Illinois Medicaid program faces looming funding crisis due to federal changes

The Illinois Department of Children and Family Services office is pictured in downtown Springfield. (Capitol News Illinois file photo)

SPRINGFIELD —  A multibillion-dollar budget crisis will hit the state’s Medicaid program in the next few years unless state lawmakers and Gov. JB Pritzker act to prevent it, budget analysts both inside and outside state government warn.

The crisis comes from changes in federal Medicaid policy that were enacted last year as part of President Donald Trump’s sweeping domestic policy agenda, known officially as H.R. 1, or the “One Big Beautiful Bill Act,” which, among many other things, slashes one of the main funding tools many states have used for four decades to fund their share of the cost of Medicaid.

“By the time you’re a few years in, you’re looking at a $4 – $5 – $6 billion a year hit, and that’s material,” Paula Worthington, a researcher with the University of Illinois’ Institute of Government and Public Affairs, said during a recent interview.

Worthington is a coauthor of a recent IGPA report that describes the upcoming changes in Medicaid funding as one of the most serious long-term fiscal challenges facing Illinois.

The funding tools at issue are known as provider taxes. Those are special taxes that states levy on hospitals, nursing homes, private insurance plans known as “managed care organizations,” or MCOs, and other kinds of health care providers.

States levy those taxes — usually on a per-patient or per-bed basis — and put the money into a fund that is used to draw down federal matching funds. The combination of state and federal funds is then used either to enhance Medicaid reimbursement rates or make direct payments to hospitals and nursing homes that serve large numbers of Medicaid patients to help sustain those facilities financially.

Capping provider taxes

When Medicaid was first established in 1965, it was a relatively modest program that provided health care benefits to people who already qualified for other kinds of public assistance, with costs split between the federal government and the states.

As both the size and cost of the program grew, however, states began looking for new ways to pay for their share of the cost outside of their general revenues. Provider taxes emerged in the mid-1980s as one such mechanism.

By the mid-1990s, Congress began putting controls on state-levied provider taxes. Those included rules that they be broad-based and uniform, meaning they had to apply evenly across an entire class of health care providers and not just those that served Medicaid patients.

The idea was that states were prohibited from holding providers harmless by assuring them they would get all their money back, and then some, once the federal matching funds were drawn down.

But the federal rules also included a “safe harbor” provision. States could avoid having to comply with the hold-harmless prohibition as long as their taxes amounted to no more than 6% of net patient revenue.

That rule has effectively served as a cap on what states can levy in the form of a provider tax. But that cap is about to be cut nearly in half.

Under a provision of H.R. 1 – a provision that only applies to states like Illinois that expanded Medicaid eligibility under the Affordable Care Act – that 6% cap will gradually be cut starting in FY 2028 until it reaches 3.5% in FY 2032.

Impact in Illinois

In FY 2025, according to the Department of Healthcare and Family Services, Illinois spent a total of $33.7 billion through its Medicaid program, making it one of the single largest categories of expenditures in state government.

Of that total, $20.9 billion, or 62%, was federal money while the remaining $12.8 billion came from state funds, including both general revenue and provider taxes.

IGPA reported that provider taxes in FY 2025 amounted to $4.7 billion, or about 37% of all the state funds that were spent on Medicaid. The bulk of that money, according to DHFS, came from two provider taxes, those on hospitals and MCOs.

A recent report by the nonpartisan health policy research organization KFF points out that Illinois stands to lose more than any other state when the reductions take effect because it is the only state whose hospital and MCO assessments are both above the 3.5% threshold.

The report by IGPA estimates that when the first reduction takes effect in FY 2028, revenues from those two assessments alone will fall $239 million. And depending on how much health care prices and Medicaid usage grows over the next five years, total reductions from those two sources could range from $1.25 billion to $2 billion by FY 2033.

“But remember, that’s just the state money,” Worthington said. “That is not taking into account the matching funds.”

Assuming the state continues to receive an average 62% federal match rate, the total impact to Illinois by FY 2033 would be between $3.3 and $5.3 billion a year.

That estimate aligns with a separate estimate from the Governor’s Office of Management and Budget, which reported in October that if the state does not make up for the reduced provider taxes through some other appropriation, “the gross amount of lost funding to the state and its Medicaid program will total over $4.5 billion annually by fiscal year 2031when factoring the lost federal match.”

Issue for lawmakers

The impending limits on Medicaid provider taxes will pose a significant challenge for lawmakers who will either have to find some other way to pay the state’s share of the cost or adjust the program to fit within the new fiscal constraints.

But because the federal changes do not take effect for another year, it is possible lawmakers will not feel pressure to take immediate action in the upcoming legislative session.

Capitol News Illinois is a nonprofit, nonpartisan news service that distributes state government coverage to hundreds of news outlets statewide. It is funded primarily by the Illinois Press Foundation and the Robert R. McCormick Foundation.