In the unfolding war between the California and federal governments, the state has a major vulnerability: its reliance on federal healthcare funds. This year’s enacted budget includes over $120 billion of federal funds for the State Department of Healthcare Services, primarily for Medi-Cal. With the passage of the One Big Beautiful Bill, the Trump administration is beginning to chip away at this funding.
As I’ve discussed on these pages previously, California uses a special tax on managed care providers to increase its federal take. By using the provider tax revenue to pay for Medi-Cal services, the state can attract extra matching funds since the federal government matches state Medi-Cal spending on a one-for-one basis for traditional beneficiaries and a nine-for-one basis for those who became eligible for Medi-Cal as part of the Obamacare Medicaid expansion. LAO recently estimated that the managed care provider tax attracted $7.6 billion of federal funds in 2024 alone.
California’s tax runs against the spirit of a 1991 federal law which required that, to attract federal matches, state provider taxes had to be broad-based and uniform. But state officials took advantage of a loophole in the regulations implementing that law to qualify its tax.
Currently, California’s tax on managed care providers is $187.50 per Medi-Cal beneficiary and only $2.00 for other covered individuals. But it still passes a flawed regulatory test to determine whether the tax qualifies for federal matching funds.
When the Biden administration’s Center for Medicare and Medicaid Services (CMS) approved the California provider tax for federal matching funds, it warned the state that a subsequent regulatory review might invalidate the state’s levy.
Nonetheless, California’s healthcare industry placed Proposition 35 on the November 2024 ballot, which made the provider tax permanent and dictated how its proceeds would be distributed.
Now the OBBB has closed the loophole the state used to obtain CMS approval for the tax. Further, under Trump, CMS was already planning to change the 1990s-era regulations to close the loophole on its own. So, it now seems inevitable that California will lose the federal funds no later than December 31, 2026, when the current approval from the Biden era expires.
The provider tax regulation is likely to be just one of multiple changes that will reduce federal support for Medi-Cal during the Trump era. An earlier version of the OBBB would have penalized California for covering undocumented immigrants. Although that provision was removed at the behest of the Senate parliamentarian, it is likely that Congress and the Trump administration will try something similar in the future.
While California policymakers may be tempted to fight federal Medi-Cal cuts in the courts, a better option would be to rein in the program’s costs. This should be possible given the fact that per beneficiary Medi-Cal costs are higher than per capita healthcare spending in Japan, France, and Canada.
One step would be to deter unnecessary emergency room visits. The California Department of Health Care Access and Information found that Medi-Cal beneficiaries were about three times more likely to make avoidable ER visits than individuals with private insurance. While most privately insured patients are responsible for a sizable copayment when they visit the ER, Medi-Cal patients face no such disincentive. Federal regulations allow states to charge Medicaid patients an $8 copayment for non-emergency ER visits, and this ceiling may well rise during the Trump administration. California should start levying these copayments.
The state should also review its use of managed care providers. Connecticut found that these middlemen were not saving the state enough money to cover their administrative costs and profits. The Nutmeg State actually lowered its Medicaid costs by reverting to a traditional fee-for-service model. Perhaps California could follow this precedent.
Finally, California needs to reconsider its aggressive rollout of Medi-Cal to the undocumented. As of March, 1.657 million individuals with “unsatisfactory immigration status” were on the program, not only driving up costs but also competing with legal beneficiaries for scarce provider resources.
While it would be wonderful to provide unlimited medical care to everyone in California, the state cannot afford to do so without massive federal assistance, and policymakers should expect that assistance to shrink during this administration.
Marc Joffe is a fellow at California Policy Center.