Medicaid is the nation’s largest health insurer, covering over 70 million Americans.  And, as a new CCF report documents, it is a particularly important source of coverage for children and adults in rural areas and small towns.  Republicans in the House are reportedly discussing (here and here) cutting federal Medicaid spending by up to $2.3 trillion (with a “t”) or more. These federal “savings” would be achieved not by reducing health care inflation but by cutting federal Medicaid payments to states. This will force states to dramatically raise taxes, cut other parts of their budget like K-12 education to make up the shortfall and, as is most likely, make deep and damaging cuts in eligibility, benefits, and/or payments to providers and plans. Those cuts, in turn, will lead to millions of people having their Medicaid benefits reduced or losing their Medicaid coverage altogether.  The resulting increase in the number of uninsured Americans — there’s been no reported discussion of “replace” — will disrupt a critical source of revenue for many hospitals, clinics, nursing facilities, and other providers, especially in those rural and urban communities where Medicaid is a dominant payor.  

That much is obvious. Or at least it should be. What is less well understood is that large cuts in federal Medicaid payments to states may also affect state credit ratings. States commonly borrow funds in order to finance capital spending like roads and schools and other infrastructure, usually by issuing general obligation bonds. Investors who purchase the bonds generally demand an interest rate that is consistent with the risk that the state will not be able to honor its financial obligations and they will not be repaid when the bond matures.  They look to credit rating agencies to assess that risk.  The greater the risk of nonpayment, the lower a state’s credit rating, and the higher the interest the state must pay in order to borrow the funds it needs for investment. In some states, a strong credit rating is a particular point of pride for policymakers.

So, what does Medicaid have to do with state credit scores?  As it happens, quite a bit.  The National Association of State Budget Officers estimates that total spending by all states in state fiscal year 2024 will be $3.064 trillion (with a “t”).  Federal funds will be the source of one third of that amount— $1.047 trillion. (The other sources are state general funds, other state funds, and bonds).  Of that $1.047 trillion, federal Medicaid funds are estimated to account for over half—$588 billion, or 56.1 percent—which is by far the largest source of federal funding for states budgets.  In short, federal Medicaid funds alone represent a little under one fifth of states’ total spending.  A significant cut in federal Medicaid funds will matter.

For this reason, companies that track state creditworthiness are watching the unfolding Medicaid debate in Congress carefully.  Here’s what S&P Global has to say in its U.S. States 2025 Outlook posted on January 7:

“…the largest flow of funds from the federal level to the states occurs in the Medicaid program. Thus, any benefit, formula, or reimbursement rate changes to Medicaid, made as an offset to the cost to extend the [Tax Cuts and Jobs Act of 2017], or otherwise, could have state-level credit quality effects as well.”

The analysis goes on to explain:

“Federal-level changes could alter Medicaid funding and place a high burden on states.   As it did in past downturns, the federal government helped close an otherwise substantial Medicaid funding gap during the pandemic, including nearly $120 billion in emergency funding during a period of higher health costs and enrollment, providing stability and expenditure flexibility for many state budgets. However, our sector view incorporates uncertainty surrounding the level of federal cooperation and Medicaid funding partnership in future years that could make states more vulnerable to higher medical costs or reduce budgetary flexibility during economic downturns. A weaker federal response to future Medicaid program needs–because of reduced fiscal capacity, structural program and funding changes, or a change in policy–could strain states’ economic and fiscal conditions. If this occurred, states might implement eligibility restrictions, benefit restrictions, or cut payments to providers to close Medicaid funding gaps, although these actions could be partly counterbalanced by other costs associated with a higher uninsured population.”

In June of 2017, when Congress last considered capping and cutting federal Medicaid funds to states as part of the ultimately unsuccessful effort to repeal and replace the Affordable Care Act, Fitch Ratings expressed similar concerns.

Medicaid cost shifts from the federal government to the states are unlikely to stop at the state level. Counties and cities are also at risk.  Here is the S&P Global view from their U.S. Local Governments 2025 Outlook (January 8):

“As the federal government takes up budget negotiations next year, we’re watching fiscal policy closely. A reduction in funding for programs administered by the states, in particular Medicaid, could have wide-ranging consequences for state and [Local Government] budgets and their ability to keep funding current priorities. Counties, often the medical providers of last resort for underinsured populations, might have limited ability to reduce emergency and inpatient expenditures in the event of a broader devolution of health care spending to states. Still, even a unified Republican government could be hard-pressed to make sweeping funding cuts; states on both sides of the aisle have benefitted from federal spending programs, including Biden-era CHIPS and Inflation Reduction Act funds.”

There are lots of questions that state and local officials, as well as constituents, should be asking their Congressional delegations about how their state or locality can be expected to deal with hundreds of billions (if not trillions) of dollars in cuts in federal Medicaid spending over the next ten years. As noted above, these cuts are simply a cost shift from the federal government to states and localities, which we know will put children and families at risk for loss of health insurance coverage and increased medical debt.  What we don’t know is how much of a cost shift a particular state or locality can absorb without seeing its credit rating fall? If the cost shift is too large, what actions, if any, can the state or locality take to avoid having its credit rating decline? And what are the implications of impaired credit ratings for state and local infrastructure and economic growth?