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Fact Sheet

Understanding Recent Medi-Cal Spending in California

What’s Really Driving Costs and What Rollbacks Would Cost Californians

May 2026 | By Adriana Ramos-Yamamoto

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key takeaway

Rising Medi-Cal spending reflects broader health care cost trends and expanded access to care, and cutting the program would harm Californians’ health and local economies without addressing the state’s underlying budget challenges.

Medi-Cal, California’s Medicaid program, provides free or low-cost coverage to more than one in three Californians, including children, pregnant individuals, seniors, and people with disabilities. It plays a central role in keeping people healthy and supporting jobs, businesses, and the broader economy.

In recent state budget discussions, Medi-Cal has been framed as a main driver of the state’s structural budget shortfall, and policymakers are considering additional cuts after already reducing support for the program last year. But this framing overlooks a fundamental issue and Californians’ health needs. California’s structural shortfall reflects a mismatch between the public investments that people want and need and the resources necessary to support them. This problem would be better addressed by closing gaps in the state’s tax base, not cutting vital services like health care.

Medi-Cal spending reflects system-wide trends that affect the entire health care system — not just Medicaid. A major driver is rising health care prices. Across the country, hospitals and physicians are raising prices for care and pharmacies are charging more for prescription drugs. As prices increase, delivering care becomes more expensive, which raises overall health care spending.

In addition to rising prices, the California Legislative Analyst’s Office recently outlined other cost factors impacting Medi-Cal spending, including:

  • Demographic changes. More seniors and people with disabilities are accessing needed care, and because they often have more complex health needs, average spending per person is higher.
  • Increased use of services. More people are receiving care in high-cost settings, such as hospital stays, and using a range of services.
  • Higher prescription drug spending. The growing use of high-cost medications has been a significant contributor to recent spending increases.
  • Policy choices to expand access. State investments have helped more Californians get care, improving health and financial stability.

Rising Medi-Cal spending, in part, reflects a state meeting the needs of its residents by helping more people get care they were previously unable to access. California’s uninsured rate has dropped significantly over the past decade, reflecting meaningful gains in access to care. Fewer Californians are delaying treatment, rationing prescription medications, or going without care they need because they cannot afford it.

But these gains are now under threat from harmful federal policy decisions. Republicans in Congress and the Trump administration enacted H.R. 1, which cut nearly $1 trillion from Medicaid over the next decade. While these cuts do not change the underlying cost of care, they increase pressure on the state budget by shifting a greater share of those costs to California.

Cutting Medi-Cal Is Counterproductive

Cutting Medi-Cal won’t solve long-term budget challenges, and it can make them worse. Reducing Medi-Cal enrollment or scaling back benefits harms people’s health while also weakening a major economic engine that supports jobs, health care providers, and local economies across the state.

When people lose health coverage, they are more likely to delay or forgo treatment. As a result, small health issues can become serious and expensive to treat. Over time, this adds new pressures to the state budget due to increased emergency care or uncompensated care.

Cuts to Medi-Cal also affect local economies. Reducing enrollment or covered services means less funding flowing into communities. Each year, Medi-Cal dollars support health care workers, hospitals, pharmacies, and many other parts of the health care system. When fewer people are covered or fewer services are reimbursed, providers bring in less revenue, which can lead to job losses and slower economic activity across the state.

While Medi-Cal cuts may offer short-term budget relief, they do not address the underlying drivers of cost growth and they come with significant trade-offs, including:

  • Reduced access to care or fewer covered services.
  • Higher out-of-pocket costs for Californians.
  • Increased strain on health care providers and safety-net systems.
  • Job losses and reduced economic activity in communities across the state.

California’s Structural Deficit Reflects Insufficient Resources to Meet Californians’ Growing Needs

At its core, the structural budget deficit reflects a mismatch between the ongoing resources raised by the state’s tax system and the public investments that are necessary to meet Californians’ needs. But cutting vital spending is not the solution because:

  • Recent investments to address people’s essential needs have improved Californians’ quality of life.
  • Californians continue to have significant unmet needs, and now federal cuts threaten to upend recent progress addressing them.
  • California wastes billions of dollars each year on tax breaks for corporations and high-income households that take vital resources away from community needs.
  • Inequities in our state’s tax system deprive the state of resources that could be better used to improve Californians’ quality of life.

Policymakers Should Focus on Sustainable Solutions

Addressing California’s budget challenges requires solutions that reflect the full scope of the problem. Increasing revenue is the most immediate way policymakers can close large, ongoing shortfalls. Other approaches can reduce costs and improve the system, but they may take time to generate savings. Rather than reducing Californians’ access to health coverage focusing on cuts to Medi-Cal, policymakers should:

  • Address underlying health care cost growth. Policymakers can build on efforts like the Office of Health Care Affordability to slow cost growth across the entire health system.
  • Strengthen preventive and primary care. Investing in prevention keeps people healthier while reducing avoidable health care spending.
  • Improve system efficiency. Reducing administrative barriers and improving care coordination can help ensure resources are used effectively.
  • Identify sustainable and equitable revenue sources. Aligning state revenues with the cost of meeting Californians’ needs is critical to supporting long-term fiscal stability.

State leaders should prioritize immediate revenue solutions to stabilize the budget while also pursuing systemic changes that will improve affordability and sustainability over time. Protecting access to health care is essential to both the well-being of Californians and the state’s long-term economic stability.

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When all Californians — regardless of race, age, disability, or immigration status — have access to affordable and comprehensive health care, the entire state benefits through overall improved health and well-being, stronger communities, and reduced long-term costs.

California had made significant advances toward providing health care for all, but recent federal and state cuts to health care access and eligibility threaten to leave millions without coverage. Additionally, as part of his 2026-27 budget, the governor is proposing additional cuts that will restrict immigrants’ access to comprehensive, affordable health care. State leaders should restore and maintain access to Medi-Cal — California’s Medicaid program — for all Californians regardless of immigration status so that everyone can have the care they need to survive.

Preventive Care Is More Affordable Than Emergency Care, Universal Coverage Can Save California Money

Routine check-ups, screenings, and other preventive services help catch and address health issues before they become serious and more expensive to treat, research shows. For example, managing high blood pressure with medication and regular doctor visits is less costly than treating a stroke or heart failure. Investing in prevention keeps people healthier, improves their quality of life, and prevents bigger health issues later in life. Preventive health care also helps reduce emergency department visit rates, resulting in better care for all hospital patients.

When people lack health coverage, they may be forced to delay or forego care until their health worsens. For example, research shows that people who do not have health coverage are less likely to receive treatment for chronic health conditions and more likely to report a poor health status. This can worsen health conditions, which are more expensive to treat and, in turn, raise costs for hospitals, health care providers, and the state. People delaying care until health issues worsen costs California’s health care system billions of dollars every year, likely outweighing the costs of providing care to all. Those dollars could be better spent on funding health care for those who lack essential coverage.

Providing People with Comprehensive Health Coverage Leads to Better Health and Community Well-Being

In 2016, California expanded Medi-Cal to cover all children up to age 18, regardless of immigration status. Data show that this expansion meaningfully improved children’s health. The proportion of non-citizen children who reported being in excellent health after the expansion increased by 10 percentage points. This suggests that increasing access to health care improves health status.

In addition to improved health, when people have access to health care, they are more likely to avoid medical debt and contribute fully to their families, workplaces, and communities. This helps strengthen the public health system, keeps the community safer, helps ensure a healthy and strong workforce, and lowers poverty in the state. New research shows that California’s health care programs help keep people out of poverty by providing critical health care and could also help reduce poverty for families.

The Health Care System Works Better When Everyone — Including Immigrants — Is Covered

When more people have access to care, the entire health system and state benefits. A growing body of research links Medicaid expansion with reduced mortality rates. Current efforts to strip many immigrants of their health coverage undermines the health care system as a whole and cuts off access to essential services to people who are vital members of the state and its communities and make meaningful contributions to the state’s robust economy.

Undocumented Californians paid nearly $8.5 billion in state and local taxes in 2022, despite being excluded from most public benefits. Denying many immigrants access to health care while the state benefits from their labor and tax payments is inequitable and harms the overall health care system.

Providing health care to all is a worthwhile investment that will significantly improve the lives of all Californians. If current cuts remain in place, state leaders will prioritize short-term savings at the expense of long-term gains in the state’s overall social and financial well-being.  Ensuring broad access to Medi-Cal improves lives, protects public health, is good for the economy, and builds a healthier California for everyone.

Adriana Ramos-Yamamoto contributed to this publication.

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key takeaway

For most Californians experiencing homelessness, CalFresh (SNAP) is among the few safety net programs that consistently provide basic access to food. Under the Republican megabill H.R. 1, arbitrary time limits and work requirements threaten food assistance for unhoused adults ages 18–64 without a disabling condition or dependents.

Many Californians experiencing homelessness rely on the Supplemental Nutrition Assistance Program (SNAP), or CalFresh in California, to meet their basic food needs while searching for or on a waitlist for a stable home. Republican Megabill H.R. 1 included historic cuts, eligibility restrictions, ineffective work requirements, and time limits for SNAP that are estimated to impact over 97% of CalFresh households. These additional administrative requirements will cost California $2.5 billion to $4.5 billion in federal funding annually, funds that could be better spent on ensuring people receive the benefits they need to survive.

Among unhoused Californians without children who reported receiving SNAP, at least 1 in 4 adults experiencing homelessness — over 24,000 Californians — could lose their benefits in 2026 due to federal changes. This includes nearly 30 percent of unhoused adults ages 18-49 and one in six unhoused older adults age 50-64.

Unhoused adults of color who reported receiving SNAP will be disproportionately harmed, with the highest risk of losing food assistance among Native Hawaiian or Pacific Islander, Asian, Black, and Multi-Race adults aged 18-49. Native Hawaiian or Pacific Islander, Asian, and Multi-Race unhoused older adults aged 50-64 also face disproportionate risk of losing their benefits.

Adults experiencing homelessness without dependents were previously exempt from a time limit on their SNAP benefits. The Republican megabill, H.R.1, explicitly removed people experiencing homelessness, along with veterans and former foster youth, from this category. Now, adults without children — whether living on the streets of their communities, in emergency shelters, or in vehicles — face a punitive 3-month SNAP time limit unless they qualify for an exemption or meet an 80-hours per month work requirement. The new federal rule leaves Californians experiencing homelessness in an impossible situation, as the median length of homelessness in California is nearly two years, largely due to a severe shortage of housing assistance and deeply affordable housing.

Portrait of child girl eating on snack time at school

H.R. 1 and the Federal Budget

H.R. 1, the harmful Republican mega bill passed in July 2025, will deeply harm Californians by cutting funding for essential programs like health care, food assistance, and education.

See how California leaders can respond and protect vital supports.

Learn More

While implementation guidelines are still being developed, SNAP recipients could be subject to these new restrictions at their next recertification within the next year. For unhoused adults, maintaining even the minimal food assistance they receive will be nearly impossible unless they meet strict exemptions, like having “certified” physical or mental limitations, participating in qualifying substance use disorder programs (which may not have a housing component), or pursuing education at least half-time. Adults with self-reported disabilities may be denied, depending on how the state verifies disabilities and applies exemptions.

People experiencing chronic homelessness or those receiving Supplemental Security Income/Social Security Disability Insurance (SSI/SSDI) should be exempt from the time limits, but many others may still lose their benefits due to administrative and eligibility barriers. Chronic homelessness has a narrow definition, and countless of unhoused Californians with disabilities are waiting on approvals, appealing denials, or stuck in the process of applying for Social Security benefits — a process worsened by federal staffing cuts at the Social Security Administration. Plus, many adults experiencing homelessness do not qualify under either of these designations, leaving them at the highest risk of losing food assistance.

chronic Homelessness

An individual experiencing chronic homelessness is defined as a person with a disability who has either been continuously homeless for a year or more or has experienced at least four episodes of homelessness in the last three years where the combined length of time unhoused is at least twelve months.

How H.R. 1’s SNAP Rules Push Survival Beyond Reach

The federal changes to SNAP create a direct threat to the survival of thousands of unhoused Californians by driving hunger, creating red tape, and compounding trauma that pushes people deeper into poverty. While many Californians who are unhoused are employed, H.R. 1’s 80-hour-per-month work or education requirement is particularly severe for people experiencing homelessness, since homelessness disrupts work and schooling. Being unhoused also limits access to transportation, water, places to prepare and store food, and other daily activities like rest — all of which are  fundamental conditions needed to maintain a job or attend school. Adults without dependents are also the largest share of California’s unhoused population, and these restrictions further erode the minimal safety net supports for which they qualify.

California Can Ensure Unhoused Adults Retain Basic Access to Food Assistance

State policymakers can protect unhoused Californians’ access to food assistance by strengthening investments in CalFresh and ensuring that all Californians meet their most basic needs. Key strategies to mitigate the harm from H.R. 1 include:

  • Expand and embed flexible exemption criteria so adults experiencing homelessness are not excluded due to traditional work or education requirements. Policies and exemption qualifications should reflect the realities and daily activities that come with living in shelters, on the streets, or in vehicles. 
  • Leverage the Homeless Data Integration System (HDIS) and relationships with homeless service providers to identify individuals who are at-risk of losing benefits or who may qualify for exemptions based on self-reported information not captured in other databases. 
  • Increase state resources to support CalFresh access by allocating additional funding for benefit continuity and application and outreach assistance.

In a state as wealthy and influential as California, no one should go hungry. State leaders can act to defend communities from harmful federal policies and ensure Californians have access to the food assistance they need to survive.

Monica Saucedo contributed to this publication.

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The most common way for Californians to shape state funding decisions and policy priorities is through the state budget process and the legislative (or policy bill) process.

The deadlines for the state budget process are established in California’s Constitution or in state law and rarely change.

In contrast, most of the deadlines for the legislative process are jointly set by the leadership of the state Senate and Assembly. These deadlines are adjusted annually to reflect the amount of time the Legislature has to complete its business. Specifically:

  • In non-election (odd-numbered) years, the deadline for the Legislature to pass bills is typically set in September — on a date determined jointly by the Assembly and Senate.
  • In election (even-numbered) years, the Legislature generally must pass bills by August 31 — a deadline established in the state Constitution. There are a few exceptions to this deadline. For example, after August 31 the Legislature may pass bills calling for elections, bills that would increase or reduce state taxes, and bills that would take effect immediately (“urgency statutes”).

The state budget process and legislative (policy bill) process differ in multiple ways. For example, the legislative process has many more deadlines compared to the state budget process, reflecting the long and linear path that policy bills take through both houses. The legislative process also has more steps and “hoops” to jump through in order to advance legislation to the governor’s desk.

However, there is a key similarity between these two processes. Much of the Legislature’s work on policy bills as well as on the state budget is organized through committees:

  • In the legislative process, Assembly and Senate policy committees consider the policy implications of a bill, while appropriations committees estimate the cost of policy bills. At each stage of the process, committees can either pass and send policy bills to the floor of each house or hold the bills in committee (where they die).
  • In the state budget process, Assembly and Senate budget committees and their subcommittees review the governor’s budget proposals, develop each house’s version of the state budget, and pass the budget-related bills that reflect each year’s state budget agreement with the governor.

Committee hearings are open to the public and typically include opportunities for public comment. Members of the public can attend committee hearings in person or watch them online through the Assembly and Senate websites.

The dates in the table below reflect deadlines established in state law and the state Constitution as well as the joint rules set by the Assembly and Senate for 2026.

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key takeaway

Most of the growth in preschool-age enrollment comes from expanded TK programs, while access for 3-year-olds remains limited due to eligibility and availability constraints.

Participation in early childhood education programs supports children’s development and contributes to improved outcomes into adulthood, particularly for children from households with low incomes. Early childhood education programs also play a critical role in enabling parents and caregivers to work. In California, a mix of publicly funded programs provide preschool-age children with these foundational opportunities. However, in addition to meeting eligibility requirements, access and participation often depend on whether families can overcome barriers to enrollment and whether available options align with their needs and preferences.

This analysis examines enrollment trends across all publicly funded early childhood education programs in California serving 3- and 4-year-old children from 2021-22 to 2022-23, with a focus on understanding how participation has shifted across these age groups.

Program expansions, policy changes, and family preferences, among other factors, have shaped enrollment in recent years. Overall participation of 3- and 4-year-olds increased from 2021-22 to 2023-24, as shown in the table above. However, behind this growth are important differences by age and program type.

  • 4-year-old enrollment grew more slowly than 3-year-old enrollment in most programs. This is especially notable in child care and development programs, where enrollment for 3-year-olds grew by 56% from 2021-22 to 2023-24, possibly reflecting slot expansion in recent years. By contrast, enrollment for 4-year-olds only grew by 35%, with some programs experiencing declines. This slower growth among 4-year-olds may reflect a shift toward Transitional Kindergarten (TK). While growth for 3-year-olds is promising, it still falls short of meeting the need because only 21% of eligible 3-year-olds were served in 2023-24. 
  • Growth in preschool programs was uneven, with TK driving most of the increase. From 2021-22 to 2023-24, total enrollment in preschool programs — including TK, State Preschool, and Head Start — all grew, but most of the increase was due to TK, where 4-year-old enrollment doubled. State Preschool saw modest gains in 3-year-olds, especially in full-day programs, but 4-year-old enrollment declined in part-day settings by about 9%. Head Start enrollment for 4-year-olds dropped by nearly 5,000 children, reflecting the workforce challenges and low-pay for educators. However, the program still served nearly 48,000 preschool-age children in 2023-24, underscoring its critical role in California’s early learning system and the need to pay early educators a fair wage.

These enrollment shifts illustrate how families are making use of available preschool options, often shaped by eligibility requirements, availability, and trade-offs between different program types. The expansion of TK has possibly contributed to slower growth or even declines in 4-year-old enrollment in other programs. At the same time, while increases in enrollment among 3-year-olds are meaningful, they remain below the need, indicating that many families still lack access to available programs. 

As California continues to expand access, it is essential for policymakers to understand the distinct role that each program plays in the landscape and ensure that investments support a range of options that reflect the needs of families.

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Californians typically pay more in federal taxes than the state receives in federal spending each year, making California a “donor state.”1All years in this fact sheet represent federal fiscal years (FFYs), which begin every October 1 and end the following September 30. The data presented in this fact sheet differs from the data included in an earlier Budget Center fact sheet — published in February 2025 — for a few reasons. First, this fact sheet analyzes data for nine fiscal years (FFYs 2015 to 2023), whereas the earlier fact sheet displayed these data for only a single fiscal year (FFY 2022). Second, this fact sheet displays federal spending data in two ways — with and without federal COVID funds — whereas the earlier fact sheet displayed spending data only with COVID funds. Finally, the data for FFY 2022 differ across the two fact sheets because the Rockefeller Institute of Government recently revised the FFY 2022 data. Between federal fiscal years (FFYs) 2015 and 2023, federal taxes paid by California residents and businesses exceeded federal spending in every year except 2020, 2021, and 2023.2FFY 2023 is the most recent year for which the Rockefeller Institute of Government’s 50-state analysis is available. In other words, California was a donor state in six out of the nine fiscal years for which data are available.

California likely would have been a donor state in additional years during this period if not for federal COVID funding. Since 2020, federal expenditures have included the substantial — but temporary — support provided to states, businesses, and individuals to address the COVID pandemic. These one-time COVID funds caused federal expenditures in California to jump significantly, which in turn has understated California’s role as a donor state.3In the four years leading up to the start of the pandemic in FFY 2020, annual federal spending in California hovered between $400 billion and $450 billion. That number jumped to over $750 billion in FFY 2020 as the pandemic took hold and federal COVID spending ramped up. Federal spending in California remained above $600 billion as recently as FFY 2023.

Excluding temporary COVID funds from the analysis provides a more accurate picture of the long-term underlying fiscal trends and California’s true position as a donor state. Using this alternative analysis, between FFYs 2015 and 2023, Californians paid more in federal taxes than the state received in federal spending in eight out of these nine years (2020 is the exception). For example, Californians’ federal taxes exceeded federal spending — excluding COVID spending — by $55 billion in 2021, $101 billion in 2022, and $17 billion in 2023.

Why Is California a Donor State?

Why do Californians typically contribute more to the federal treasury than the state gets back in federal funding? The explanation touches on both the spending and revenue sides of the equation.

On the spending side:

  • States with higher poverty rates, a large population of older adults, major federal facilities (such as military bases), a large volume of federal contracts, and/or a substantial federal employee presence are likely to receive a disproportionate share of federal funds. These factors contribute to relatively higher federal spending in many other states (on a per capita basis) compared to California.

On the revenue side:

  • States with more wealthy residents and high per capita incomes — like California — account for a disproportionate share of federal tax revenue due to the progressive federal tax system.

With Trump-Era Federal Budget Cuts, the Gap Between California’s Federal Tax Contributions and Federal Spending in the State Will Increase

In July 2025, President Trump signed into law a budget bill (H.R. 1) that will deeply harm Californians by cutting spending for essential programs like health care, food assistance, and education in order to help fund massive tax breaks to the wealthy and corporations, and increased immigration enforcement. The spending cuts included in H.R. 1 will disproportionately impact families with low incomes, immigrants, and communities of color, pushing more people into poverty and widening racial and economic inequities across the state.

State policymakers can mitigate the harm of H.R. 1., however, the massive federal funding cuts are too large to be entirely backfilled with state dollars. As a result, essential services like Medi-Cal health coverage and CalFresh food assistance are in jeopardy as state leaders assess how to address the impact of harmful federal reductions.

Portrait of child girl eating on snack time at school

H.R. 1 and the Federal Budget

H.R. 1, the harmful Republican mega bill passed in July 2025, will deeply harm Californians by cutting funding for essential programs like health care, food assistance, and education.

See how California leaders can respond and protect vital supports.

Learn More

Moreover, as the provisions of H.R. 1 are implemented through 2028, the gap between what Californians pay in federal taxes and federal spending in the state will grow larger.

This is because Californians will continue to disproportionately contribute to federal revenues whereas California will get back even less of those dollars as deep cuts to health care, food assistance, and other vital services take effect.

Federal Tax Dollars Should Be Used to Strengthen Essential Services

California contributes much to the nation thanks to the creativity, vitality, and hard work of the nearly 40 million people of diverse backgrounds who call the Golden State their home.

Federal tax dollars — including Californians’ very generous contributions to the federal treasury — should be used to strengthen vital public services and help all people make ends meet, rather than helping corporations and the wealthy avoid paying their fair share of federal taxes.

Update: This fact sheet was revised in August 2025 to include newly released federal tax and spending data from the Rockefeller Institute of Government (federal fiscal years 2015–2023), with revised figures and updated charts.

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  • 1
    All years in this fact sheet represent federal fiscal years (FFYs), which begin every October 1 and end the following September 30. The data presented in this fact sheet differs from the data included in an earlier Budget Center fact sheet — published in February 2025 — for a few reasons. First, this fact sheet analyzes data for nine fiscal years (FFYs 2015 to 2023), whereas the earlier fact sheet displayed these data for only a single fiscal year (FFY 2022). Second, this fact sheet displays federal spending data in two ways — with and without federal COVID funds — whereas the earlier fact sheet displayed spending data only with COVID funds. Finally, the data for FFY 2022 differ across the two fact sheets because the Rockefeller Institute of Government recently revised the FFY 2022 data. ↩︎
  • 2
    FFY 2023 is the most recent year for which the Rockefeller Institute of Government’s 50-state analysis is available. ↩︎
  • 3
    In the four years leading up to the start of the pandemic in FFY 2020, annual federal spending in California hovered between $400 billion and $450 billion. That number jumped to over $750 billion in FFY 2020 as the pandemic took hold and federal COVID spending ramped up. Federal spending in California remained above $600 billion as recently as FFY 2023. ↩︎

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Corporate profits have skyrocketed in recent years while workers’ wages have stagnated and families struggle to keep up with the rising costs of living. Despite these disparities, large tax breaks, such as the “Water’s Edge” loophole, remain in place. Big corporations have also benefited greatly from the 2017 Trump tax cuts and stand to receive more benefits from the federal tax package recently signed into law. Corporate tax breaks largely benefit corporate shareholders, who are disproportionately wealthy and white, widening economic and racial inequality. 

California policymakers should ensure that profitable corporations pay their fair share in state corporate taxes — which represent a tiny share of their expenses — to support the public services that Californians need. This is especially urgent to help mitigate the harms of the harmful federal cuts to health care, food assistance, and other basic needs programs. 

State leaders should end the state’s most costly corporate tax break — the water’s edge loophole, which allows corporations to avoid around $3 billion in California taxes each year and deprives the state of needed resources to address the most pressing concerns facing Californians.

As state leaders look to blunt the harm of the federal budget on Californians with low incomes and the state’s finances, it’s clear that California’s corporate tax structure is in need of repair. While large, profitable corporations benefit from new federal tax breaks, California policymakers must ensure these businesses pay their fair share in state taxes. There is no one-size-fits-all solution: different options can all complement each other. For example, limiting corporate tax credit usage will raise revenues by itself but will also prevent erosion of the revenue potential from ending the water’s edge loophole.

MORE IN THIS SERIES

To learn more about the water’s edge election, net operating losses, tax credits, corporate tax rates, and options for common-sense reform, see the other fact sheets in this series:

The Problem: Multinational Corporations Avoid Billions in State Taxes by Shifting US Profits Offshore

Large corporations that have affiliated companies outside of the US can use a variety of mechanisms to artificially shift hundreds of billions in US profits to foreign jurisdictions with low tax rates — known as tax havens — to reduce their federal and state taxes. In fact, corporations report to federal tax authorities that their profits in some well-known tax havens are multiple times larger than the entire economies of these places, indicating that most if not all of those profits are only there on paper. 

As one example of how a corporation might accomplish this, a US corporation can transfer ownership of intellectual property like patents or trademarks to a foreign affiliate and pay the affiliate for the right to use them, effectively moving income off the books of the US corporation while keeping it within the larger corporate group. This is a tactic that industries such as tech and pharmaceuticals can easily employ, but corporations across the board have options to engage in offshore profit shifting and tax avoidance.

Corporations Can Greatly Reduce Profits Subject to Taxation — and Their Taxes — by Shifting Profits Abroad and Using the Water’s Edge Election

Infographic showing a US-based parent company with $5 billion in profits connected to four subsidiaries. On the left are two US-based subsidiaries with profits of $500 million and $200 million. On the right are two foreign subsidiaries with profits of $4 billion and $2 billion. One foreign subsidiary includes a note that $3 billion of its profits were actually earned by the parent company and shifted abroad. A small airplane icon and a dotted vertical line visually separate the foreign subsidiaries from the US-based companies, illustrating corporate profit shifting to foreign tax havens.

CORPORATE GROUP TOTAL PROFITS

If the example corporation above uses the default Worldwide Combined Reporting method, all worldwide profits are included: $5B + $500M + $200M + $4B + $2B = $11.7 Billion.

If the corporation chooses to use Water’s Edge Election, only domestic profits are included (yellow oval): $5B + $500M + $200M = $5.7 Billion.

Note: This is a simplified example.

California’s “water’s edge election” allows corporations to choose whether or not to include the profits of their foreign affiliates when they report their total profits that can be divided up among, or “apportioned” to, the states where they are subject to tax.1Additionally, while some groups of related corporations may elect to file a group tax return in California, each corporation may file separate returns but are still required to combine profits at the corporate group level first, before apportioning profits between taxing jurisdictions and individual corporate entities.Generally, profits are apportioned to states by multiplying the total profits by the “sales factor”, which is determined by dividing the corporation’s sales into the state by its total sales. For filers electing the water’s edge method, the denominator is only domestic sales.

The water’s edge election creates several issues:

  • Smaller, domestic businesses likely pay higher shares of their income in taxes than large multinational corporations because they are unable to shift profits overseas.
  • Giving corporations the option of two filing methods means they will always choose the one that lowers their tax bill. For corporations with significant offshore profits, the water’s edge method will likely result in lower taxes. If corporations have domestic profits and foreign losses, using the “worldwide combined reporting” method — where all worldwide profits and losses are combined — would result in a lower tax bill.
  • Allowing corporations to ignore foreign profits can encourage them to shift profits to foreign tax havens and avoid state taxes by using the water’s edge election.

Maintaining the water’s edge election will cost the state an estimated $3.1 billion in 2024-25, increasing to $3.5 billion by 2026-27, according to the Department of Finance.

The Solution: Close the Water’s Edge Loophole and Require Worldwide Combined Reporting

Requiring large multinational corporations to use the worldwide combined reporting method would eliminate the state tax benefit of shifting profits abroad and close this loophole, resulting in additional revenue for California. Under this method, corporations are required to include the income of all their domestic and foreign affiliates in their total profits before determining what share is taxable by each state. This is already the default tax filing method for corporations subject to tax in California that don’t elect the water’s edge method, so some corporations currently use this method when it is beneficial for them.

In tandem with requiring worldwide combined reporting, policymakers could take steps to prevent corporations from underreporting their sales into California, driving down the “sales factor” used to determine the share of their profits that can be taxed in California, and ultimately reducing their state taxes. For example, policymakers can clarify state law to ensure corporations report the final destination of their sales — not the location of intermediaries — for the purpose of the sales factor, and require more robust reporting on the locations of sales to allow tax authorities to better identify cases when a corporation may be underreporting. This is a reform that should generate additional revenue on its own, but would also help prevent the erosion of revenues that could be gained from requiring worldwide combined reporting, as requiring corporations to report their global profits may lead them to find other ways to reduce their California tax bill, like underreporting sales into the state.

Ending the water’s edge loophole for large corporations and requiring worldwide combined reporting is a common-sense reform to ensure corporations contribute a fair share of their profits in California taxes to support the state services and infrastructure that allow companies, their workers, and their consumers to thrive.

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    Additionally, while some groups of related corporations may elect to file a group tax return in California, each corporation may file separate returns but are still required to combine profits at the corporate group level first, before apportioning profits between taxing jurisdictions and individual corporate entities. ↩︎

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In California, workers’ wages have stagnated and families struggle to keep up with the rising costs of living, while corporate profits have skyrocketed. Big corporations have also benefited greatly from the 2017 Trump tax cuts and are poised to receive more benefits from the federal tax and budget bill just enacted by the Trump administration and congressional Republicans. Large tax breaks for corporations widen economic and racial inequality because they largely benefit corporate shareholders, who are disproportionately wealthy and white. 

California policymakers should ensure that profitable corporations pay their fair share in state corporate taxes — which represent a tiny share of their expenses — to support public services and help shield Californians from the harms of federal cuts to health care, food assistance, and other basic needs programs. 

MORE IN THIS SERIES

To learn more about the water’s edge election, net operating losses, tax credits, corporate tax rates, and options for common-sense reform, see the other fact sheets in this series:

How do large, profitable corporations currently get away with paying so little in California taxes?

California’s tax code contains several provisions, including the water’s edge election, net operating loss (NOL) deductions, and tax credits like the research and development credit, that corporations can take advantage of to reduce their state taxes. While actual corporate tax calculations can be exceedingly complicated, the following hypothetical — and very simplified — example demonstrates the ways that corporations operating across multiple states and countries can reduce the taxes they owe to California. 

State leaders can limit the opportunities corporations have to wipe out their tax bill in years when they are profitable by reforming these elements of the corporate tax system that enable them to do this.

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