Five Key Facts About California’s Soon-to-Expire “MCO Tax”

When Governor Gavin Newsom released his proposed 2019-20 budget this past January, one of the biggest surprises was that he did not include a proposal to extend California’s tax on health insurance plans — or  “managed care organizations” (MCOs) — which expires on July 1. (An extension of this tax would require federal approval.) The Governor’s position is puzzling because the MCO tax package generates a net state General Fund benefit of roughly $1.5 billion each year. If the MCO tax goes away, so does this General Fund benefit, thus reducing the capacity of the state budget to support public services and systems, such as child care for working families and higher education.

The Governor has expressed concern that pursuing a reauthorization of the MCO tax could conflict with the state’s efforts to renegotiate, with the federal government, two Medi-Cal “waivers” that will expire in 2020. (Waivers help to determine how services are delivered in Medi-Cal, our state’s Medicaid program.) However, the nonpartisan Legislative Analyst’s Office (LAO) has evaluated this concern and concluded that the Newsom Administration “has not laid out a convincing rationale” for letting the MCO tax package lapse. Furthermore, the LAO notes that “California’s prospects of receiving federal approval of a reauthorized MCO tax are strong.”

In order to help shed light on a critical policy issue that has major implications for the state budget but has largely been flying under the radar, here are five key facts about California’s current MCO tax package:

1. The current MCO tax package took effect in 2016 following more than a year of intense lobbying by the Brown Administration.

The current MCO tax package was approved by the Legislature on a bipartisan vote in early 2016, following over a year of all-hands-on-deck lobbying by Governor Brown and his administration. Due to new federal rules, California’s then-current MCO tax no longer complied with federal guidelines and needed to be revised. Ultimately, Governor Brown called the Legislature into special session with the goal of creating a new MCO tax that would adhere to federal rules while also generating substantial General Fund savings. In addition to a revamped MCO tax, the final tax package included offsetting state tax cuts for the health insurance industry that were designed to ensure that the industry, as a whole, would be no worse off financially as a result of the revised MCO tax. The final tax package won broad support, including from health plans, and took effect on July 1, 2016.

2. The MCO tax package reduces — or “offsets” — state General Fund spending on Medi-Cal by well over $1 billion per year, freeing up these dollars to support other state priorities.

This General Fund offset results from a complex financing arrangement. (See this LAO report for an overview of how it works.) Essentially, California taxes MCOs and uses the proceeds to leverage federal funds to support Medi-Cal, our state’s Medicaid program. The MCO tax package frees up around $1.5 billion in General Fund revenues each year that would otherwise go to Medi-Cal. These freed-up funds support an array of public services and systems that are funded through the state budget.

3. By leveraging federal dollars for Medi-Cal — at no cost to the state’s General Fund — the MCO tax allows California to come closer to claiming its fair share of federal Medicaid funding.

It’s long been known that the main formula for determining how much federal funding states receive for their Medicaid programs is flawed, and in a way that puts California at a financial disadvantage. (This formula is officially known as the FMAP.”) For California, the key problem is that the state “receives a low federal matching rate despite its relatively low ability to fund [Medi-Cal] program services,” according to the US Government Accountability Office (GAO). By providing another way for California to tap federal Medicaid funds — at no cost to the General Fund — the MCO tax helps to lessen the inequities that are built into the FMAP formula by boosting federal support for Medi-Cal.

4. If the MCO tax were allowed to expire, state General Fund costs for Medi-Cal would ultimately increase by more than $1 billion per year, but without any additional benefit to the Medi-Cal program.

If the MCO tax expires, policymakers would have to replace the lost MCO tax revenues with state General Fund dollars in order to maintain current federal Medicaid matching funds and keep the Medi-Cal program whole. In fact, this is what Governor Newsom’s proposed 2019-20 budget assumes — that the General Fund will backfill the foregone MCO tax revenues. This, in turn, would reduce the amount of state funds available to support other key public services and systems.

5. Alternatively, extending the MCO tax would free up General Fund dollars that could be used to expand key services beginning in the 2019-20 fiscal year, which starts on July 1.

As noted above, Governor Newsom assumes that state General Fund spending on Medi-Cal will rise beginning in 2019-20 due to the (presumed) expiration of the MCO tax — an assumption that is built into his proposed state budget. Alternatively, if the MCO tax were extended, this General Fund “backfill” for Medi-Cal would not be necessary. As a result, these General Fund dollars, ultimately reaching around $1.5 billion per year, would be newly available — relative to the Governor’s current multi-year budget forecast — to pay for other state priorities. For example, these freed-up dollars could help to move California closer to universal health coverage. Key policy options here include improving and expanding Medi-Cal and creating new state subsidies to reduce the cost of coverage for low- and moderate-income Californians who purchase health insurance on the individual market.

Conclusion

The current MCO tax package leverages federal funds for Medi-Cal, leaves the health insurance industry no worse off financially, and provides a net annual state General Fund benefit of roughly $1.5 billion, with these freed-up dollars supporting critical public services and systems. It’s not too late for the Newsom Administration to reverse course and work with state lawmakers to craft an updated MCO tax package that can win federal approval this year.

— Scott Graves