Newsom Bets Big On Trump’s Goodwill To Shrink California’s Budget Hole

SACRAMENTO, California — Gavin Newsom is making a billion-dollar gamble in his latest budget plan, banking on money from a tax on health insurance carriers to help close a projected deficit.

There’s one big problem with that: The tax expires in June, and unless California wins a special reprieve from the Trump administration to keep it in place for the second half of the year, it will lose upward of $1.1 billion in projected revenue. It’s an enormously consequential proposition for Newsom, a likely presidential contender laboring to avoid a budget disaster in his final year as governor. And Democrats are aware of the risk, considering how ferociously President Donald Trump and Newsom have torn into each other in recent months.

“We're making a huge assumption that they're going to approve us all the way to December,” state Sen. Caroline Menjivar, chair of the Senate Health Budget Subcommittee, said to administration officials at a recent budget hearing. “I don't know what friends you have over there, and I didn't think we had any friends in the federal government.”

For Newsom, the tax looms as one more point of tension in a fraught budget year. Already, Newsom is counting on artificial intelligence companies to continue the explosive growth that has propped up the state’s finances with billions of dollars in tax revenue — a calculation that fiscal watchdogs at the nonpartisan Legislative Analyst’s Office say is far too optimistic and disregards the possibility that AI companies will falter. While the $349 billion spending plan Newsom put out projects the state will face a $3 billion deficit, the LAO is predicting a funding hole at least six times as large.

At issue is the managed care organization tax, or MCO, which California has relied on for years to cover the costs of Medi-Cal, the state’s Medicaid program.

Like other states, California levies a tax on Medi-Cal plans and uses that money to draw down matching funds from the federal government. It uses those combined dollars to increase doctor pay, send money to hospitals or fund other priorities in Medi-Cal or balance the state’s budget.

The tax has been a huge boon to states, but a major thorn in the side of presidents who view it as a way for states to bleed federal coffers for local priorities. In California that has included providing free health care to undocumented immigrants.

After former President Joe Biden targeted the MCO tax for changes, the Trump administration has continued with the campaign. Sweeping spending legislation the president signed last year included a provision that requires states to levy such taxes equally. California, which taxes Medi-Cal insurance plans at a higher rate than private plans, was allowed to continue collecting the tax until the end of June while it worked on reconfiguring it to comply with new rules.

Now, Newsom is crossing his fingers that the state gets another extension.

“We are hopeful that we'll get the full transition period,” said Lupe Manriquez, the program manager for health at the state’s Department of Finance. “Otherwise we'd see an immediate hit of $1.1 billion.”

CMS Administrator Mehmet Oz has the discretion to extend that runway, and H.D. Palmer, a spokesperson for the state’s Department of Finance, said the department is engaging with federal officials to win the additional six months.

But when Oz’s agency issued the final policy on the taxes, it said states that already had been warned their taxes would be out of compliance — like California — would not get the full grace period. And the rhetoric coming from Washington has been decidedly chilly.

“States are gaming the system — creating complex tax schemes that shift their responsibility to invest in Medicaid and rob federal taxpayers,” Oz said in a statement announcing the new rules in May. Oz called this tax a “money laundering scheme” that states exploit.

The LAO has been sounding the alarm about the tax. It issued a report last year noting that changing federal rules meant it would generate only tens of millions annually instead of the billions it currently does. The report recommended using the Democrats’ legislative super majority to open up the voter-approved tax and start over.

If the state doesn’t receive permission to keep the MCO tax in place, the total hit to its finances could go well beyond the $1 billion cut to the general fund.

All told, the tax nets about $8 billion to the state each calendar year, said Jennifer Kent, who led the Department of Health Care Services in different roles in three administrations and helped write the proposition that laid out the tax structure.

Losing out on six months of that would equate roughly to a $4 billion loss, with the rest of the money earmarked for specific programs outside the general fund.