The California Medical Association and the California Association of Health Plans sued Gov. Gavin Newsom and state officials over a revised health care tax they allege illegally raises insurance premiums.
The coalition of physician and health plan trade associations filed a petition with the California Supreme Court on Oct. 1, challenging California’s Senate Bill 125. The law levies a tax on managed care organizations to help fund Medi-Cal, the state’s Medicaid program for low-income residents. The state’s budget plan also uses the gained revenue to offset General Fund spending, which managed care organizations have opposed.
The lawsuit unites two sectors of the health care industry that often clash over reimbursement rates and payment negotiations. Physicians push for adequate reimbursement to sustain patient care, while insurers seek to manage health care spending and negotiate payment rates with providers.
Newsom’s office disputed the claims, stating, “The state disagrees with their claims, and we believe the courts will too.”
Still, the dispute raises questions about costs, healthcare funding and the limits on state authority. The court’s decision will direct what Californians pay for health insurance, how much funding Medi-Cal receives and the financial pressure hospitals and physicians face.
What’s Happening To Insurance Premiums In California
California’s new law sets the tax at $8.85 per enrollee per month from 2027 through 2029, pending federal approval. The California Medical Association and the California Association of Health Plans allege that the rate conflicts with Proposition 35, which caps the tax on commercial health coverage at $2.50 per member per month.
Insurers argue they operate on tight margins and warn that the added costs will pass directly to consumers and employers through higher monthly premiums. However, the state is attempting to use the gained revenue from the health insurance tax to also fund its general budget. Medical groups allege that using these funds for purposes outside of healthcare violates state law.
If the California Supreme Court strikes down SB 125, the state could face a potential financial strain. California would lose the tax mechanism filling its proposed healthcare and general budget, potentially forcing cuts to services and programs. The court’s decision could have significant implications for community hospitals, clinics and physicians serving underfunded communities. These providers often rely on Medi-Cal reimbursements to cover the cost of treating patients.
The next step is for the California Supreme Court to decide how to handle the petition filed.
Why The Case Matters Beyond California
This year has been transformative for health care, shifting how care is financed, paid for and reimbursed nationwide.
The federal government imposed tighter restrictions on how states can use health care-related taxes to help fund Medicaid. States can no longer establish new healthcare provider taxes or increase existing tax rates to help fund their share of Medicaid costs. New federal rules also restrict how states may structure provider taxes across Medicaid to qualify for federal matching funds.
Roughly 20 states use MCO taxes to help fund Medicaid, alongside other health care-related taxes and federal matching funds. These arrangements help states finance coverage and reimburse providers serving Medicaid patients. However, as federal funding and subsidies face new restrictions, states are exploring ways to maintain health coverage and insurance premiums for low-income populations.
In California, Medi-Cal covers roughly one-third of the state’s population, or about 15 million residents. California’s approach has been to restructure its tax on private health plans to help fund its safety-net program. Traditionally, most states relied on separate tax rates for private and Medi-Cal enrollment, using revenue from the managed care tax to support Medi-Cal and draw federal matching funds.
Many states are watching the outcome of California’s lawsuit as they consider how to finance Medicaid and state budgets under the new federal restrictions. A key point of contention is whether states can use health care-related tax revenue to offset other budget expenses beyond health.
Medicare Budget Gaps In Focus
The tax fight has implications for both patients and providers. Clinics and hospitals face a growing risk of treating uninsured and underinsured patients as coverage and premiums become less affordable and accessible. Next year, federal changes ending subsidy programs add more limits on patients’ coverage options and providers’ ability to secure reimbursement. Safety-net providers serving large numbers of Medicaid patients are especially exposed to these changes.
States, like California, use managed care taxes to generate additional revenue for Medicaid. However, the dispute centers on California’s plan to use some of the generated health revenue for broader state budget expenses rather than directing it all toward health care services and provider reimbursement.
Critics argue that the revised structure would direct much of the revenue toward broader state budget expenses, such as schools, police and roads, rather than additional health care spending. In October, the California Hospital Association and other provider associations filed an amicus letter supporting the legal challenge to the replacement tax.
“Raising health insurance premiums to help balance the state budget is simply robbing Peter to pay Paul,” said Dr. René Bravo, president of the California Medical Association.
Medicaid faces persistent reimbursement challenges nationwide, and California faces its own significant funding pressures. Payments often fall short of the cost of delivering care. When Medicaid payments fall short, hospitals and clinics must make up the difference through other revenue sources, absorb losses, shift costs to privately insured patients or limit the Medicaid services they offer.
California faces these same reimbursement challenges, alongside growing uncertainty over how it will finance Medi-Cal. Yet the state plans to use some of the revenue generated by its MCO tax for broader state budget expenses beyond Medicaid and health care.
A Push To Center On Healthcare
In California, the California Hospital Association, California Medical Association, California Primary Care Association and other health care groups have argued that MCO tax revenue should support higher Medi-Cal reimbursement and strengthen services such as primary and specialty care, mental health and hospital care. In a 2024 letter, the groups warned that expanding coverage without raising provider rates leaves Medi-Cal patients in an underfunded system and makes it harder for providers to maintain access to care.
“We cannot continue to raid healthcare dollars and expect our system to absorb the millions more Medi-Cal patients we have seen over the last several years,” they wrote.
The California Medical Association, California Hospital Association and more than 10 other trade organizations representing clinicians have urged the state to ensure that revenue generated by the MCO tax directly supports Medi-Cal.
“We strongly believe that revenue generated by the reinstatement of the MCO tax must be directly dedicated to supplementing and enhancing the core areas of the Medi-Cal program such as primary and specialty care, community clinics, emergency department access, hospital services, family planning, mental health and workforce needs, to provide the funds necessary to stabilize California’s healthcare system,” they explained.
Several states have used Medicaid provider-tax revenue to reduce their reliance on general fund dollars, freeing up money for other budget priorities. California’s lawsuit is testing this longstanding Medicaid financing strategy under new federal restrictions. The state’s revised tax structure has also sparked a separate dispute over how much of the revenue should go directly toward health care.
