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Tomorrow, California’s excise tax on cigarettes will jump by $2 per pack. This substantial increase is required by Proposition 56, which voters approved last November. In addition, the state’s excise tax on other tobacco products, such as chewing tobacco, will go up by an equivalent amount, and electronic cigarettes (“e-cigarettes”) that contain nicotine will be subject to this tax for the first time. Although excise taxes are generally levied on distributors, Prop. 56’s new taxes are expected to be passed on to consumers. In fact, tobacco companies have been raising their prices in the days leading up to the April 1 implementation of the measure.

By significantly boosting the prices of cigarettes and other tobacco products, Prop. 56 is expected to reduce tobacco consumption. However, because nicotine is highly addictive, the sad truth is that many Californians will continue to smoke, chew, and vape despite the high financial cost, not to mention the severe health consequences. As a result, Prop. 56 will raise substantial new state revenue — as much as $1.8 billion by June 2018, according to estimates from Governor Brown’s Department of Finance. The vast majority of this new funding — $1.3 billion — is required to go to Medi-Cal, which provides health care services to roughly 14 million Californians with low and moderate incomes.

Yet, while Prop. 56 clearly directs most of the new tobacco-tax revenues to Medi-Cal, a dispute has emerged over exactly how these dollars should be spent within the program. On the one hand, Governor Brown contends that Prop. 56 revenues can be used simply “to support new growth” in Medi-Cal spending. Put differently, the Governor proposes to use Prop. 56 dollars “to pay for typical year-to-year cost increases in Medi-Cal,” rather than using these funds to “expand the current scope” of the program, according to the Legislative Analyst’s Office (LAO). In the Governor’s view, this use of Prop. 56 revenues supplements, rather than supplants, existing General Fund support for Medi-Cal, and therefore is consistent with the measure’s requirements.

On the other hand, some advocates and state legislators say that Prop. 56 revenues for Medi-Cal must be used to increase payments for doctors, dentists, and other providers in the program. (We reached the same conclusion in our analysis of Prop. 56 last fall.) For example, doctors and dentists argue that the Governor’s interpretation “conflicts with the plain language” of Prop. 56, which “directs funds to be spent to improve access [to Medi-Cal services] by improving provider payments.” These groups also suggest that the Governor’s proposed use of Prop. 56 funds does not comply with the measure’s “non-supplantation” requirements for Medi-Cal spending.

Legislators could reject the Governor’s interpretation and craft a 2017-18 state budget that uses over $1 billion in Prop. 56 revenues to increase payments for Medi-Cal providers. Such an action, however, would create a hole of more than $1 billion in the Medi-Cal budget. This is because the Medi-Cal costs that the Governor proposes to pay for with Prop. 56 dollars would remain, and would need to be funded from a different revenue source. In theory, state policymakers could fill this hole with revenues from the state’s General Fund. However, unless revenue collections are expected to exceed the Governor’s most recent forecast (updated estimates are due out in May), shifting more General Fund dollars to Medi-Cal could require cuts to other state services.

Any way you look at it, this clash over the meaning of Prop. 56 is shaping up to be one of the key state budget battles of 2017.

— Scott Graves

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