September 21, 2020

Major Potential State Fiscal Risk Averted Following Withdrawal of Proposed Federal Medicaid Financing Regulation

This Budget and Policy post is intended to notify the Legislature of the federal government’s recent decision to withdraw the proposed Medicaid Fiscal Accountability Regulation (MFAR), proposed in 2019. For additional information on MFAR and its potential implications on state finances, please see the MFAR section of our report, The 2020‑21 Budget: Analysis of the Medi-Cal Budget.

Medi-Cal Is Funded Through a Variety of Financing Mechanisms. Medi-Cal is the state’s Medicaid program, providing health care coverage to around 13 million Californians at an annual cost of over $100 billion in total funds. Medi-Cal is funded through a variety of financing mechanisms and from a variety of sources. These fund sources include federal funds, state General Fund, local funds, and state special funds, the last of which are regularly funded with health care-related taxes. “Medi-Cal financing mechanisms” refer to the various methods by which non-General Fund revenues and funds are captured, generated, or transferred for use in the Medi-Cal program. Below are three examples of important Medi-Cal financing mechanisms:

  • Local Funds Provided by Public Hospitals. Public hospitals leverage billions of dollars in federal funding using their own local funds—in place of what otherwise likely would have to be state funds—to pay for the nonfederal share of cost of Medi-Cal services.

  • Hospital Quality Assurance Fee. The state levies a fee on stays in private hospitals. Revenues from this fee are used to increase hospital payments and help fund the Medi-Cal program.

  • Managed Care Organization (MCO) Tax. The state imposes a tax on MCOs, revenues from which are used to help fund Medi-Cal.

Federal Government’s MFAR Proposal Potentially Would Have Disallowed Many Major Medi-Cal Financing Mechanisms. In October 2019, the federal government released a draft regulation known as MFAR. As proposed, MFAR significantly modified federal Medicaid financial reporting requirements and financing rules, including those related to the use of state special funds, local funds, and health care-related taxes. Under the proposed version of MFAR, many of the state’s mechanisms for financing Medi-Cal with non-General Fund sources were at risk of ultimately being disallowed. For example, MFAR effectively would have prohibited health care-related taxes that place different tax rates on taxpayers based on their levels of Medicaid (versus non-Medicaid) activity. In their current forms, both the hospital quality assurance fee and the MCO tax likely would have run afoul of these rule changes.

As Proposed, MFAR Eventually Could Have Resulted in the Loss of Billions of Dollars in Non-General Fund Funding for Medi-Cal. By effectively disallowing certain major Medi-Cal financing mechanisms, MFAR could have resulted in the loss of billions of dollars in non-General Fund funding for Medi-Cal on annual basis. Rather than materializing immediately, the fiscal impact of MFAR on Medi-Cal likely would have fully materialized over the course of several years since the regulation gave states time to come into compliance with the rule changes. In response to MFAR, the Legislature would have had to take one or some combination of the following steps: (1) increase the General Fund contribution to the program, (2) make cuts to the program (such as to eligibility, benefit, and payment levels), and/or (3) make significant—and sometimes difficult—changes to Medi-Cal financing mechanisms to conform with MFAR rules.

In September 2020, the Federal Government Announced It Was Withdrawing MFAR. On September 14, 2020, the federal government announced that MFAR was no longer being pursued. In its withdrawal notice, the head of the federal agency that administers Medicaid cited state and health care provider concerns that MFAR could have unintended consequences, noting that these potential unintended consequences warrant further study. Included among the many states that submitted comments, in January 2020, both the Department of Health Care Services and the Department of Finance submitted letters to the federal government voicing major concerns with the proposed regulation.

Withdrawal of MFAR Saves the State From Having to Make Major Changes to Medi-Cal Financing in the Near Term. The withdrawal of MFAR means that the state—in the near term—likely will not have to make major changes to Medi-Cal financing in response to changes in federal rules. However, we understand that some of the rule changes included in MFAR may reflect longstanding goals of federal policymakers. Accordingly, Medicaid financing rule changes similar to those included in MFAR potentially could re-emerge in future federal Medicaid rulemaking. Whether such future rulemaking would have as significant of impacts on Medi-Cal financing as the MFAR proposal would have is unclear and would depend significantly on the details of the proposed regulation.