Two health care groups have filed a lawsuit with the California Supreme Court challenging the state’s managed care organization tax.

The dispute centers on Senate Bill 125’s monthly managed care organization (MCO) tax of $8.85 for all health plan enrollees. The California Medical Association and the California Association of Health Plans said Oct. 2 that the tax violates Proposition 35, a voter-approved state law that capped the tax at $2.50 per enrollee per month for those with private insurance.

The associations also claim that SB 125, which comes into effect 2027–29, diverts MCO revenue to pay for general expenses in the state budget, in violation of Proposition 35 which directs the funds for use in the state’s Medicaid system, Medi-Cal.

“Health plans have historically supported the MCO tax as long as it was affordable and made meaningful improvements to Medi-Cal,” Charles Bacchi, president and CEO of the California Association of Health Plans, said in a statement.

“California should not resolve its budget shortfall by imposing a massive tax increase on health care costs for working families,” he said.

The plaintiffs are asking the California Supreme Court to invalidate SB 125 and block the state from submitting the current MCO tax plan for federal approval. They want the court to require state officials to submit a tax plan that complies with both Proposition 35 and federal law by Dec. 31, when the existing MCO tax structure expires, and spend the tax revenue only as Proposition 35 allows.

“California voters passed Proposition 35 and made it law,” Dustin Corcoran, CEO of the California Medical Association, said. “The state does not get to ignore that law simply because following the law is inconvenient.”

Federal rules changed with the 2025 One Big Beautiful Bill Act, which bars states from taxing Medicaid enrollment more heavily than other enrollment if they want to collect matching federal funds. Currently, California charges about $274 a month for a Medi-Cal enrollee and around $2 for a private health plan enrollee.

The governor’s office defended the new tax structure and disputed the groups’ allegations.

“The state disagrees with their claims, and we believe the courts will too,” the governor’s press office said in an email to The Epoch Times. “The MCO tax allows the state to protect healthcare for Californians.”

The governor’s press team said the MCO tax approved in this year’s budget allows the state to continue to support the Medi-Cal program and maintain targeted rate increases for Medi-Cal providers—including primary and maternal health care. 

They said it was crafted to comply with the federal law changes that Congress passed and Trump signed last year. They did not comment on Proposition 35.

U.S. Rep. Jay Obernolte (R-Calif.) said June 28 that he sent Newsom a letter wanting answers on whether the new MCO tax would raise costs for privately insured Californians.

“Families are already paying too much for health care,” Obernolte said in a post on X. “Sacramento should be working to lower costs, not finding new ways to pass them along to consumers.”