(Bloomberg) -- California’s health-care plan for the poor, serving one in three people in the state and almost half its children, is facing a $1.1 billion funding gap amid a squabble over how to replace a tax the federal government said is unfair.

To finance Medi-Cal, California charges 25 managed-care plans a 3.9 percent tax on their total Medi-Cal revenue. The U.S. Department of Health and Human Services has said the levy fails to comply with federal guidelines because it doesn’t apply to all managed-care providers.

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If California doesn’t fix the system before its tax expires in June 2016, the state risks losing $1.1 billion in matching federal funds that help pay the health-care costs for 11.3 million people. Seven other states, including Georgia, Kentucky, Michigan, Missouri, Ohio, Oregon and Pennsylvania, levied taxes similar to California’s.

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“There are very dire consequences for not resolving the issue now,” said California Assemblyman Marc Levine, a Democrat. “If we have to cut the budget to fill this hole, it will require increasing tuition at universities, deferring maintenance on highways and cutting services to our most vulnerable populations.”

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Special session

Governor Jerry Brown, lawmakers and health plans haven’t been able to agree on how to replace the tax, prompting the governor to call a special session that convened earlier this month.

Brown, a Democrat, has proposed requiring about 40 managed- care organizations to pay the tax using a tiered system based on how many patients are enrolled in Medi-Cal. His budget office estimated the levy would raise $1.7 billion. Health providers would receive $1.1 billion, leaving them a financial liability of $660 million, according to a July 2 report by the state’s legislative analyst’s office.

His proposal would give some managed care organizations a competitive advantage, since those competing for Medi-Cal patients would be subject to different tax rates based on that enrollment, the legislative analyst’s office said in a July 20 report.

Health plans with higher taxes could cede market share to others with lower fees, according to the study.

Flat tax

Levine introduced a bill that would instead levy a flat tax of $7.88 for each person enrolled per month in 45 health plans that provide managed-care coverage to 21 million Californians.

Of the $1.9 billion raised under the proposal, $1.1 billion would pull in federal matching funds and the remainder would help pay for home-care services, developmental disability programs and increased reimbursement rates to Medi-Cal providers.

The state’s three largest managed-care organizations would owe substantially more tax under this structure, the legislative analyst’s office found.

“The governor has been clear that everything is on the table for discussion during this special session,” said Brown’s spokesman Evan Westrup.

Insurance providers say Brown’s and Levine’s plans would raise premiums for millions of consumers. The insurers are working with Brown’s office and legislators to devise a replacement to the existing tax, said Charles Bacchi, chief executive of the California Association of Health Plans, a Sacramento-based trade group.

“When the federal government changed course and declared taxes like California’s questionable it created a situation that threatens our state medical program,” Bacchi said. “What they are asking us to do is make employers and individuals pay a tax they don’t currently pay in order to receive federal funding.”

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California&rsquo;s health program for the poor faces $1.1 billion gap

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California’s health program for the poor faces $1.1 billion gap