“Federal Medicaid Cuts: A Credit Crunch for States and Its Impact on Public Health”

Medicaid stands as the largest health insurance program in the country, providing coverage to more than 70 million Americans. Furthermore, as documented in a recent CCF report, it serves as a particularly vital source of coverage for both children and adults residing in rural regions and small communities. Reports indicate that House Republicans are deliberating (here and here) cutting federal Medicaid expenditure by as much as $2.3 trillion (with a “t”) or beyond. These federal “savings” will not come from mitigating healthcare inflation but rather by slashing federal Medicaid payments to states. This predicament will compel states to substantially increase taxes, reduce other segments of their budgets such as K-12 education to compensate for the deficit, and, more likely than not, impose drastic and harmful reductions in eligibility, benefits, and/or payments to providers and plans. Such reductions will inevitably result in millions of individuals having their Medicaid benefits diminished or losing their coverage entirely. The subsequent rise in uninsured Americans—there has been no noted dialogue about “replacement”—will jeopardize a crucial source of income for numerous hospitals, clinics, nursing homes, and additional providers, particularly in those rural and urban regions where Medicaid plays a predominant role.

This much is clear. Or at the very least, it ought to be. However, what is less widely recognized is that substantial reductions in federal Medicaid payments to states may also influence state credit ratings. States frequently borrow capital to fund initiatives such as infrastructure projects, typically by issuing general obligation bonds. Investors who acquire these bonds generally demand an interest rate that aligns with the risk of the state failing to meet its financial responsibilities, which includes repayment at bond maturity. They rely on credit rating agencies to evaluate that risk. The higher the risk of default, the lower a state’s credit rating, resulting in a greater interest rate that must be paid to borrow the necessary funds for investment. In certain states, possessing a robust credit rating is a source of pride for legislators.

So, how is Medicaid connected to state credit assessments? As it turns out, significantly. The National Association of State Budget Officers projects that total spending by all states in the fiscal year 2024 will amount to $3.064 trillion (with a “t”). Federal funding will constitute one-third of that total— $1.047 trillion. (The remaining funds come from state general funds, other state funds, and bonds). Federal Medicaid funds are expected to comprise over half of that $1.047 trillion— $588 billion, or 56.1 percent—making it by far the most significant source of federal funding for state budgets. In summary, federal Medicaid funds alone account for just under one-fifth of total state expenditures. Therefore, any significant reduction in federal Medicaid funds will be consequential.

For this reason, organizations that monitor state credit viability are closely observing the ongoing Medicaid discussions in Congress. Here’s what S&P Global remarked in its U.S. States 2025 Outlook published on January 7:

“…the largest transfer of funds from the federal level to the states occurs in the Medicaid program. Hence, any modifications to benefits, formulas, or reimbursement rates related to Medicaid, instituted as an offset to the expenses of extending the [Tax Cuts and Jobs Act of 2017], or otherwise, could impact state-level credit quality as well.”

The analysis continues to clarify:

“Changes at the federal level could alter Medicaid funding and impose significant pressures on states.   As seen during previous downturns, the federal government bridged a considerable Medicaid funding deficit during the pandemic, including nearly $120 billion in emergency assistance amid increased healthcare costs and enrollment, providing stability and expenditure flexibility for numerous state budgets. Nevertheless, our sector perspective contains uncertainties regarding the degree of federal collaboration and Medicaid funding partnerships in forthcoming years that could render states more susceptible to escalating medical expenses or lessen budgetary flexibility during economic recessions. A diminished federal reaction to future Medicaid program demands—due to reduced fiscal capacity, structural program adjustments, or policy changes—could strain the economic and fiscal conditions of states. Should this transpire, states may impose eligibility limitations, benefit restrictions, or diminish payments to providers to reconcile Medicaid funding deficits; however, these actions could be somewhat counterbalanced by other expenses tied to a growing uninsured population.”

In June 2017, when Congress contemplated limiting and reducing federal Medicaid funding to states as part of the ultimately failed attempt to repeal and substitute the Affordable Care Act, Fitch Ratings voiced comparable apprehensions.

The shifts in Medicaid costs from the federal government to the states are improbable to end solely at the state level. Counties and cities also face risks. Here’s the perspective from S&P Global in their U.S. Local Governments 2025 Outlook (January 8):

“As the federal government undertakes budget discourse next year, we are closely monitoring fiscal policies. A decrease in funding for state-administered programs, particularly Medicaid, could have extensive repercussions for state and [Local Government] budgets and their capability to continue funding essential priorities. Counties, which frequently serve as the medical care providers of last resort for underinsured communities, may have limited options for reducing emergency and inpatient expenditures should there be a significant shift in healthcare spending to states. Nevertheless, even a unified Republican government may struggle to impose sweeping funding reductions; states across the political spectrum have benefited from federal funding programs, including Biden-era CHIPS and Inflation Reduction Act financing.”

There are numerous inquiries that state and local authorities, along with constituents, ought to pose to their Congressional representatives concerning how their state or locality plans to address hundreds of billions (if not trillions) in reductions in federal Medicaid expenditure over the upcoming decade. As previously mentioned, these cuts merely represent a cost shift from the federal level to states and localities, which we know will endanger children and families due to potential loss of health insurance coverage and mounting medical debt. What remains uncertain is the extent of cost shifts a specific state or locality can withstand without experiencing a decline in credit rating. If the cost shift is excessively large, what measures can the state or locality undertake, if any, to prevent a downgrading of its credit rating? And what consequences do impaired credit ratings have for state and local infrastructure and economic expansion?