Q&A: The Special Legislative Session on Funding for Health and Human Services

The fate of a state tax on health plans that supports health care services for low-income residents, and brings more than $1 billion in federal funds to California each year, hangs in the balance following the collapse last month of negotiations aimed at revising the tax to meet new federal guidelines.

The negotiations over the tax — which is formally known as the managed care organization (MCO) tax — occurred as part of a special legislative session called by Governor Jerry Brown this past June. The scope of this special session goes beyond the MCO tax and its support for Medi-Cal (California’s Medicaid program), which provides health care to more than 12 million low-income residents. The Governor also asked lawmakers to approve additional special fund — not General Fund — revenues to achieve the following goals: (1) boost reimbursement rates for doctors and other providers in Medi-Cal; (2) increase payments for community-based services that assist Californians with developmental disabilities; and (3) permanently shift certain costs for In-Home Supportive Services (IHSS) off the General Fund, the state’s main “checking account.” (IHSS helps more than 460,000 seniors and people with disabilities remain safely in their own homes, avoiding more costly out-of-home care.) As with revising the MCO tax, lawmakers so far have made no concrete progress toward resolving these other funding and policy concerns that are the focus of the special session.

This Q&A addresses seven key questions about the special session as we anticipate the release — this coming January — of the Governor’s proposed state budget for the 2016-17 fiscal year, which begins next July 1.

Q: What exactly is the “MCO tax”?

A: This tax — which expires on July 1, 2016 — applies only to managed care organizations that operate Medi-Cal managed care plans (in other words, the tax has a “narrow base”). In addition, as a result of a complex financing mechanism, MCOs that do pay the tax don’t actually see a financial hit to their bottom lines. Instead, state and federal dollars offset the amount that MCOs owe, with the result that MCOs are held harmless from the tax.

In 2015-16, the current fiscal year, California will use MCO tax revenues to (1) bring in $1.2 billion in federal Medicaid funds and (2) reduce — or “offset” — the state’s General Fund costs for Medi-Cal by $1.1 billion. In turn, these General Fund savings are used to support other state priorities. For a comprehensive overview of the MCO tax, see this report from the Legislative Analyst’s Office (LAO).

Q: Why is the MCO tax at issue now?

A: Last year, the federal government notified states that health care financing taxes that look like California’s MCO tax will be subject to more stringent federal rules. In California’s case, taxing only MCOs that operate Medi-Cal managed care plans is a key reason that the MCO tax runs afoul of the new federal guidelines. As a result, the current MCO tax is “likely impermissible,” according to the LAO. The feds gave states until August 2016 to revise their taxes in order to comply with the stricter federal standards or potentially risk losing a portion of their federal Medicaid funding, which in California’s case would be more than $1 billion per year.

Q: Why did the Governor call a special session?

A: Earlier this year, lawmakers considered proposals to revise California’s MCO tax as part of state budget deliberations. However, they were unable to reach an agreement that satisfied all parties, including Governor Brown, MCOs, and Republican legislators, whose support is needed to meet the two-thirds vote threshold for passing tax increases. As a result, the Governor called the special session in order to continue shining a light on this issue and provide a forum for finding a solution.

Revising the MCO tax has been difficult because complying with the new federal rules would — for the first time — have a net financial impact on at least a few MCOs. In other words, some MCOs would see a hit to their bottom lines, even as many others would continue to be held harmless from the tax. This has created a politically challenging situation that has substantially increased the complexity of moving a solution through the Legislature.

Q: What does the Governor mean when he says he wants the Legislature to approve “permanent and sustainable” revenues as part of the special session?

A: The Governor’s proclamation made clear that any new revenues approved as part of the special session should not come from the state’s General Fund. Instead, he called on lawmakers to pass a new MCO tax “and/or alternative fund sources,” which would flow into special funds rather than into the General Fund. This stance is in keeping with the Governor’s longstanding objective to limit increases in General Fund spending.

One “alternative fund source” that legislators examined this year is the state tobacco tax, which is currently set at 87 cents per pack of cigarettes. A bill by Senator Ed Hernandez — SB X2 14 — would have increased this tax to $2.87 per pack, raising an additional $1.3 billion per year, with most of these revenues used to boost payments for Medi-Cal providers. (This bill also would have revised and extended the state’s MCO tax and used a small portion of the proceeds to increase payments for services provided to Californians with developmental disabilities.) SB X2 14 didn’t advance out of the state Senate this year, and the bill remains in limbo. However, proposals to raise the tobacco tax and dedicate the additional revenues to health care, including Medi-Cal, are likely to resurface in the Legislature next year. Absent legislative action, proponents of a tobacco tax increase have vowed to put this issue before the voters in November 2016 via the initiative process.

Q: The Legislature adjourned for the year on September 11. What does that mean for the special session?

A: Under the state Constitution, special sessions operate on their own timeline. Although the special session is currently dormant, it’s still bubbling beneath the surface. Leaders in both the Assembly and the Senate recently appointed members to a special session conference committee. At a minimum, this committee could hold hearings during the fall to continue addressing the issues raised in the Governor’s proclamation.

Q: It sounds pretty unlikely that there will be an agreement on a revised MCO tax this fall. If no deal emerges, what would this mean for the proposed 2016-17 budget that the Governor will release this coming January?

A: The current MCO tax expires on July 1, 2016, the first day of the 2016-17 fiscal year. Failure to extend this tax would result in a more than $1 billion General Fund shortfall in the 2016-17 state budget — a funding gap that the Governor would have to address in his proposed spending plan next January.

One option would be for the Governor to once again call on lawmakers to pass a revised MCO tax. By assuming that such a tax would be approved and take effect on July 1, 2016, the Governor’s proposed budget would eliminate the $1 billion shortfall, at least on paper. Such an approach would meet the requirements of the state Constitution: “If recommended expenditures exceed estimated revenues, the Governor shall recommend the sources from which additional revenues should be provided” (Art. IV, Sec. 12(a)).

Of course, the Governor also has the option of closing the funding shortfall – in whole or in part — by proposing reductions to General Fund spending. Any such cuts could target not only Medi-Cal, but any public services that rely on the General Fund. Moreover, any cuts to state support for Medi-Cal would also reduce federal funding for the program. For example, reducing state spending on Medi-Cal by $1 billion — assuming a cut of that magnitude were even possible — would result in a loss of well over $1 billion in federal Medicaid funds.

Q: What about the other issues the Governor raised in his special session proclamation, like providing new funding for IHSS and boosting payment rates in Medi-Cal and the developmental disabilities system? Where do these issues stand?

A: They’re in the same boat as the MCO tax. In theory, lawmakers could reach a deal that addresses the various funding concerns this fall. If these issues remain unresolved moving into 2016, the Governor could either propose solutions of his own in January or wait for the Legislature to act. Voters also could be asked to weigh in. As noted above, a proposal to increase the state tobacco tax and dedicate the funding to health care, including Medi-Cal, could appear on the November 2016 statewide ballot if the Legislature doesn’t pass an increase.

— Scott Graves