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Last year at this time, Gov. Arnold Schwarzenegger was imploring his Legislature to spend billions of dollars to make California the second state to mandate health care coverage for all its residents. But in January, faced with a serious budget shortfall, the Republican governor reversed course, proposing cuts in Medicaid, the federal-state insurance program that covers 50 million low-income people nationwide.

For fiscal 2009, the governor proposed $650 million in Medicaid cuts, including reduced dental, vision, and mental health benefits for adults, as well as reductions in payments to doctors, hospitals, and other medical providers, said Robin Rudowitz, who is the principal policy analyst at the Kaiser Family Foundation’s Commission on Medicaid and the Uninsured. “California was looking at major reform last year. And part of that was to increase payment rates” to doctors and hospitals participating in Medicaid, she said. “This is a pretty big turnaround.”

Indeed, as the nation’s economy worsens, 22 states face a combined budget shortfall of $39 billion for fiscal 2009, according to the Center on Budget and Policy Priorities. The crunch has prompted states to rapidly shift gears on health care. Widespread efforts to expand insurance coverage have ground to a halt. Instead, a few states are contemplating reductions to Medicaid and the State Children’s Health Insurance Program, which many state leaders futilely pushed the federal government to expand last year.

Diane Rowland, executive director of the Kaiser Commission, points to one ironic consequence that confronts state governments during economic downturns: “When unemployment goes up, more people seek Medicaid coverage. When you need revenue the most, you have the least to meet the increased demand.”

For state Medicaid directors, “these are times of high stress,” Barbara Edwards, interim director of the National Association of State Medicaid Directors, said at a February briefing by the Alliance for Health Reform. Medicaid already consumes 20 to 24 percent of state budgets, she noted. “The demand grows just at the moment the state can least afford to pay for it. When Medicaid grows, it’s such a big piece of the budget that it puts immediate pressure on state budgets and can be a part of what drives deficits for state budgets.”

Every 1 percent increase in unemployment means that 2.5 million people across the nation lose their employer-sponsored health insurance, according to a February report by the Urban Institute. About 400,000 of them buy private insurance on their own, 1.1 million become uninsured, and about 1 million of the jobless enroll in Medicaid or SCHIP, according to the report. The increased cost to Medicaid and SCHIP totals about $3.4 billion, with states responsible for $1.4 billion of that amount, the report estimates. And, of course, the consequen-ces multiply as unemployment rises.

Perhaps an even costlier problem for Medicaid is that when workers lose their jobs, states lose significant tax revenue that they need to finance their share of the program. Currently, states pay about 40 percent of Medicaid’s costs, and the federal government pays the rest. The Urban Institute estimates that state revenue could drop 3 to 4 percentage points for every 1-percentage-point increase in unemployment. Because 49 states have laws requiring them to balance their budgets, they must make up the lost revenue somehow; the budget gap could translate into average cuts of 3 to 4 percent in state funding for Medicaid and SCHIP.

To be sure, Medicaid has weathered economic downturns in the past. The usual drill in a sour economy is for states to trim benefits, pay doctors and hospitals less, and ask the federal government for extra money. As a last resort, states sometimes tighten Medicaid eligibility requirements.

During the state budget crunch after the 2001 recession, Congress passed a relief package that provided $10 billion in federal block grants to the states and $10 billion in extra matching funds for Medicaid and SCHIP. To qualify for the additional help from Uncle Sam, state governments had to agree not to toughen Medicaid eligibility.

Overall, the federal assistance plan was considered successful, although John Holahan, director of the Health Policy Center at the Urban Institute, outlines two problems to consider when contemplating another round of federal relief. First off, he said, federal relief needs to reach states more quickly. “The delay in getting the legislation passed [after the 2001 recession] meant that many states had already made a lot of cuts before the fiscal relief was available,” he said at the Alliance for Health Reform’s briefing.

In addition, he said, the last recession hit some states much harder than others. “Some states actually received windfalls and were able to use the money to build up rainy day funds or reserves. And other states got a lot less help than they needed, or they got it after they needed it,” Holohan said. “So [federal assistance] was both poorly timed and poorly targeted.”

In a January 28 letter, the National Governors Association urged congressional leaders to include additional Medicaid funds for states in the stimulus package then under consideration. Congress passed the package but left out Medicaid relief.

With or without federal relief for states, the current downturn may be more painful for Medicaid than a typical recession. One big problem is that states have had only two years of fatter state budgets, in 2005 and 2006, to try to reverse the last round of cutbacks.

The worst year for the national economy was 2001, but states’ troubles lagged a couple of years behind. So the tightest budget years for most states were 2003 and 2004, and they generally weren’t able to begin putting money back into Medicaid until 2005. “Some of the things states did last time that were effective in controlling costs are not as available now,” said Kaiser’s Rudowitz; back then, she said, many states cut Medicaid payments to doctors and hospitals. “They haven’t had enough time to rebuild those [payments] after several years of freezing or cutting them. Medicaid pay is already pretty low relative to other payers,” she said.

Medicaid pays medical providers a mere fraction of the rates that Medicare and private insurance pay. For all medical services in 2003, across all states, Medicaid paid on average about 69 percent of what Medicare paid for physician services. Many states began increasing Medicaid payments again in 2005 and 2006, Rowland said, although rates haven’t been fully restored.

States’ budget woes are not limited to Medicaid, according to a March report by the Center on Budget and Policy Priorities. “State expenditures fell sharply relative to the economy during the 2001 recession, and for all states combined they remain below the fiscal year 2001 level,” the center reported. “In 18 states, general fund spending for fiscal year 2008—six years into the economic recovery—remains below pre-recession levels as a share of the gross domestic product.”

That already-tight situation may make states look for savings in Medicaid quicker than they otherwise might have, Edwards said. “It’s such a big piece of the budget, you have got to pay attention to it, and make changes to the spending in that program.… In the last recession, they cut everything else, and there is not much left if you don’t start going into Medicaid.”

States’ ability to get health coverage to more people is also hampered by a directive issued in August by the Health and Human Services Department’s Centers for Medicare and Medicaid Services. That directive limits state leaders’ authority to expand SCHIP coverage to children whose family income is more than $52,500 for a family of four (250 percent of the poverty threshold).

An even bigger problem, said Ray Scheppach, executive director of the NGA, comes from Bush administration regulations that critics say shift more financial responsibility for Medicaid to the states. (Congress has put some of those new rules on hold.) “The … regs have a huge impact,” Scheppach said. “The Office of Management and Budget said [that the regulations] could mean an estimated $13-[billion]-to-$14-billion loss for states over five years.”

This time around, the Urban Institute’s Holahan says, the federal government should provide additional Medicaid funds based on each state’s unemployment level Congress and the White House need to take into account that a downturn doesn’t just throw more people onto Medicaid rolls; it also “affects states’ ability to support the base Medicaid program,” he said.

Today, Scheppach said, a handful of the hardest-hit states, including California, are considering making cuts to Medicaid. Other states may be close behind. “We’re not seeing significant changes yet,” he said. “I don’t think we’ll hit bottom for seven to eight months.”