CHICAGO — The future of Medicaid, which eats up nearly a quarter of states’ budgets, will play a key role in governments’ fiscal health over the next several years, Standard & Poor’s said in a new report on the federal program.

The costly entitlement program is growing as the country’s population ages and states grapple with a weak economy.

Those demographcis pose a problem not only for states, but also for the national economy, analysts warn. States rely heavily on federal matching funds to finance Medicaid.

Federal aid usually increases during times of recession. But the program’s growing costs, the fate of the new health care law, and proposed cuts to federal funding all pose big challenges to states’ fiscal positions over the next several years, according to the report, “States of Health: Medicaid May Not Imperil State Credit Quality, But It Presents a Long-Term Budget Challenge.”

Unlike the Medicare old-age health insurance program, Medicaid, which serves those with low incomes, is jointly financed by states and the federal government.

It represents one of the largest parts of a state’s budget next to education, and any changes to the program often have a direct impact on a state’s fiscal health. But it’s uncertain what that impact will be over the next several years, according to Standard & Poor’s.

Under the new health care law, states starting in 2014 are required to expand  Medicaid eligibility requirements.

The expansion will increase Medicaid spending by $627 million through 2021, and state funding by $60 billion, according to the Congressional Budget Office.

The future of the new law is uncertain after the Supreme Court agreed recently to hear several challenges to the act, including those brought by several states fighting the law based on the increase in spending.

Efforts to reduce the federal deficit could also impact Medicaid. Several lawmakers and President Obama have proposed major structural changes to the program, and that could mean big cuts on the horizon, S&P said.

Those changes could also give states greater flexibility in how they design the program, which would be a credit-positive. For states, part of the problem is that Medicaid rolls tend to expand during economic downturns.

That means states need to increase spending as revenues fall.

But the federal government has historically stepped in with more aid to protect states from the worst of the blows, analysts said. The stimulus act, for example, included $105 billion of additional dollars for states with Medicaid costs.

“This was welcome — albeit only partial — fiscal assistance for states that faced cumulative budget gaps totaling an estimated $431 billion between fiscal years 2009 and 2011,” S&P analysts said in the report.

The current debate over the deficit and the health care law, as well as the coming 2012 elections, make it unlikely that an increase in aid would materialize.

“While we are skeptical that extraordinary federal funding would be made available given the current political landscape, it is not clear to us that funding reductions to the program are likely,” S&P said.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.