The federal government’s program to help rural hospitals has grown bloated and unwieldy, according to a report released Thursday by the Office of Inspector General of the Department of Health and Human Services. The program costs the government and Medicare beneficiaries up to a billion dollars a year more than the original parameters of the law allowed, the agency found.

The critical access hospital program was intended to financially stabilize small, rural institutions by providing them with higher Medicare reimbursement rates. The hospitals in the program are supposed to have 25 or fewer beds and be at least 35 miles away from another facility (15 miles across mountainous terrain) in communities that would otherwise have limited access to health care services. The effort was a response to a spate of 360 rural hospital closures in the 1980s and 1990s.

But there was a loophole:  Until 2006, states were allowed to waive the distance requirement and designate small hospitals considered “necessary providers” as critical access hospitals as well, even if they were close to other facilities. The program grew quickly and now nearly one in four acute care hospitals are getting the extra payments. Congress got rid of the loophole in 2006, but hospitals that already had the exemption were grandfathered.

The OIG looked at all 1,329 hospitals currently in the program and found that 849 of them would not meet the requirements if they were required to reenroll – nearly 64 percent. And that’s costing the government an extra $860,000 per critical access hospital each year, according to the report.

Medicare beneficiaries are also paying more. Coinsurance rates are an average of $400 more for outpatient care at critical access hospitals. That costs beneficiaries an average of $485,000 extra in coinsurance per hospital, the OIG found. That’s a total of about $1.3 million in excess payments a year per hospital for taxpayers and beneficiaries. So, all told hospitals in the program that are “exceptions” cost the federal government $1.1 billion.

The report does not recommend repealing the critical access status of all of those 849 hospitals. Instead, it advises that Medicare take a second look at all of the hospitals in the program to ensure that the only ones to retain their certification “are those that continue to serve beneficiaries who would otherwise be unable to reasonably access hospital services.” That would likely mean that the vast majority of hospitals that don’t meet the distance requirement would lose their critical access status, and many would likely close.

The report is likely to send shock-waves through the rural health community.

“We are alarmed by the message this is sending to rural America,” says Brock Slabach, senior vice president of the National Rural Health Association. “Using Missouri as an example, roughly 70 percent of the rural critical access hospitals in that state alone would lose their designation, and face possible closure.  Does that sound rational to anyone living outside of Washington, DC?”

More than 60 million rural residents rely on critical access hospitals, he says, and they tend to have high rates of poverty, chronic disease and uninsurance. Without a local hospital, rural primary care doctors and clinics also tend to abandon an area, which could be “devastating to a community,” he says.

He adds that the report’s recommendations are politically impossible. “This is going to be dead on arrival in Congress. No one is going to support shutting down 70 percent of the rural hospitals in their state,” he says.

President Barack Obama has recommended a less extreme cut to the critical access program. His budget proposals since 2011 have recommended narrowing the definition of a critical access hospital to exclude those that are within 10 miles of another hospital – a move that has the potential to change the status of 61 hospitals.

Correction: An earlier version of this post contained an incorrect calculation. The critical access hospitals cost the government and Medicare beneficiaries up to a billion dollars more than the original parameters of the program, not a trillion dollars.