency’s proposed 2007 rules for the inpatient
prospective payment system. CMS’s notice of proposed
rulemaking (NPRM) required comments to be submitted by
June 12, 2006. Proposed Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2007 Rates, 71
Fed. Reg. 23,996, 23,996 (Apr. 25, 2006) [hereinafter
Proposed 2007 Rule]. Although the notice indicated that
comments could be hand delivered to CMS’s Baltimore
office, it also stated, “If you intend to deliver your comments
to the Baltimore address, please call telephone number (410)
786-7195 in advance to schedule your arrival with one of our
staff members.” Id. The consultant hand delivered his
comment to the Baltimore office without first calling this
number. In a sworn declaration, the consultant stated that he
called an individual he knew who worked in CMS’s Division
of Acute Care, “the part of the agency responsible for
[inpatient prospective] payment issues.” Giovanis Decl. ¶¶ 3–
4. The CMS employee met the consultant in the lobby of the
Baltimore office, accepted the comment letter, and signed a
delivery receipt confirming that the comment was submitted
on June 9, 2006, three days before the end of the comment
period. See id. ¶¶ 2–6. The record contains no evidence of
what the employee did with the letter after receiving it. But
what is clear is that CMS failed to respond to the consultant’s
comment in its final 2007 rule. See Final 2007 Rule, 71 Fed.
Reg. 47,870.
9
Following the 2007 rulemaking, CMS “reevaluated [its]
rural floor adjustment methodology.” Cape Cod Hosp., 677
F. Supp. 2d at 24. Specifically, in May 2007, it published a
proposed rule for fiscal year 2008 that would offset the rural
floor by adjusting area wage indexes rather than by adjusting
the standardized amount as CMS had done in the past. Id.;
see also Proposed Changes to the Hospital Inpatient
Prospective Payment Systems and Fiscal Year 2008 Rates, 72
Fed Reg. 24,680, 24,792 (May 3, 2007) [hereinafter Proposed
2008 Rule]. CMS also proposed a special “rural floor
adjustment” that would slightly increase the standardized
amount. Proposed 2008 Rule, 72 Fed. Reg. at 24,839.
Nowhere in the NPRM, however, did it explain the purpose of
this adjustment.
After requesting and being denied additional information
regarding CMS’s proposed rule, the hospitals submitted
comments that noted, among other things, that the agency’s
proposals appeared inadequate to reverse the cumulative
reduction in aggregate payments caused by CMS’s apparent
errors in calculating rural-floor budget-neutrality adjustments
for prior years. Many other hospitals and trade associations
submitted similar comments.
In its 2008 final rule, CMS adopted its proposal and
applied the rural-floor budget-neutrality adjustment to area
wage indexes rather than to the standardized amount. See
Changes to the Hospital Inpatient Prospective Payment
Systems and Fiscal Year 2008 Rates, 72 Fed. Reg. 47,130,
47,329 (Aug. 22, 2007) [hereinafter Final 2008 Rule]. CMS
pointed out that although its previous adjustments to the
standardized amount had been cumulative, its adjustment of
wage indexes would be noncumulative. Id. at 47,330.
Responding to commenters’ requests for more information
10
regarding the special “rural floor adjustment” to the
standardized amount, CMS explained that it was a one-off
adjustment “meant to address” the “transition from a
cumulative budget neutrality adjustment . . . to a
noncumulative adjustment.” Id. at 47,421. The agency made
clear that the adjustment removed only the effect of the 2007
rural-floor budget-neutrality adjustment to the standardized
amount, thus leaving in place all rural-floor budget-neutrality
adjustments made before 2007. Id. (“The rural floor
adjustment removes the effect of the budget neutrality
adjustment applied in [fiscal year] 2007 to the standardized
amount for application of the rural floor.”). In response to
commenters’ concerns that the changes CMS proposed were
insufficient to remedy the effects of previous miscalculations,
the agency stated that the “calculation of budget neutrality in
past fiscal years [was] not within the scope of [its]
rulemaking.” Id. at 47,330. Without admitting that it made
computational errors in prior years, CMS declared that even if
such errors were made, it “would not make an adjustment to
make up for those errors when setting rates for [fiscal year]
2008.” Id. “[F]inality,” CMS explained, “is critical to a
prospective payment system.” Id. As a result, it concluded
that “the need to establish final prospective rates outweighs
the greater accuracy [it] might gain if [it] retroactively
recomputed rates whenever an error is discovered.” Id.
All five hospitals that are parties to this appeal filed
timely petitions challenging the 2007 final rule with the
Department of Health and Human Services’ Provider
Reimbursement Review Board. See 42 U.S.C. § 1395oo.
Two hospitals also challenged the 2008 final rule. After the
Review Board determined it lacked authority to resolve the
legal questions presented by the hospitals, they filed a
complaint against the Secretary in the U.S. District Court for
the District of Columbia. See id. § 1395oo(f)(1) (permitting
11
medical providers to file suit in federal district court
following a Review Board determination that it lacks
authority to decide the legal question presented). The parties
submitted cross-motions for summary judgment. The
Secretary also filed a motion to strike, arguing that the
consultant’s 2006 email exchange and comment letter, which
the hospitals had submitted to the district court, were not
properly part of the 2007 rulemaking record. Without those
documents, the Secretary asserted, the hospitals were unable
to overcome her contention that they had waived their
objection to the 2007 rule by failing to raise it during the
rulemaking process.
Although the district court granted the Secretary’s motion
to strike with respect to the email exchange, it ruled that the
Secretary had improperly excluded the consultant’s comment
letter from the 2007 rulemaking record. Cape Cod Hosp., 677
F. Supp. 2d at 25–29. In particular, the district court
determined that the CMS employee’s acceptance of the letter
“indicated that [the consultant’s] submission was acceptable”
despite the consultant’s failure to call the telephone number
listed in the NPRM. Id. at 28. On the merits, the district
court largely rejected the hospitals’ challenges to the 2007
and 2008 rules and entered summary judgment in the
Secretary’s favor. According to the court, the Secretary
reasonably interpreted BBA section 4410(b) as imposing
upon her no obligation to reconsider rural-floor budget-
neutrality adjustments calculated in prior years. Id. at 29–32.
The court also concluded that the Secretary sufficiently
responded to comments regarding the 2008 proposed rule. Id.
at 34–35. Although acknowledging that the Secretary failed
to respond to the hospital consultant’s comment letter
regarding the 2007 rule, id. at 34, the court determined that by
making an upward adjustment to the standardized amount in
2008 to reverse the effect of the 2007 rural-floor budget-
12
neutrality adjustment, CMS “moot[ed]” the hospitals’
challenge to the 2007 rule, id. at 35–36. The Secretary does
not defend this ruling on appeal, and we agree with the
hospitals that since the 2008 rule in no way compensated for
any underpayments that might have been made in 2007, a live
controversy remains regarding the hospitals’ objection to the
2007 rule.
II.
The hospitals argue that CMS’s 2007 and 2008 rules
were arbitrary and capricious and violated BBA section
4410(b), the rural-floor budget-neutrality provision. See 5
U.S.C. § 706(2)(A) (requiring a court to “hold unlawful and
set aside” a final agency action “found to be . . . arbitrary,
capricious, an abuse of discretion, or otherwise not in
accordance with law”). In response, the Secretary contends
that she acted within the scope of the discretion Congress
afforded her in achieving budget neutrality. Furthermore, she
argues, the district court erred in supplementing the 2007
rulemaking record with the consultant’s June 2006 comment
letter and should instead have ruled that the hospitals waived
their objection to the 2007 rule by failing to follow the proper
procedures in submitting the letter. We review the district
court’s decision to supplement the 2007 rulemaking record for
abuse of discretion. See James Madison Ltd., by Hecht v.
Ludwig, 82 F.3d 1085, 1095 (D.C. Cir. 1996). Our review of
the hospitals’ contention that CMS’s 2007 and 2008 rules
were arbitrary and capricious and violated BBA section
4410(b) is plenary. See Methodist Hosp., 38 F.3d at 1229.
The 2007 Rulemaking
The hospitals contend that in 2007, as in previous years,
the Secretary improperly calculated a budget-neutrality
adjustment that compensated for the full effect of the rural
13
floor, rather than the incremental annual change, and then
applied this adjustment to the carried-over adjusted
standardized amount, which already included similar
adjustments from prior years. According to the hospitals, this
“incoherent admixture” of cumulative and noncumulative
methodologies produced aggregate payments that were less
than the amount that would have been paid in 2007 if the rural
floor had not been applied, thus violating section 4410(b)’s
budget-neutrality requirement. Appellants’ Opening Br. 34.
For her part, the Secretary argues that the hospitals
waived their objection to the 2007 rule by failing to “follow
the Secretary’s clear and express procedures for commenting
on the proposed rule.” Appellee’s Br. 57–58. In particular,
the Secretary emphasizes that the consultant failed to abide by
the NPRM’s request that individuals planning to hand deliver
their comments to CMS’s Baltimore office first call a
particular telephone number to schedule the delivery. See
Proposed 2007 Rule, 71 Fed. Reg. at 23,996. According to
the Secretary, the consultant’s failure to call this number
hampered the agency’s ability to ensure that staff members
responsible for the 2007 rulemaking received the comment in
a timely manner and had the ability to consider it before
issuing the final rule. As a result, the Secretary contends, the
consultant’s letter was properly excluded from the 2007
rulemaking record, thus depriving the hospitals of a basis for
pursuing their challenge to the rule.
Where, as here, an agency has issued a rule under the
Administrative Procedure Act’s notice-and-comment
provisions, see 5 U.S.C. § 553, courts ordinarily refuse to
consider objections not submitted in accordance with agency
procedures during the rulemaking process. See Appalachian
Power Co. v. EPA, 251 F.3d 1026, 1036 (D.C. Cir. 2001).
“[S]imple fairness to those who are engaged in the tasks of
14
administration . . . requires as a general rule that courts should
not topple over administrative decisions unless the
administrative body not only has erred but has erred against
objection made at the time appropriate under its practice.”
United States v. L.A. Tucker Truck Lines, Inc., 344 U.S. 33,
37 (1952). Under the unique circumstances of this case,
however, barring the hospitals’ challenge to the 2007 rule
would be patently unfair. Through their consultant, the
hospitals submitted a comment letter outlining their objection
to the rule to a CMS employee who worked in the very
division “responsible for [inpatient prospective] payment
issues.” Giovanis Decl. ¶ 3; see also Cerne Decl. ¶ 1. True,
the consultant failed to call the telephone number listed in the
NPRM before delivering the letter. But the CMS employee
nonetheless accepted the letter without even hinting that the
consultant’s submission was in any way improper. Although
the employee now asserts that she was unaware that the
document was a comment regarding a proposed rule, see
Cerne Decl. ¶ 9, she signed a delivery-confirmation receipt
expressly stating that the document was a “Comment Letter to
[the] Centers for Medicare and Medicaid Services on the
Proposed [Fiscal Year] 2007 [Inpatient Prospective Payment
System] Changes.” Furthermore, since the employee admits
that she has “some familiarity with the annual . . . rulemaking
process,” she has no basis for plausibly claiming either that
she failed to understand what the document she accepted was
or that she failed to appreciate the importance of ensuring that
it was forwarded to the staff members responsible for the
2007 rulemaking. Id. ¶ 4. Given these facts, we agree with
the district court that the consultant was entitled to presume
that his “submission was acceptable.” Cape Cod Hosp., 677
F. Supp. 2d at 28.
In reaching this conclusion, we in no way suggest that
agencies lack authority to impose and enforce submission
15
requirements of the kind at issue here. To the contrary, we
have little doubt that the CMS employee to whom the hospital
consultant tendered his comment letter could have refused to
accept it based on the consultant’s failure to call the
prescribed telephone number. But since the CMS employee
accepted the letter without objection, the agency may not now
complain about the consultant’s failure to call the number
listed in the NPRM. The district court thus did not abuse its
discretion in supplementing the 2007 rulemaking record with
the consultant’s letter. See James Madison, 82 F.3d at 1095
(noting that courts may supplement the official administrative
record compiled by an agency when the agency has
“deliberately or negligently excluded documents that may
have been adverse to its decision”); see also Kent Cnty., Del.
Levy Court v. EPA, 963 F.2d 391, 395–96 (D.C. Cir. 1992)
(supplementing the administrative record with internal EPA
documents that the agency negligently failed to consider
during the rulemaking process). And because CMS failed to
address the consultant’s letter when issuing its 2007 final rule,
we shall remand for CMS to provide a reasoned response to
this “relevant and significant public comment[].” Pub.
Citizen, Inc. v. FAA, 988 F.2d 186, 197 (D.C. Cir. 1993)
(“The requirement that agency action not be arbitrary or
capricious includes a requirement that the agency adequately
explain its result and respond to relevant and significant
public comments.”) (internal citation and quotation marks
omitted); see also Fox Television Stations, Inc. v. FCC, 280
F.3d 1027, 1050–51 (D.C. Cir.), modified on reh’g, 293 F.3d
537 (D.C. Cir. 2002).
In so doing, we have no need to decide whether, as the
hospitals argue, BBA section 4410(b)’s express reference to
“area wage index[es]” required CMS to offset the effect of the
rural floor by adjusting area wage indexes rather than the
standardized amount. Perhaps, as the hospitals contend,
16
adjusting wage indexes would have averted the computational
errors alleged in this litigation. But even assuming that
section 4410(b) requires CMS to achieve budget neutrality
only through adjustments to wage indexes—an issue, we
reiterate, we are not deciding—the hospitals concede that
CMS’s departure from the statutory language “would have
had no practical effect” had the agency correctly implemented
its chosen methodology of cumulatively adjusting the
standardized amount. Appellants’ Opening Br. 32. Because
courts must overlook “harmless” agency errors, PDK Labs.
Inc. v. DEA, 362 F.3d 786, 799 (D.C. Cir. 2004); see also 5
U.S.C. § 706 (requiring courts reviewing agency action to
take “due account . . . of the rule of prejudicial error”), we
understand the primary issue with respect to the 2007 rule to
be whether CMS overly deflated aggregate payments by
incorrectly calculating rural-floor budget-neutrality
adjustments to the standardized amount, not whether the
agency has committed some free floating statutory error that
may have “no practical effect.”
The 2008 Rulemaking
As explained above, in 2008 the Secretary switched from
making cumulative rural-floor budget-neutrality adjustments
to the standardized amount to making noncumulative
adjustments to the wage index. In connection with this
change, the Secretary made a small, one-off adjustment that
reversed the effect of the 2007 rural-floor budget-neutrality
adjustment. See Final 2008 Rule, 72 Fed. Reg. at 47,330,
47,421. The hospitals argue that in transitioning from a
cumulative to a noncumulative methodology, the Secretary
should have increased the standardized amount sufficiently to
reverse the effects of all prior rural-floor budget-neutrality
adjustments, not just the one made in 2007. The Secretary’s
failure to do so, the hospitals contend, resulted in aggregate
payments in 2008 that were “less than those which would
17
have been made” had the rural floor never been enacted, thus
violating BBA section 4410(b).
The Secretary does not contend that the hospitals failed to
present this argument to CMS during the 2008 rulemaking,
and for good reason: the rulemaking record is replete with
requests that the agency increase its one-off upward
adjustment to the standardized amount to offset the effect of
rural-floor budget-neutrality adjustments made in years
preceding 2007. Yet in issuing its 2008 final rule, CMS
provided little justification for failing to reverse those prior
adjustments. Observing that it had a “longstanding policy that
finality is critical to a prospective payment system,” CMS
merely asserted that the “calculation of budget neutrality in
past fiscal years [was] not within the scope of th[e] [2008]
rulemaking.” Id. at 47,330.
This response to the commenters’ concerns is insufficient
for two reasons. First, CMS’s interest in the finality of
prospective payment rates cannot justify failing to correct past
errors in calculating rural-floor budget-neutrality adjustments
that affect the aggregate amount of current Medicare
payments. Second, the agency’s interest in finality fails to
address the hospitals’ contention that in transitioning from a
cumulative to a noncumulative system, CMS needed to
reverse all prior rural-floor budget-neutrality adjustments to
the standardized amount even if those adjustments had been
calculated correctly.
As to the first point, in both her response to comments
regarding the 2008 rule and her brief on appeal, the Secretary
has invoked what might be called the “Mark McGwire
defense,” seeking to avoid the potential consequences of the
mistakes the hospitals allege CMS has made by repeatedly
asserting that she is “not here to talk about the past.” See
18
Anne E. Kornblut, Two Parties in Congress Are at Odds Only
Against Witnesses, N.Y. Times, Mar. 18, 2005, at D6 (noting
that in a March 17, 2005, congressional hearing on steroid use
in baseball, homerun slugger Mark McGwire responded to
committee members’ questions about his use of performance-
enhancing substances by repeatedly stating that he was “not
here to talk about the past”); cf. Final 2008 Rule, 72 Fed. Reg.
at 47,330 (“With regard to alleged errors in [fiscal years]
1999 through 2007, our calculation of budget neutrality in
past fiscal years is not within the scope of th[e] [2008]
rulemaking.”). This will not do. Having built the past into
the cumulative methodology it chose for counteracting the
budgetary impact of the rural floor, CMS may not now ignore
past errors that have the effect of overly deflating current
aggregate payments in violation of BBA section 4410(b)’s
budget-neutrality mandate.
To the extent the Secretary argues that the Medicare
statutes authorize or require CMS to carry over from year to
year erroneously calculated rural-floor budget-neutrality
adjustments to the standardized amount, her interpretation of
the statutes is not a “permissible construction” entitled to
Chevron deference. Chevron, U.S.A., Inc. v. Natural Res.
Def. Council, Inc., 467 U.S. 837, 843 (1984). Congress has
required only that the standardized amount be carried over
annually (with appropriate adjustments for inflation). See 42
U.S.C. § 1395ww(d)(3)(A)(iv)(II). The Secretary points to no
statutory provision requiring rural-floor budget-neutrality
adjustments to the standardized amount to be carried over in
this manner. Indeed, in promulgating the 2008 final rule,
which itself reversed the 2007 rural-floor budget-neutrality
adjustment, CMS seems to have recognized the absence of
any statutory bar to reversing the effect of prior rural-floor
budget-neutrality adjustments. If, as the Secretary seems to
suggest, prior adjustments to the standardized amount are
19
sacrosanct, it is difficult to understand how CMS could have
made this small corrective adjustment in 2008.
Far from requiring CMS to carry over past adjustments
that improperly deflate aggregate Medicare payments, BBA
section 4410(b) seems to mandate precisely the opposite.
That provision compels the Secretary to make appropriate
adjustments to ensure that aggregate payments “in a fiscal
year for the operating costs of inpatient hospital services
[covered by the prospective payment system] are not greater
or less than those which would have been made in the year if
[the rural floor] did not apply.” BBA § 4410(b). Under a
cumulative methodology, past budget-neutrality adjustments
are incorporated into the current year’s adjustment. Thus, if
those past adjustments were incorrectly calculated, the
budget-neutrality adjustment for the current fiscal year will
almost certainly be erroneous as well, meaning that aggregate
payments will differ from the amount that would have been
paid absent the rural floor. As a result, we fail to see how the
Secretary can plausibly argue that past cumulative
adjustments to the standardized amount are outside “the
scope” of a rulemaking focused in part on the question of
whether the rural floor has been implemented in a budget-
neutral manner. Final 2008 Rule, 72 Fed. Reg. at 47,330.
On appeal, the Secretary insists that Congress has ratified
her position that section 4410(b) permits her to ignore
mistakes made in calculating rural-floor budget-neutrality
adjustments for prior years. Although the Supreme Court has
stated that “Congress is presumed to be aware of an
administrative or judicial interpretation of a statute and to
adopt that interpretation when it re-enacts a statute without
change,” Merrill Lynch, Pierce, Fenner & Smith, Inc. v.
Curran, 456 U.S. 353, 382 n.66 (1982) (internal quotation
marks omitted), this canon of statutory interpretation has little
20
relevance here given that Congress has never reenacted
section 4410, see Pub. Citizen, Inc. v. Dep’t of Health &
Human Servs., 332 F.3d 654, 668 (D.C. Cir. 2003). Nor is
this a case where Congress can be said to have “implicitly
ratified” a longstanding administrative interpretation of a
statute by failing to enact legislation to overturn that
interpretation. Id. at 669–70. Presuming ratification based on
congressional inaction is inappropriate “absent some evidence
of (or reason to assume) congressional familiarity with the
administrative interpretation at issue.” Id. at 669. Since
CMS’s alleged errors in calculating the rural-floor budget-
neutrality adjustment came to light only recently, the agency’s
position that section 4410(b) imposes no obligation on CMS
to correct those errors even if they affect the aggregate
amount of current Medicare payments is simply of too recent
vintage to presume that Congress has tacitly ratified CMS’s
interpretation by failing to overturn it.
In rejecting the Secretary’s argument that section 4410(b)
permits CMS to ignore prior errors in calculating rural-floor
budget-neutrality adjustments that affect current payments,
we also necessarily reject the Secretary’s related contention
that the hospitals are improperly seeking a form of
“retroactive relief” inconsistent with the prospective nature of
the payment system used to compensate hospitals for
providing inpatient Medicare services. Appellee’s Br. 23; see
also Final 2008 Rule, 72 Fed. Reg. at 47,330 (“Although
errors in ratesetting are inevitable, we believe the need to
establish final prospective rates outweighs the greater
accuracy we might gain if we retroactively recomputed rates
whenever an error is discovered.”). True, the hospitals did
seek reimbursement of underpayments for years preceding
2007 in their comments regarding the 2008 final rule, but they
have abandoned those claims here and instead focus on their
challenges to the 2007 and 2008 rules, which were issued
21
after CMS’s alleged computational errors came to light.
There was nothing “retroactive” about the hospitals’ requests
during the 2007 and 2008 rulemakings that Medicare
payments for those years be calculated in accordance with
section 4410(b)’s budget-neutrality mandate.
Since the hospitals are only seeking recalculation of
payments made in 2007 and 2008, the Secretary’s reliance on
Methodist Hospital of Sacramento v. Shalala is misplaced.
There, the Secretary published an area wage index calculated
based on erroneous data. Methodist Hosp., 38 F.3d at 1228.
After learning of the error, the Secretary promptly issued a
corrected wage index but refused to give the correction
retroactive effect. Id. Although we upheld the Secretary’s
decision not to apply the correction retroactively, id. at 1229–
35, we never suggested that even after the error in the data on
which the Secretary had relied was brought to her attention,
she could have chosen to continue using the inaccurate wage
index in calculating future payments. To the contrary, we
indicated that any such refusal to correct the wage index
going forward would be impermissible. See id. at 1230
(“Administrative proceedings and judicial review could still
provide a meaningful corrective remedy if, for example, the
Secretary refused to make any revision to an erroneous wage
index.”).
Indeed, the Secretary herself has taken the position that
correcting prior computational errors that affect current
payments is perfectly permissible when making such changes
has benefited Medicare. In Regions Hospital v. Shalala, 522
U.S. 448 (1998), the Supreme Court upheld a regulation
permitting the Secretary to conduct supplementary audits of
cost reports that hospitals submitted for the 1984 fiscal year.
The Secretary issued this regulation because she believed that
“some ‘questionable’ [graduate medical education] costs had
22
been ‘erroneously reimbursed’ to providers for their 1984
fiscal year.” Id. at 454 (quoting Changes in Payment Policy
for Direct Graduate Medical Education Costs, 53 Fed. Reg.
36,589, 36,591 (proposed Sept. 21, 1988)). Unless corrected,
the inflated 1984 reimbursements would have been
perpetuated under a new reimbursement methodology
Congress enacted in 1986 that established the costs
“ ‘recognized as reasonable’ ” for fiscal year 1984 as the
baseline for calculating payments to hospitals for graduate
medical education costs. Id. at 453 (quoting 42 U.S.C.
§ 1395ww(h)(2)(A)). A hospital subjected to a
supplementary audit argued that the Secretary’s “reaudit”
regulation constituted an “impermissible retroactive rule.” Id.
at 456. Rejecting this contention, the Court emphasized that
“a prescription is not made retroactive merely because it
draws upon antecedent facts for its operation.” Id. (internal
quotation marks omitted). The Court thus agreed with the
Secretary that the regulation was not “retroactive” because it
merely “sought to prevent future overpayments and to permit
recoupment of prior excess reimbursement only for years in
which the reimbursement determination had not yet become
final.” Id. at 454. If, as the Secretary argued in Regions
Hospital, her recalculation of prior reimbursement figures
used in determining current payments was not retroactive, we
find it difficult to see how the Secretary can fairly
characterize the hospitals’ request here—that CMS correct
prior computational errors so that they no longer affect
current payments—as a claim for retroactive relief.
As mentioned above, CMS’s invocation of its interest in
finality suffers from a second defect: it fails to address the
hospitals’ contention that CMS needed to reverse all prior
rural-floor budget-neutrality adjustments—even those that
were correctly calculated—in transitioning from a cumulative
to a noncumulative methodology for offsetting the effect of
23
the rural floor. To understand the hospitals’ argument,
consider again the hypothetical employer that splits its
employee’s total compensation of $10 per hour between a
wage and the value of a company car. Assume that in year
one, the employee received a wage of $9 per hour and a
company car worth $1 per hour. Then, in year two, the
employer upgraded the employee’s car to one worth $2 per
hour. If the employer was correctly using a cumulative
approach to calculate the employee’s year-two wage, it would
subtract the marginal $1 increase in the value of the car from
the employee’s year-one wage of $9 per hour to calculate the
employee’s new wage of $8. Now assume that the employer
decides to switch to a noncumulative approach for calculating
the employee’s wage in year three and that the car’s value
remains unchanged at $2 per hour. It would make no sense
for the employer to use the $8 wage as a baseline, subtract $2
for the car’s value, and determine the employee’s year-three
wage should be $6. Instead, the employer should reverse the
prior adjustments to the employee’s wage, subtract $2 from
$10, and calculate the correct, unchanged wage of $8 per
hour. Critical to the issue before us, in switching from the
cumulative to the noncumulative methodology, the employer
would need to reverse the adjustments made to the
employee’s wage in years one and two even if it had
calculated those adjustments correctly. Thus, no purported
interest in the “finality” of prior calculations could save the
employer from the responsibility of reversing previous
adjustments to the employee’s wage. So too here. CMS’s
interest in the finality of prospective payment rates cannot
justify failing to reverse the effects of prior cumulative
adjustments to the standardized amount that threaten to
duplicate the agency’s noncumulative wage-index adjustment.
We of course recognize not only that the Medicare
program is far more complicated than this simple
24
hypothetical, but also our obligation to afford great deference
to the Secretary’s expertise in implementing the “complex and
highly technical” statutes governing Medicare. Methodist
Hosp., 38 F.3d at 1229 (internal quotation marks omitted).
Our deference, however, is not unlimited. We must engage in
a “searching and careful” review of the record to ensure that
the Secretary has applied her expertise in a reasoned manner
and has not acted arbitrarily or capriciously or otherwise
violated legislative mandates. Citizens to Preserve Overton
Park, Inc. v. Volpe, 401 U.S. 402, 416 (1971); see also 5
U.S.C. § 706(2)(A). Here, the hospitals have made a
compelling argument that regardless of whether CMS made
computational errors in calculating the rural-floor budget-
neutrality adjustments for years preceding 2008, it should
have reversed all of those prior adjustments in transitioning to
its new system of making noncumulative adjustments to the
wage index. CMS failed adequately to address this concern in
issuing its 2008 final rule. Furthermore, the rationale that
CMS did provide—that its interest in finality justifies its
refusal to revisit previously calculated rural-floor budget-
neutrality adjustments—fails on its own terms because BBA
section 4410(b) does not permit the agency to ignore prior
errors in calculating rural-floor budget-neutrality adjustments
when those errors are built into the formula used to calculate
current Medicare payments. We shall thus remand for CMS
either to explain why reversing all prior rural-floor budget-
neutrality adjustments was unnecessary to achieve budget
neutrality in 2008 or, if it can provide no explanation beyond
the finality concern we have rejected here, to recalculate the
payments due the hospitals under a formula that removes the
effects of the prior rural-floor budget-neutrality adjustments.
See Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm
Mut. Auto. Ins. Co., 463 U.S. 29, 52 (1983) (concluding that
the National Highway Traffic Safety Administration’s
explanation for rescinding passive-restraint requirements was
25
“not sufficient to enable [the Court] to conclude that the
rescission was the product of reasoned decisionmaking” and
thus remanding for the agency to further consider the matter).
III.
For the foregoing reasons, we vacate the judgment of the
district court and remand with instructions to (1) vacate those
portions of the 2007 and 2008 rules challenged in this suit,
and (2) remand to the Secretary for further proceedings
consistent with this opinion.
So ordered.