CHICAGO — Illinois Gov. Pat Quinn unveiled a plan Thursday to trim $2 billion in Medicaid spending through cuts and other savings while raising $700 million in new revenue from a cigarette tax hike and federal matching funds in an attempt to ease the program’s strain on state finances.

Quinn’s restructuring calls for a rate reduction in compensation to providers of $675 million and $1.35 billion in various cuts, reductions and other efficiencies. He wants to raise the state’s tax on a cigarette pack by $1 to generate $337.5 million which would leverage the same amount in federal funds.

“We must act quickly to save the entire Medicaid system from collapse, and protect providers and the millions of Illinois residents that depend upon Medicaid for their health care,” the governor said. “This proposal will fundamentally restructure our Medicaid system, alleviate the pressures on the rest of our budget and ensure the program is sustainable for years to come.”

The proposals stem from discussions held by Quinn’s administration and a working group of lawmakers and impacted parties. The governor earlier this year warned of the dire need to revamp Medicaid and tackle pension reforms when he unveiled his $33.9 billion fiscal 2013 operating budget. Spending on the two consume 39% of state general fund revenues. Proposed pension reforms will be announced Friday.

The two issues along with a backlog of $8 billion of unpaid bills are straining the state’s fiscal balance sheet, and Standard & Poor’s has warned that a failure to act could result in a downgrade to Illinois’ A-plus rating. S&P assigns a negative outlook. Moody’s Investors Service rates the state’s general obligation debt A2 with a stable outlook and Fitch Ratings assigns an A with a stable outlook.

The state’s Medicaid program serves 2.7 million and officials expect to close out the fiscal year in June with $1.9 billion in unpaid Medicaid bills. The Civic Federation of Chicago warned in a recent report that the number could grow to $21 billion by 2017 absent changes, putting straining the state’s ability to fund education, public safety and capital projects. Spending has grown by 6% annually since 2008 due to the program’s growing rolls.

The proposal aims to reduce fraud and abuse, eliminate or reduce coverage for some, and cut coverage of some services along with reimbursement levels. The state anticipates federal matching funds for the revenues collected from the cigarette tax increase. “This is a balanced approach,” Quinn said. 

Reaction to the plan was mixed and it’s unclear whether Quinn can win over lawmakers on the cigarette tax hike. The Senate has twice passed an increase only to see it fail in the House. “It’s just good fiscal and health policy and it should be part of our Medicaid stabilization plan in Illinois,” a statement from Democratic Senate President John Cullerton said.

“We have been working with the governor and it’s all part of the equation to get to a balanced budget,” Steve Brown, a spokesman for Democratic House Speaker Michael Madigan, said of Quinn’s overall plan.

Republic Senate Minority Leader Christine Radogno and House Minority Leader Tom Cross said in a joint statement; 'We are encouraging the working group to continue working in a bi-partisan way to come up with $2.7 billion in Medicaid reforms and cuts, not revenue enhancements,” they said.

The American Cancer Society praised it as the tax increase likely would reduce the number of smokers, while hospital groups warned of the dire impact of the proposed cuts. The Illinois Hospital Association praised some components of the plan but said hospitals couldn’t afford the combined impact of $500 million in rate cuts and other reductions. “The proposal is still too drastic and too rash to impose on the state’s already fragile health care system,” the association said.

The Medicaid issue is just one of two developing issue challenging hospitals here. Quinn recently lifted a six-month moratorium on stripping hospitals of their property tax-exemptions for failing to provide sufficient charity care.

A long debate over whether nonprofits provide enough charity care escalated last August when the Illinois Department of Revenue moved to deny exemption applications for three hospitals for providing charity care equal to just 1% to 2% of their operating revenues. Hospitals here must submit a new application for a property tax-exemption under several circumstances including a change in ownership or in use and other capital changes.

In a special report Monday, Fitch warned that “the additional cost of property taxes could negatively affect the ratings for Illinois not-for-profit other hospitals” with lower-rated credit particularly vulnerable due to their limited ability to absorb the added expenses.

“Fitch will review the credit impact of property tax payments on a case-by-case basis, which will be dependent on the assessed valuation and tax rate, the credit profile of the organization, and management’s plan to absorb the impact on operating profitability,” the report’s authors, Dana Sodikoff and Jim LeBuhn, wrote.

Fitch rates 19 Illinois-based hospitals and health care systems between AA to BBB-plus.  The agency also believes similar crackdowns could escalate nationally as “states and local governments look for additional revenue sources.”

Illinois’ actions don’t affect a hospital’s federal status that allows it to tap the tax-exempt bond market, but Bank of America Merrill Lynch’s municipal research group led by John Hallacy warned in a recent review that the crackdown could eventually spread.

“As mergers and acquisitions escalate, and more exemptions are reviewed, Illinois hospitals could find themselves with greater amounts of taxed property,” the group wrote. “Another concern of hospitals is that the property tax precedent might give some leverage to the state or federal authorities to use to question the tax exemption in other areas, such as for borrowings.”

Illinois’ hospitals trade at a higher spread because of their challenges. Hallacy’s group noted that a review of trades showed the spread differential between A-rated Illinois health care bonds and aggregate A health care credits was greatest at around 41 basis points during the period reviewed, compared to 23 basis points for the AA category and 30 basis points for the BBB category.

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