California’s Medicaid Gimmick Becomes a Premium Tax

In fiscal year (FY) 2025, California’s government spent more than half a trillion taxpayer dollars  (including $172 billion in federal funds) while its residents continued to flee the state’s third most punitive tax regime in the country, the most onerous regulatory restrictions, and exorbitant bureaucracies—bureaucracies that still fail to deliver results commensurate with their budgets. Since FY 2023, the state’s all-in budget has ballooned by nearly $100 billion, yet it is difficult to see what the additional money absorbed by the public-sector apparatus contributed.

And still, California’s budget is structurally imbalanced by billions of dollars. California Governor Gavin Newsom (D) scrambled for every fiscal patch available to close a $16 billion hole in the FY 2026-2027 budget. Among those patches is a proposed tax increase on commercial health plans that, if implemented, could raise private insurance premiums by $400 a year, as reported by The Wall Street Journal.

The tax rate on commercial plans has been set at only $2.25 per enrollee per month, compared to $274 per enrollee per month paid by Medicaid managed care organizations (MCOs), which largely administer Medi-Cal (California’s Medicaid) plans––a rate roughly 122 times as high. Under the new federal law, MCO-tax rates can no longer exceed those on commercial insurers. To comply with the new federal rules, Newsom has proposed an $8.85-per-month, per-enrollee tax on all insurance plans––Medicaid, ObamaCare, and employer health plans––to partially offset the loss of more than $7 billion in annual net revenue that the current MCO tax generates for California’s budget.

The rationale for raising a tax on commercial plans is one of necessity, argues California’s Department of Health Care Services.  Government officials say this is being done to conform with new “stringent” federal requirements that “prohibi[t] taxes that assess higher tax rates on Medi-Cal plans than commercial plans or otherwise place a disproportionately higher tax burden on Medi-Cal plans.”

In other words, after the One Big Beautiful Bill reined in states’ Medicaid financial gimmick known as provider taxes—devised to boost federal Medicaid matching dollars and offset states’ expenditures on the program—California opted to force commercial-plan insurers, that is to say their policyholders, to make up for the lost Medi-Cal tax collections instead of finding a way to pare down $217 billion of projected Medicaid spending for the upcoming year.

As Milton Friedman once said: “Rest[ing] one bad principle on another is hardly a way to establish a valid argument.” California’s government has long used provider taxes on MCOs as a tool to extract more federal dollars to finance Medi-Cal instead of relying on the state’s general fund. In the decade since 2014, the federal Medicaid share rose faster than the state’s, growing by roughly 150 percent. Through financial gimmicks and a lack of cost discipline, California increasingly relied on federal Medicaid funds: the federal share reached its peak in 2022 at roughly 68 percent of the program’s expenditures.

Yet, as Thomas Savidge at the American Institute for Economic Research argues, “When federal aid comes into the picture, decision-making becomes distorted. Federal transfers allow states to export some of their burden of funding their own budgets to taxpayers across the country.” The federal government pays between $1 and $9 for each dollar California and other states contribute. “As a result, states will overspend on federally subsidized activities,” Savidge explains.

Indeed, California’s Medi-Cal spending has more than doubled since 2014. Moreover, as Chris Pope at the Manhattan Institute puts it, “The goal of increasing spending to maximize federal dollars also invites a lapse in program security, inviting fraud and abuse.”

Since 2022, however, as the federal government has sought to reduce its Medicaid expenditures, California has had to contribute an increasingly higher share of Medicaid spending. Between FY 2023 and FY 2024, state Medicaid expenditures grew by 37.6 percent, compared to only 6.1 percent federally. The following year, California spent another 16.7 percent more on the program. The shift in the spending burden has already put California’s budget under strain. So now the federal curtailment of provider taxes is further compounding the state’s difficulty in financing Medi-Cal.

California’s government increasingly struggles to pay for the bloated public insurance program yet still resorts to the wrong tools to fix its fiscal problems. Newsom continues to turn a blind eye to the most obvious and long-overdue solution: reining in Medicaid spending. Alas, that would require acknowledging the need for prudent stewardship of California taxpayer money, which, as the state’s budget suggests, its government lacks.