California’s Proposition 35 Will Result in More Irresponsible Spending with Only Marginal Returns

In April 2023, California passed a bill authorizing the state government to levy a tax on the state’s many ‘managed care organizations,’ which are insurance providers contracted by California to provide Medicaid services. This tax was approved until 2026 and will raise around $8 billion annually. Proposition 35 proposes to make the 2023 tax permanent.

California’s managed care tax takes advantage of federal regulations relating to how Medicaid is funded. Medicaid spending is set by states, but the federal government then reimburses a percentage of this state spending. Federal reimbursement is dependent on the state’s per capita income and the design of the state’s Medicaid program.

Originally, Medicaid intended for states’ taxpayers to pay the entirety of the state share of Medicaid. However, since the 1980s, states have been taxing providers and using that revenue to fund their share of Medicaid.

Using tax revenues from providers to increase Medicaid expenditure allows states to receive more in federal matching funds. Interestingly, providers also support being taxed, as most of the tax revenues will be used to increase Medicaid reimbursement rates. This ultimately increases the providers’ revenues.

Proposition 35 and the 2023 managed care tax are classic examples of this phenomenon: the 2023 tax allowed California’s state government to receive $1.5 billion more in federal funds. It also allowed the state to increase Medicaid reimbursement rates to providers (although the type of providers eligible for rate increases differ between the managed care tax and Proposition 35).

The only party that loses out in managed care taxes is the federal government. In 2023, Californians paid $568 billion in federal taxes, the most in the nation. So current unsustainable trends in federal spending should concern all Californians.

The main drivers of unsustainable federal spending are mandatory entitlement programs, like Social Security, Medicare, and Medicaid. Managed care taxes, like the ones being made permanent in Proposition 35, drive up Medicaid spending significantly: the Committee for a Responsible Federal Budget estimates that a nationwide crackdown on these taxes would reduce federal spending by $1.4 trillion over a period of ten years.

If the goal is to expand low-income care accessibility, then increasing Medicaid reimbursement may only have marginal effects. A 2014 survey of Michigan Medicaid providers found that the primary reason for not accepting more Medicaid patients was a lack of capacity. Medicaid reimbursement rates were secondary to this main concern.

By 2030, California will face a shortage of approximately 33,000 physicians, the most in the nation. In 2020, seven million Californians lived in areas with physician shortages. These shortages strain the capacity of providers to accept new low-income patients. Increasing Medicaid reimbursement rates will not do anything to fix these economic realities.

California’s physician shortage is fed by the state’s occupational licensing regime. For example, California bans hospitals from hiring doctors as employees, which, according to the Berkeley Research Group, has contributed significantly to shortages in physicians. Moreover, California artificially depresses its numbers of non-physician providers through policies like having a low physician-to-physician assistant ratio of 1:4, whilst other states have increased this ratio to 1:6 or have eliminated physician supervision entirely.

Liberalizing California’s occupational licensing regime and increasing the supply of providers will significantly increase access to healthcare for low-income individuals. And it will not cost taxpayers a cent. On the other hand, increasing Medicaid reimbursement rates through financial gymnastics government will contribute to the nation’s growing debt.