Newsom taps federal government to help fill California’s budget hole

With a combination of more aggressive revenue forecasts, reserve drawdowns, deferrals, and other adjustments, Gov. Gavin Newsom has largely avoided making meaningful cuts to California’s 2024-2025 budget. He also avoided tax increases, except for a proposed hike on a levy paid by Medi-Cal Managed Care Organizations (MCOs).

Since the tax does not directly fall on individuals, it is easy to ignore. But, because it unlocks more money from the federal Medicaid program, it will ultimately burden federal taxpayers, including those of us who live in California.

Taxpayers generally do not like paying taxes, but Medicaid providers are an exception. Hospitals have sometimes lobbied to be taxed, because as long as their state dedicates the tax revenue to making Medicaid provider payments, the new state revenue will be matched by the federal government.

Federal officials have been critical of provider taxes because they accelerate the federal budgetary impact of Medicaid, on which federal spending rose from $351 billion in fiscal year 2015 to $591 billion in fiscal year 2022. As far back as 1991, Congress expressed alarm at the abuse of provider taxes and imposed some limitations on them. And, in his earlier role as vice president, now-President Joe Biden agreed with then House Majority Leader Eric Cantor that provider taxes were “a scam”.

Forty-seven states impose one or more Medicaid provider taxes, but these generally apply to hospitals, nursing homes, and intermediate care facilities. California is one of eighteen states that tax Medicaid MCOs, which are insurance providers that pay Medicaid claims on behalf of the state.

California adopted the latest version of its MCO tax last June to help close the FY 2023-2024 budget gap. Collection of the tax, which sunsets in 2026, was deferred until the federal Center for Medicare & Medicaid Services (CMS) provided a waiver permitting the new levy. That approval came last month, but with a key caveat.

Because the new California MCO provider tax appeared to skirt limitations Congress imposed back in 1991, CMS advised California that it would have to “develop and propose new regulatory requirements” governing the provider tax waiver process. The letter did not state whether the proposed rules would make it easier for California to obtain future approvals or would close a loophole California used to obtain approval this time.

CMS’s stance could affect California’s latest budget solution. To get further budget relief from the federal government, Newsom is now proposing to raise the MCO tax the legislature just approved last June. The plan is to seek legislative and then federal approval for an MCO tax hike retroactive to January 1, 2024 which will yield $1.5 billion in additional state revenue. And the healthcare industry would like to see the tax become permanent; the California Medical Association is sponsoring a ballot measure that would accomplish this.

Apparently, the Newsom Administration prefers these financial gymnastics to trimming state Medi-Cal spending which is projected to total $156.6 billion in 2024-2025 including $35.9 billion from the general fund. California remains one of only two states to provide Medicaid benefits to undocumented immigrants regardless of age (Oregon is the other), after Illinois put its own plan to extend Medicaid coverage to middle-age and older undocumented immigrants on pause amidst budgetary pressures.

Further, California has not removed as many Medi-Cal beneficiaries as expected when the pandemic-era federal moratorium on eligibility redeterminations ended last April, suggesting that the State Department of Healthcare Services may not be sufficiently aggressive in confirming Medi-Cal beneficiaries’ continued eligibility.

With a strong economy and declining population, one might expect Medi-Cal rolls to decline sharply, but the governor expects 14.8 million Californians, or more than one in three, to remain on the program. Rather than continuing to tap federal taxpayers for more support, California policymakers should start looking for ways to rein in its costly Medi-Cal program.

Marc Joffe is a federalism and state policy analyst at the Cato Institute.