Federal health officials have identified approximately $1.3 billion in questioned Medicaid expenditures across several Democratic-led states, with California accounting for the overwhelming majority. The preliminary audit findings—representing many times more than California’s previous settlement just eighteen months ago—have ignited one of the fiercest federal-state healthcare battles in decades.
Seven States in Federal Crosshairs
CMS Administrator Dr. Mehmet Oz announced audits targeting California, Illinois, Oregon, Washington, Colorado, Washington, D.C., and Minnesota—all states with Democratic governors that opposed Trump in 2024.
“In California, we’ve already identified about $1.3 billion dollars of federal dollars spent to take care of illegal immigrants,” Oz declared, signaling an aggressive new enforcement posture.
What Federal Law Actually Allows
Federal Medicaid law prohibits matching funds for undocumented immigrants except for emergency medical conditions—life-threatening situations requiring immediate intervention like heart attacks, severe injuries, or labor and delivery.
Emergency Medicaid nationally accounts for about 0.4 percent of total spending, roughly $9 to $10 per resident, and California must now prove every dollar claimed met this narrow emergency standard.
How California Calculated Federal Reimbursement
The controversy centers on California’s “proxy methodology” for separating emergency from routine care in managed-care payments.
California applied a roughly 40 percent calculation—developed from early 2000s fee‑for‑service data—to determine what portion of insurance payments covering undocumented enrollees qualified for federal reimbursement, and federal auditors now claim this decades‑old formula significantly overcounted allowable emergency services.
California’s Medicaid Expansion for Undocumented Immigrants
In January 2024, California became the first state to provide comprehensive healthcare coverage to all income‑eligible residents regardless of immigration status.
The phased expansion began in 2016 with children, extended to young adults in 2020, seniors over 50 in 2022, and finally working‑age adults. State officials have emphasized that this broader coverage is primarily financed with state funds rather than new federal dollars.
When Costs Spiral Out of Control
California originally projected spending around $3 billion annually to cover several hundred thousand undocumented residents.
Subsequent estimates and budget updates showed costs rising sharply, with current projections or reported spending for the 2024‑2025 period in the range of $8.4 to $9.5 billion—several billion above initial estimates. Factors driving the increase include higher‑than‑expected enrollment, policy changes affecting seniors, and broader demographic and economic trends.
Enrollment Freeze Takes Effect
Facing a significant budget shortfall, California approved an enrollment freeze for new undocumented adults in Medi‑Cal beginning in January 2026, while allowing currently enrolled individuals to remain covered.
The state also scheduled the elimination of most dental benefits for undocumented adults on July 1, 2026, and a $30 monthly premium requirement starting in mid‑2027, changes that advocates warn will trigger substantial disenrollment and are projected to save the state hundreds of millions of dollars annually.
The September Policy Shift That Changed Everything
In September 2025, CMS issued guidance changing how states can claim federal emergency Medicaid reimbursement for undocumented immigrants.
The agency announced states can no longer make broad capitation payments to managed‑care organizations covering undocumented enrollees and then use proxy formulas to claim federal funds; instead, states must track and claim only actual emergency services provided, and federal auditors are applying this standard to California’s audit period.
Why the MCO Tax Became Controversial
Administrator Oz accused California of using managed‑care organization taxes and related financing arrangements to channel federal funds into coverage for undocumented immigrants.
In this model, California taxes insurance companies, uses that revenue to draw federal matching funds, then reimburses insurers through Medicaid payments, and Oz argued that new rules are needed to ensure federal Medicaid dollars are directed only to services permitted under federal law.
Democrats Allege Retaliation
The focus on Democratic‑governed states prompted immediate accusations of political motivation. Senator Kirsten Gillibrand condemned the actions as political retaliation, saying, “To use the power of the government to harm the neediest Americans is immoral and indefensible.”
The Medicaid audits coincided with legal battles over a large federal child‑care funding pause in Democratic states and threats to withhold Minnesota Medicaid funds, intensifying partisan tensions.
But Preliminary Findings Don’t Equal Final Bills
Critically, the Trump administration’s claims stem from preliminary audit findings, not legally enforceable disallowances.
Federal procedures require draft reports, state responses, exit conferences, formal disallowance letters, reconsideration periods, and appeal rights before repayment becomes mandatory. California has not publicly confirmed receiving a final, binding disallowance letter or agreeing to repay the full amount cited by CMS as of January 2026.
Safety-Net Hospitals Face Existential Crisis
California’s public hospitals, community clinics, and emergency departments face immediate pressure from both state budget actions and potential federal clawbacks. In recent years, multiple California hospitals have closed or narrowly avoided closure, and several facilities have reduced or shuttered key service lines, including maternity and pediatric units, citing financial strain.
Safety‑net hospitals often operate on margins in the low single digits; research indicates Medicaid expansion reduced uncompensated care costs substantially, and any major coverage rollback would likely reverse these gains and force difficult service reductions.
Federal Immigration Enforcement Connection
CMS has ordered states to verify immigration status for certain Medicaid enrollees identified through federal data matches, providing lists of names to selected states for review.
Data‑sharing agreements between CMS and the Department of Homeland Security and heightened verification efforts have created anxiety in immigrant communities, leading some eligible individuals to disenroll or avoid enrollment, which compounds coverage losses linked to fiscal and policy changes.
Historical Context
Federal‑state Medicaid disputes over eligibility and financing are not new: prior audits and investigations found states such as New York, California, Colorado, Kentucky, and Minnesota received billions in federal funds for potentially ineligible enrollees or problematic financing arrangements during the Affordable Care Act expansion years.
However, the current dispute’s scale, its concentration on Democratic‑led states, and the public nature of CMS’s announcements before final disallowances distinguish it from many earlier cases.
California’s Legal Options
California has already filed numerous lawsuits against the Trump administration on various policy disputes, showing a willingness to contest federal actions in court.
If administrative appeals fail, California may challenge any final disallowances in federal court, following precedents such as Bowen v. Massachusetts (1988), and state officials continue to insist that they rely on state‑only funding for individuals regardless of immigration status when federal law requires it.
Technical Challenges of Managed Care Accounting
Healthcare financing experts note genuine complexity in separating emergency from non‑emergency costs within prospective managed‑care payments. Capitation represents an aggregate amount for all services to defined populations, which makes retrospective emergency‑only calculations inherently imprecise and raises questions about retroactive policy shifts.
California could argue that applying the September 2025 guidance to prior periods conflicts with administrative law principles requiring reasonable notice before policy changes take effect, a contention Oz rejects by stating that “every dollar misspent is a dollar taken away from an eligible, vulnerable individual.”
Broader Federal Medicaid Cuts Create Compounding Pressure
The audit dispute is unfolding alongside sweeping changes to federal Medicaid policy enacted in the 2025 budget reconciliation law, which is projected to reduce federal Medicaid spending by about $911 billion over ten years, largely through eligibility and work‑requirement provisions.
Analysts estimate that these provisions could leave several million more Americans uninsured by 2034 and reduce federal matching rates for some categories of beneficiaries, increasing pressure on state budgets.
September Court Victory Offers Limited Relief
Photo by Bermix Studio on Unsplash
A federal judge in Texas struck down a set of CMS provider‑tax restrictions in 2025, ruling that the agency exceeded its authority and issuing a permanent injunction.
Congress soon after enacted similar restrictions and related Medicaid financing changes directly through the 2025 budget reconciliation law, effectively superseding the court’s ruling by embedding those limits in statute rather than regulation.
Timeline Remains Uncertain
The multi‑stage administrative process for Medicaid disallowances typically spans months or years. California may request formal CMS reconsideration, appeal to the HHS Departmental Appeals Board, negotiate reduced settlements, or litigate in federal court.
Without public access to the full preliminary audit report or any final disallowance documentation, definitive timelines and final repayment amounts remain uncertain
Implications for Healthcare Coverage Nationwide
California’s experience—rapid expansion of coverage for undocumented residents followed by retrenchment under fiscal and federal‑policy pressure—highlights the challenges facing other states considering similar programs.
Only a limited number of states currently provide substantial state‑funded coverage to undocumented immigrants beyond emergency services, and the federal audit dispute may further constrain policy innovation by creating uncertainty about acceptable financing mechanisms and the risk of retroactive enforcement.
Sources:
“California Improperly Claimed $52.7 Million in Federal Medicaid Reimbursement for Capitation Payments.” HHS Office of Inspector General, May 2024.
“Emergency Medicaid Services Provided to Undocumented Immigrants.” CMS State Medicaid Director Letter (SMD 25-003), September 2025.
“Emergency Medicaid Spending for Undocumented Immigrants Accounts for Less Than 1% of Total State Expenditures.” Kaiser Family Foundation, October 2025.
“Cost of undocumented healthcare in California is billions above estimates.” Los Angeles Times, March 2025.
“Understanding Recent Increases in the Medi-Cal Senior Caseload.” California Legislative Analyst’s Office, March 2025.
“Health Provisions in the 2025 Federal Budget Reconciliation Law.” Kaiser Family Foundation, December 2025.