For Immediate Release · October 2, 2026

CMA and CAHP Sue State Over MCO Tax

Lawsuit challenges tax structure that violates the state constitution, increases costs tied to commercial health coverage and diverts money away from Medi-Cal

SACRAMENTO, Calif.— The California Medical Association (CMA) and the California Association of Health Plans (CAHP) today filed a lawsuit with the California Supreme Court challenging the state’s proposed Managed Care Organization (MCO) tax, arguing that it violates the state constitution, circumvents Proposition 35, exceeds taxation limits on health insurance coverage established by California voters and does not spend the revenue derived from this health care tax in accordance with Prop 35.

The lawsuit argues that the state cannot create a MCO tax methodology outside the parameters set by Proposition 35 to avoid the requirements of the voter-approved law, including limits designed to constrain the tax imposed on commercial health coverage to keep costs down, requirements governing how MCO tax revenues are used to increase access to Medi-Cal care, and the process voters established for amending the law.

According to the nonpartisan Legislative Analyst’s Office, approximately $1.5 billion, or two-thirds of the net funding generated by the renewed tax, would come from working Californians and employers.

“California voters passed Proposition 35 and made it law. The state does not get to ignore that law simply because following the law is inconvenient,” said Dustin Corcoran, CEO of the California Medical Association. “H.R. 1 changed the federal rules governing the MCO tax, but it did not erase California law. The state has a path to comply with both. Instead, it is choosing to pursue a higher-revenue approach that violates the law and will make health care more expensive for Californians, while diverting the tax revenue away from improving access to health care. We are asking the court to enforce the law voters approved.”

“Health plans have historically supported the MCO tax as long as it was affordable and made meaningful improvements to Medi-Cal,” said Charles Bacchi, President and CEO of the California Association of Health Plans. “California should not resolve its budget shortfall by imposing a massive tax increase on health care costs for working families. Proposition 35 established protections intended to limit that burden. The state should follow those voter-approved protections.”

Proposition 35 was approved by 67.9% of California voters in November 2024. The measure made the MCO tax permanent under state law, dedicated MCO tax revenues to specified Medi-Cal purposes, and established a limit on the tax imposed on commercial enrollment. The measure also requires a three-fourths vote of the Legislature for amendments that are consistent with and further the purposes of the initiative.

The state’s proposed MCO tax structure, established through SB 125, imposes an $8.85-per-enrollee-per-month tax on commercial enrollment, far exceeding the $2.50-per-member-per-month limit established by Proposition 35. SB 125 was also enacted without the three-fourths vote required to amend the voter-approved law.

California’s working families, individuals, and employers will ultimately bear the cost of a tax that Proposition 35 specifically limited to protect the cost of commercial health coverage.

Prop 35 requires MCO tax revenue to be used to expand access to Medi-Cal care. Instead via SB 125 and the state budget, the state is using those dollars to backfill the General Fund—diverting resources away from patients.

Diverting resources away from Medi-Cal leaves patients without access to care. Patients who cannot find timely care can end up in already-crowded emergency rooms, increasing wait times for everyone. And when hospitals and clinics struggle financially, communities can lose critical providers altogether.

The state argues that changes to federal law under H.R. 1 require California to change the structure of its MCO tax. CMA and CAHP agree that California must adapt to the new federal requirements. But federal changes do not give the state permission to disregard Proposition 35.

The lawsuit asks the court to:

• Declare SB 125 invalid given that it conflicts with Proposition 35, a voter approved law;
• Require the state to pursue an MCO tax structure that complies with both Proposition 35 and federal law by December 31, 2026 before the federal transition period to comply with HR 1 ends; and
• Require MCO tax revenues to be handled consistent with Proposition 35’s dedicated funding requirements.

“This lawsuit is about a simple principle: the state has to follow the law,” Corcoran said. “California needs a sustainable MCO tax to support Medi-Cal. But the answer to a change in federal law cannot be to ignore a law approved by voters, exceed the taxation limits they established, divert funding intended to increase access to care and make health insurance more expensive for Californians.”

Background

The MCO tax is a financing mechanism used by California and other states to help fund Medicaid. California taxes managed care organizations, and the revenue can be used toward the state share of Medi-Cal expenditures, allowing California to draw down federal matching funds. The MCO tax has been an important source of Medi-Cal financing for many years.

Historically, MCO tax revenue has also allowed the state to cover health care costs that otherwise would have required General Fund dollars, freeing those resources for other state priorities.

Proposition 35 changed that framework. The measure made the MCO tax permanent, subject to continued federal approval, and dedicated revenues collected under its framework to specified Medi-Cal purposes to increase access to care beginning in 2025.

Importantly, Proposition 35 also established a $2.50-per-member-per-month limit on the tax imposed on commercial health plan enrollment. That limit was designed to prevent the MCO tax from placing a significant additional burden on businesses and Californians who purchase commercial health coverage. The measure permits a limited increase when necessary to comply with federal law or obtain federal approval.

Through the passage of SB 125, the state’s new MCO Tax structure establishes an $8.85-per-enrollee-per-month tax, substantially exceeding the commercial-enrollment tax limit established by Proposition 35. This will increase the cost of commercial health coverage for Californians and businesses and violates the protections voters put into the law.

Separately, H.R. 1 changed federal requirements governing Medicaid provider taxes. Among other changes, the new federal framework restricts provider taxes that place a disproportionately higher tax burden on Medicaid plans than other coverage. California’s existing MCO tax remains federally authorized through December 31, 2026, after which the existing structure will no longer be federally approvable.

California therefore needs to modify its MCO tax structure. The state is pursuing a two-component approach – first a Proposition 35-related structure that will be rejected under the new H.R. 1 requirements and an alternative structure under SB 125, which clearly violates Proposition 35, as enacted by the voters. Under Proposition 35’s requirements, the state is required to make changes to its existing tax methodology to comply with H.R.1, while at the same time staying within the boundaries set by Proposition 35. Proposition 35 both sets limits on taxing commercial health plans and requires the revenue from this health care tax to be spent in specific ways to improve access to health care.

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CMA and CAHP contend that California can respond to the federal changes while complying with Proposition 35. The plaintiffs are asking the court to require the state to do so rather than use a tax structure that circumvents the law voters approved.