Federal-Level Changes Could Materially Alter Medicaid Funding And Place A High Burden On States

Uncertainty surrounding the level of federal participation in the Medicaid and CHIP funding partnership could make states' budgets more vulnerable to medical cost increases. Absorbing higher costs could also be more difficult during an economic downturn if revenue trends decline and Medicaid rolls increase. S&P Global Ratings considers Medicaid expenditures to be a nondiscretionary, fixed cost for most states, given that state-level Medicaid changes must remain compliant with all federal requirements, barring a waiver or allowance to modify Medicaid.

Several options that might be considered as part of the budget reconciliation process that could affect Medicaid include:

• Moving to a fixed block grant program structure;
• Establishing work requirements for eligibility;
• Lowering the current 50% floor for certain states' federal medical assistance percentage (FMAP);
• Reducing the federal reimbursement rate, which varies by state; and
• Limiting or eliminating states' ability to levy provider taxes.

The move to a fixed block grant could cap federal Medicaid funding to states, with annual adjustments tied only to population growth. This is a departure from the current percentage-based federal-state formula, which is adjusted based on various economic, demographic, enrollment, or health care demands that necessitate funding adjustments. Other options' impacts could be costly, such as establishing work requirements to determine or retain Medicaid eligibility, or lowering the current floor for certain states' FMAP set in statute at 50%. This change could affect 10 higher income states that currently receive funding at this rate, as could lower federal reimbursement of adult Medicaid expansion population to states' normal FMAP formula rate from the current 90%. Another option--to limit or eliminate states' levying of provider taxes--could remove a key Medicaid program funding source used by 49 states.

This shift in funding responsibilities could introduce downside credit risks for states if absorbing higher Medicaid costs strains their financial capacity, or if it is compounded by other structural budget pressures.

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States' Autonomy To Manage Medicaid Programs Could Partly Mitigate Elevated Funding Risks

Barring the emergence of other structural or economic pressures, we view most states as well-positioned to absorb short-term Medicaid spending increases. States' considerable expenditure flexibility and record-high reserves and liquidity amassed over the past three fiscal years could serve as a near-term buffer to manage some spending increases as they weigh long-term funding solutions. States have also demonstrated substantial resilience and increased savings for economic and fiscal uncertainties in the wake of the pandemic. Some, such as Indiana, Ohio, Oklahoma, Tennessee, and Utah have set aside resources through specified Medicaid stabilization or trust funds from accumulated excess savings to further cushion state finances during a potential transitional period in Medicaid funding.

To mitigate ongoing cost pressures, states might implement more drastic actions, including eligibility or benefit restrictions, or cut payments to providers to close Medicaid funding gaps. However, these actions could be partly counterbalanced by other costs associated with a higher uninsured population or cuts that can add financial stress on hospitals and health providers.

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A Strong Federal-State Medicaid Partnership Remains Critical To State Credit Quality

As it did in past economic downturns and recessions, periods where enrollment and health costs typically increase, the federal government helped close an otherwise substantial Medicaid funding gap during the pandemic, including through nearly $120 billion in emergency funding, automatic stabilizers, and enhanced Medicaid reimbursement rates. Providing this stability and expenditure flexibility for many state budgets aids general state credit conditions in countercyclical periods. A weaker federal response to future Medicaid program needs--whether due to reduced fiscal capacity, structural program and funding changes, or a change in policy--will likely further strain states' fiscal conditions in difficult economic times.

Considering elevated policy uncertainty on Medicaid funding, we'll continue to monitor how states balance health care quality and efficiency with reducing administrative and programmatic costs to curb Medicaid spending. In our opinion, this has made continuous budget monitoring and forecasting critical tools during this transition period.

Related Research

• U.S. States 2025 Outlook: Eyes On Washington, Focus On Budgets, Jan. 7, 2025
• U.S. State Medicaid Transition: Stable Condition Near Term, With Outyears Demanding Care, May 2, 2024