The Provider Tax Tango, California, CMS, and the $33 Billion Medicaid Loophole That Won’t Die
On the surface, it is a familiar political tableau: Gavin Newsom, the governor of California, deploys his press office to bombard social media with exposés of healthcare fraud in Republican-led states. The posts are designed to position California as the guardian of fiscal integrity, the state that would never stoop to the creative accounting gimmicks employed by its red-state rivals. They are performative virtue-signalling, calibrated to appeal to a progressive base that views Medicaid expansion as a moral achievement and its defence as a political imperative.
Beneath the surface, however, a rather different reality obtains. Newsom’s latest budget, released in January 2026, assumes the continued operation of a Medicaid provider tax that Congress explicitly outlawed months ago—a “funding gimmick” that the Centers for Medicare and Medicaid Services (CMS) has described as “money laundering” and that Vice President Joe Biden reportedly called a “scam.” The tax, levied on managed-care organisations at a rate of $274 per enrollee per month while assessing other insurance beneficiaries at just $2.25 per month, is designed to do one thing and one thing only: maximise the flow of federal matching funds to California without requiring the state to contribute its own resources.
This is not a technical dispute about actuarial tables or reimbursement methodologies. It is a deliberate, systematic exploitation of a loophole that Congress and the administration have repeatedly signalled their intention to close. It is a game of fiscal chicken, with California betting that federal regulators lack the will to enforce the law against the nation’s largest state, and that the political costs of cutting off billions in Medicaid funding will deter any administration from following through on its own regulations.
The stakes are substantial. The CMS proposed rule issued last May estimated that closing this loophole would save $33.2 billion in federal costs and an additional $18.8 billion in state spending from 2026 through 2030. Those are not rounding errors; they are the price of a policy preference that California has chosen to pursue despite years of warnings, explicit statutory prohibition, and unambiguous administrative guidance.
The question is no longer whether California’s provider tax violates federal law. It does. The question is whether any federal official—in the Trump administration, in CMS, in the Department of Health and Human Services—possesses the institutional resolve to enforce that law against a state of 39 million people with a $300 billion budget and an unlimited capacity for legal and political warfare.
The Mechanics of the Gimmick: How Provider Taxes Became Money Laundering
To understand why California’s provider tax is not merely aggressive but abusive, one must first understand the peculiar economics of Medicaid financing. Medicaid is a joint federal-state programme, with the federal government matching state expenditures at rates determined by each state’s per capita income. For every dollar California spends on Medicaid, the federal government contributes approximately 50 cents—more for certain populations and services, less for others, but always a substantial subsidy.
This matching structure creates an obvious incentive: states want to maximise their federal matching funds while minimising their own financial contributions. The provider tax is a mechanism for achieving precisely this objective.
Here is how it works. A state imposes a tax on healthcare providers—hospitals, nursing homes, managed-care organisations—that participate in Medicaid. The revenue from this tax is deposited into the state treasury and then returned to the same providers in the form of increased Medicaid reimbursements. The state claims these increased reimbursements as state Medicaid expenditures, triggering federal matching funds. The net effect is that the federal government pays the majority of the cost of the tax, which is then returned to the providers who paid it, with the state contributing little or nothing of its own resources.
The CMS description of this arrangement as “money laundering” is not hyperbole; it is structurally accurate. Money flows from providers to the state, from the state to providers (via increased reimbursements), and from the federal government to the state (via matching funds). The only party that consistently loses money in this circular flow is the federal taxpayer.
Congress has long recognised the abusive potential of provider taxes and has imposed various restrictions on their use. States are permitted to levy such taxes, but they must be broad-based and uniform—applied equally to all providers in a class, not selectively targeted to maximise federal matching. The requirement of uniformity is intended to prevent precisely the kind of discriminatory taxation that California has perfected.
California’s provider tax on managed-care organisations violates this uniformity requirement in the most brazen possible manner. Insurers covering Medicaid enrollees are assessed at $274 per enrollee per month. Insurers covering other populations—those with employer-sponsored coverage, individual market plans, Medicare Advantage—are assessed at $2.25 per enrollee per month. The 122-to-1 ratio is not an accident of actuarial science; it is a deliberate design feature engineered to extract maximum federal dollars from the Medicaid population while shielding commercially insured Californians from any significant tax increase.
The Regulatory History: Years of Warnings, Repeated Non-Compliance
California cannot claim ignorance of the law. The state has been on notice regarding the problematic nature of its provider tax for years. CMS has issued repeated warnings. The Trump administration’s proposed rule, published in May 2025, explicitly identified California’s tax as non-compliant and proposed to terminate the loophole immediately upon publication of the final rule. Congress, through a provision in the Big Beautiful Bill Act, enacted statutory language closing the loophope, with the provision becoming effective “upon the date of enactment.”
The only remaining question was the duration of any transition period. The statute authorised CMS to determine an “appropriate” transition period of up to three fiscal years. In November 2025, CMS issued guidance indicating that the transition period would last until the end of the state’s current fiscal year—for California, until June 30, 2026.
This guidance was explicit, unambiguous, and communicated through formal channels. It informed California that it had until June 30, 2026, to bring its provider tax into compliance with federal law. It did not invite negotiation. It did not offer alternative interpretations. It stated, clearly and finally, what the law required and when compliance was expected.
Newsom’s budget, released in January 2026, simply ignores this guidance. It assumes that the existing, non-compliant tax structure will remain in place through December 2026—a full six months beyond the deadline established by CMS. It offers no explanation for this departure from federal requirements. It does not acknowledge that the tax is illegal. It proceeds as if the law has not changed, as if the warnings were never issued, as if the billions of dollars at stake are California’s to claim regardless of what Congress and the administration have decided.
This is not oversight; it is defiance. It is the posture of a state that has concluded, perhaps correctly, that federal enforcement mechanisms are too weak, too slow, and too politically costly to constrain its behaviour.
The Political Theatre: Performative Anti-Fraud vs. Substantive Compliance
The dissonance between Newsom’s public posture and his budgetary choices could not be more stark. His press office floods social media with exposés of healthcare fraud in red states—Texas, Florida, Mississippi—casting California as the vigilant guardian of taxpayer dollars against Republican malfeasance. The implication is clear: we are the responsible ones; they are the scammers.
Yet the budget tells a different story. California is not merely resisting federal efforts to close a loophole; it is actively seeking to perpetuate a funding gimmick that even the Biden administration—no enemy of Medicaid expansion—recognised as abusive. The $33.2 billion in federal savings that CMS estimates would result from closing this loophole is not an abstract fiscal projection; it is the measure of California’s intended extraction from the federal treasury.
This is not to suggest that California is uniquely culpable. Other states have employed similar provider tax arrangements, and some have resisted compliance with federal restrictions. But California is not other states. It is the nation’s most populous state, its largest economy, and its most visible progressive laboratory. Its choices carry symbolic weight far beyond their fiscal impact. When California defies federal law on a matter of healthcare financing, it signals to every other state that compliance is optional, that enforcement is unlikely, and that the costs of non-compliance are manageable.
The Newsom press operation’s focus on fraud in red states is therefore not merely hypocritical; it is strategically convenient. It directs public attention outward, toward Republican malfeasance, and away from California’s own choices. It invites the press and the public to share the governor’s indignation about waste in Texas while ignoring the $33 billion gimmick in his own budget. It is a classic political misdirection, executed with considerable skill and absolutely no shame.
The Enforcement Dilemma: Why CMS Hesitates
If California’s provider tax is so clearly illegal, and if CMS has the statutory authority to enforce compliance, why hasn’t the agency done so? The answer illuminates the structural weakness of federal enforcement in intergovernmental fiscal relations.
The most direct enforcement mechanism available to CMS is the withholding of federal matching funds. If a state refuses to comply with federal Medicaid requirements, the secretary of Health and Human Services can reduce or terminate the state’s federal funding. This is the nuclear option, and it is rarely employed because its consequences are so severe. Withholding funds from California would disrupt healthcare coverage for millions of beneficiaries, destabilise the state’s healthcare delivery system, and generate immense political backlash.
The threat of fund withholding is therefore a bluff that both sides know is a bluff. California understands that CMS is unlikely to trigger a public health crisis in the nation’s largest state over a $33 billion accounting dispute. CMS understands that California understands this. The result is a stable equilibrium of non-compliance: California continues to employ its illegal tax; CMS continues to issue warnings and guidance; Congress continues to pass statutes closing loopholes that remain open. The only losers are the federal taxpayers who fund the matching payments and the beneficiaries in other states whose programmes compete with California for有限 federal resources.
The November 2025 CMS guidance, which purported to establish a June 30, 2026 compliance deadline, is the latest iteration of this equilibrium. It is a firm deadline, clearly stated, with no apparent ambiguity. But it is also a deadline that CMS has limited capacity to enforce and that California has already signalled its intention to ignore. The question now is whether the Trump administration, which has demonstrated considerably less patience with state non-compliance than its predecessor, will be willing to escalate the conflict—to move from guidance to enforcement, from warnings to consequences.
The Path Forward: What Compliance Would Require
Bringing California’s provider tax into compliance with federal law would require either equalising the tax rates across all managed-care enrollees or repealing the tax entirely and replacing the lost revenue with other state funds.
Equalisation would mean either raising the tax on commercially insured enrollees from $2.25 to $274 per month—a politically impossible increase of more than 12,000 per cent—or reducing the tax on Medicaid enrollees from $274 to $2.25 per month, which would eliminate virtually all of the revenue the tax currently generates. Either option would impose substantial costs on California, either by increasing taxes on commercially insured residents or by requiring the state to replace billions in lost provider tax revenue with general fund appropriations.
Repeal is equally unpalatable. The provider tax generates approximately $15 billion annually for California’s Medicaid programme, a sum that cannot be replaced without significant budget cuts or tax increases elsewhere. Newsom’s budget, which assumes the tax will continue through December 2026, offers no plan for managing its elimination. The state has simply decided, as a matter of fiscal policy, to pretend that the problem does not exist and hope that federal enforcement never materialises.
This is not a sustainable posture. The gap between what California’s budget assumes and what federal law permits is not a minor technical discrepancy; it is a multi-billion-dollar chasm that will eventually require resolution. The longer California delays compliance, the more difficult the eventual adjustment will be—and the more aggressive federal enforcement is likely to become.
Conclusion: The Price of Defiance
Gavin Newsom’s press office will continue to tweet about healthcare fraud in Texas. His budget will continue to assume the continued operation of an illegal tax. His administration will continue to hope that CMS blinks, that Congress loses interest, that the $33 billion question simply fades away.
It will not. The provider tax loophole has been identified, analysed, condemned, and statutorily closed. The only remaining question is whether the closure will be enforced. That question will be answered not in Sacramento but in Washington, not by budget assumptions but by regulatory action, not by social-media posts but by the exercise of federal authority.
The Trump administration has an opportunity here that its predecessor lacked. It can demonstrate that the rule of law applies to all states equally, regardless of size or political complexion. It can insist that California, like every other state, must comply with federal Medicaid requirements within the transition period established by CMS. It can enforce the statutory prohibition on discriminatory provider taxes and capture the $33 billion in savings that Congress intended.
Or it can allow California’s defiance to stand, signalling to every other state that non-compliance carries no meaningful cost and that federal statutes are merely suggestions to be ignored when inconvenient. The choice will reveal much about the administration’s conception of its own authority—and about whether the federal government retains the capacity to enforce its laws against the most powerful states in the union.
Q&A Section
Q1: What is a Medicaid provider tax, and how does California’s version violate federal requirements?
A1: A Medicaid provider tax is a state levy on healthcare providers that participate in Medicaid. States use the revenue from these taxes to claim federal matching funds, effectively shifting costs to Washington. Federal law requires such taxes to be broad-based and uniform—applied equally to all providers in a given class—to prevent states from gimmicking the system. California’s tax on managed-care organisations violates this uniformity requirement by imposing wildly disparate rates: insurers covering Medicaid enrollees are taxed at $274 per enrollee per month, while insurers covering commercially insured populations are taxed at just $2.25 per enrollee per month. This 122-to-1 ratio is deliberately designed to maximise federal matching funds from the Medicaid population while shielding commercially insured Californians from significant tax increases. CMS has described such arrangements as “money laundering,” and Vice President Biden reportedly called them a “scam.”
Q2: What actions have Congress and CMS taken to close this loophole, and how has California responded?
A2: The Trump administration issued a proposed rule in May 2025 to close the loophole, estimating $33.2 billion in federal savings from 2026-2030. Congress then enacted statutory language in the Big Beautiful Bill Act making the prohibition effective “upon the date of enactment,” with CMS authorised to determine an “appropriate” transition period of up to three fiscal years. In November 2025, CMS issued guidance stating that the transition period would last until the end of the state’s current fiscal year—for California, June 30, 2026. Despite these clear statutory and regulatory signals, Governor Newsom’s January 2026 budget assumes the non-compliant tax will continue through December 2026, a full six months beyond the CMS deadline. California has offered no explanation for this departure from federal requirements and has not proposed any alternative compliance pathway. This is not oversight but deliberate defiance.
Q3: Why does the article describe California’s anti-fraud social media posts as “performative virtue-signalling” and “strategic misdirection”?
A3: The article makes this characterisation because the dissonance between California’s public posture and its budgetary choices is so extreme. Newsom’s press office aggressively publicises healthcare fraud investigations in Republican-led states, positioning California as the vigilant guardian of taxpayer dollars against red-state malfeasance. Yet the governor’s own budget assumes the continued operation of a funding gimmick that Congress has explicitly outlawed and CMS has described as “money laundering.” This is not merely hypocrisy; it is strategically convenient hypocrisy. By directing public attention and media scrutiny toward fraud in Texas, Florida, and Mississippi, the Newsom administration seeks to deflect attention from its own $33 billion extraction scheme. The implication—”we are the responsible ones; they are the scammers”—is directly contradicted by the fiscal choices embedded in the state budget.
Q4: What is the “enforcement dilemma” facing CMS, and why has the agency hesitated to withhold funds?
A4: The enforcement dilemma arises from the asymmetry between the severity of the available sanction and the political costs of imposing it. The most direct enforcement mechanism available to CMS is withholding federal Medicaid matching funds. However, withholding funds from California—the nation’s most populous state, with 39 million residents and a $300 billion budget—would disrupt healthcare coverage for millions of beneficiaries, destabilise the state’s healthcare delivery system, and generate immense political backlash. Both sides understand that this is a bluff: California knows CMS is unlikely to trigger a public health crisis over a $33 billion accounting dispute, and CMS knows California knows this. The result is a stable equilibrium of non-compliance: California continues its illegal tax; CMS issues warnings and guidance; Congress passes statutes closing loopholes that remain open. The November 2025 guidance establishing a June 30, 2026 deadline is the latest iteration of this equilibrium, but California’s budget indicates it will simply ignore this deadline as it has ignored previous warnings.
Q5: What options does California have to achieve compliance, and why are they politically unpalatable?
A5: California has two basic options to achieve compliance, both politically difficult:
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Equalise tax rates: Either raise the tax on commercially insured enrollees from $2.25 to $274 per month (a 12,000 per cent increase, politically impossible) or reduce the tax on Medicaid enrollees from $274 to $2.25 per month (which would eliminate virtually all revenue the tax currently generates).
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Repeal the tax: Eliminate the provider tax entirely and replace the approximately $15 billion in annual revenue with general fund appropriations or budget cuts.
Neither option is attractive. Raising taxes on commercially insured Californians would generate fierce opposition from employers, insurers, and voters. Cutting Medicaid provider payments or eliminating the tax would require the state to find $15 billion annually from other sources—equivalent to roughly 5 per cent of the state’s general fund. Newsom’s budget simply assumes the problem away, extending the illegal tax through December 2026 with no plan for compliance. This is not a sustainable posture; the gap between what California’s budget assumes and what federal law permits is a multi-billion-dollar chasm that will eventually require resolution, and the longer compliance is delayed, the more disruptive the eventual adjustment will be.
