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Legislators this week approved a health tax bill meant to continue critical federal funding for the state’s Medicaid program, also known as Medi-Cal. Their approval comes despite warnings from health industry leaders that the tax, as designed, will raise premiums for privately insured Californians.

New federal rules are forcing the state to restructure its managed care organization tax, or MCO tax, which the state collects from health insurance plans that coordinate care for their members. California has been charging Medi-Cal insurance plans at a higher rate than private plans. The state’s newly-designed solution, Senate Bill 125, will lower the tax on Medi-Cal plans and raise the tax on private plans to the same level. If finalized by the governor, and accepted by the federal government, the new plan would shift more of the cost burden onto people who buy private insurance but bring in less revenue overall.

Senate President Pro Tem Monique Limón, a Santa Barbara Democrat, told reporters earlier this week that there was no perfect plan for redesigning the tax and that the Senate still has concerns, but the proposal they voted through is one that would bring in money quickly.

“We have as a Senate been very clear that we needed revenue … it was a matter of making a decision which we could troubleshoot given what is happening at the federal level,” Limón said.

As part of the tax and spending law Congress passed last summer, the federal government imposed new restrictions on provider taxes, including the one imposed on health plans. Under existing rules, California received almost $8 billion annually from this tax; the new limits mean the state will receive billions less. The Legislature’s plan tries to fill at least some of that gap.

The plan does not directly raise health insurance premiums. Instead it imposes a higher tax on private plans, which have said they’d pass the cost down to consumers.

The proposal would require all health plans, both public and private, to pay a monthly rate of $8.85 per enrollee – a total cost of about $1.5 billion a year for private plans. If health plans pass the entire tax to their members, Californians could see  about a 1.5% increase in their monthly premiums, according to the independent Legislative Analyst’s Office. That’s on top of the yearly premium rate increases that people see year to year.

The California Association of Health Plans, the health insurance lobby, estimates this would translate to consumers paying about $100 more in premiums each year. That means a family of four could be looking at $400 more a year in health premiums.

Charles Bacchi, president of the association, said health plans roll taxes and fees into the administrative portion of premiums. “That is just actuarial science,” he said. “So when you increase taxes on health plans and insurers, that is built into premium rates and the customer pays it.”

Affordability is Key Concern

The Legislature’s plan largely mirrors what Gov. Gavin Newsom and his Department of Finance proposed last month. Bacchi argues the state could have imposed a smaller tax to lessen the impact on plans and consumers.

The Department of Finance said it tried to balance affordability for privately insured patients with generating enough revenue to keep the safety net afloat amid federal funding cuts. The department settled on the $8.85 a month assessment because that  rate would generate $2.3 billion a year – roughly the amount that the state generated before 2023 to support Medi-Cal, said H.D. Palmer, a spokesperson for the Department of Finance.

Of that total, $2 billion would support existing Medi-Cal services, while roughly $300 million would fund previously established rate increases for providers delivering primary, maternal, and mental health care to enrollees, Palmer said.

Some legislators continued to raise concerns late into the week. Sen. Akilah Weber Pierson, a San Diego Democrat, said she found the tax plan “extremely problematic” as she questioned the administration during a hearing Wednesday. “I am very uncomfortable with this proposal and the economic burden it will have on the families I serve as a Senator but also a physician.” She voted for the measure on Thursday.

Bacchi’s organization, along with physician groups and the California Hospital Association, urged legislators to reject the tax proposal as is.

“What makes this vote especially disappointing is that California leaders continue to talk about affordability as a top priority,” health plans said in a statement after the Assembly approved the measure. “It is difficult to reconcile those statements with a vote that will increase health insurance premiums on the very people policymakers say they are trying to help.”

Industry leaders also argued that the tax measure conflicts with Proposition 35, which voters passed in 2024 and which limits the taxes charged to private health plans. Prop. 35 also requires that much of the revenue be used to expand Medi-Cal services and increase provider rates, rather than offset general fund spending on the program.

“Raising health insurance premiums to help balance the state budget is simply robbing Peter to pay Paul,” said Dr. René Bravo, president of the California Medical Association, which represents doctors around the state. “It will only make it harder for families to keep coverage and get the care they need.”

New Federal Rules Prompt Tax Redesign

California is redesigning its MCO tax to comply with new federal rules implemented through H.R. 1, the spending plan Congress approved last year. California currently charges Medicaid plans, which are reimbursed jointly by the state and federal government, a significantly higher tax than private plans. The state then uses revenue from this tax to draw down matching federal funds.

The Trump administration argues states “exploit” this funding mechanism by effectively pushing their share of Medicaid costs onto the federal government. Critics of the tax describe its “net effect” this way: Insurers remain financially whole, federal Medicaid spending increases, and states reduce their own costs.

To close what federal officials call a “loophole,” the Centers for Medicare and Medicaid Services issued a final rule earlier this year prohibiting states from taxing Medicaid plans more than commercial plans. Now that the legislature has approved California’s revised MCO tax plan, Newsom must sign the measure in order for the state to seek approval for it from the federal government.

Consumer advocates say that maintaining strong revenues from the MCO tax is key to keeping the Medi-Cal program running. But if the state knows that insurers will pass the cost onto private customers through higher premiums, California legislators should ensure the money remains within the health system and improves care.

“What we don’t find acceptable is to have individual healthcare consumers pay increased premiums to support the MCO tax, and then just have that money backfill the general fund,” said Kiran Savage-Sangwan, executive director of the California Pan-Ethnic Health Network.

Newsom Expected to Approve the Tax Hike

Because the Legislature’s plan resembles the governor’s proposal, budget experts expect Newsom to sign it as part of the larger budget package. One major hurdle remains, however: federal approval. The Trump administration must approve the state’s revised tax plan for California to continue drawing down federal matching funds.

The job of lawmakers is to put together a proposal that is compliant with new federal rules, said Adriana Ramos-Yamamoto, a senior policy fellow at the California Budget and Policy Center.

But, she added, “it’s not a guarantee that the federal government will approve our new MCO tax proposal.”

Supported by the California Health Care Foundation (CHCF), which works to ensure that people have access to the care they need, when they need it, at a price they can afford. Visit www.chcf.org to learn more.

This article was originally published on CalMatters and was republished under the Creative Commons Attribution-NonCommercial-NoDerivatives license.