A growing inability to pay ever-increasing Medicaid (search) costs has forced Vermont into an innovative deal with the federal government that critics fear could jeopardize a safety net dating back to the Great Society (search).

Gov. James Douglas (search) says he's confident his Global Commitment to Health (search), in which the state has agreed to accept caps to federal Medicaid funding over the next five years, will give state officials unprecedented flexibility to manage the health insurance program for the poor and begin to control costs. The program went into effect Saturday, with the start of the federal fiscal year.

States across the country, as well as officials in the Bush administration and a congressional commission, are watching Vermont's approach because it could provide a road map for reforming an entitlement program whose costs have risen beyond most governments' ability to pay.

There is irony in Vermont, a solidly Democratic state, pursuing a federal funding cap.

Vermont was one of the first states to expand Medicaid ambitiously beyond its historic use as a health insurance program for the poor and disabled. Over the past decade, the state has transformed Medicaid into a program in which even middle class families can get their insurance, especially for children. Now, roughly one of every four Vermonters is covered.

But soaring medical inflation, particularly among the traditional users of Medicaid, has forced even this bluest of states to try some fresh thinking.

"I'm sure they'd be looking at states like Vermont, states that have gone ahead and tried new approaches," said Martha Roherty, director of the National Association of State Medicaid Directors. "The (Medicaid reform) commission and others in Congress would be looking to states like that, to see how they've restructured, how it's working."

Other states already are looking at caps of their own. Florida has proposed somewhat more ambitious caps as pilot projects in a couple of counties, and South Carolina wants to do it statewide, said Laura Tobler, an analyst at the National Conference of State Legislatures.

Montana, California, Missouri and Ohio are among the other states considering some kind of reform, although not necessarily spending caps, she said.

Both Congress and the Bush administration also have been looking for ways to curb Medicaid inflation that has been running around 20 percent a year. The federal government pays roughly 60 percent of the costs of providing health insurance to the poor and disabled and state governments pay the rest.

States administer Medicaid, but must do so under stringent federal rules, unless they win a waiver of those regulations. States say the 40-year-old rules often stifle creativity and innovation that might make Medicaid cheaper or, at least, easier to run.

Those two goals now are beginning to intersect as both state and federal governments search for ways to reduce spending and the states clamor for flexibility.

In Vermont, Douglas, a Republican, believes he has found a marriage of those objectives. The administration and state legislators have struggled for years to figure out how to continue funding Medicaid. They've instituted premiums and co-payments and tightened regulations, but still the costs rise and the potential deficits grow.

Douglas turned to Washington early this year asking for a guaranteed level of spending from the federal government and new control over running it.

He got much of what he wanted, although less guaranteed money from Washington than he initially sought. One of the unique aspects is that Medicaid would be administered through a statewide managed care organization, which would be paid a fee for each person insured and then would have to manage with that money.

A pending agreement calls for total Medicaid spending in Vermont to be no more than $4.7 billion over the next five years, with roughly 60 percent of the bill being paid by Washington. The Douglas administration and the Legislature estimate spending will total only $4.2 billion.

The state also estimates that it will save between $135 million and $165 million under the new arrangement over the next five years. But even then, the state's funding problems will only be partially solved; Vermont will still be short on its contribution to the Medicaid program by $300 million over the whole period.

Another hitch in the minds of some critics -- one that they worry could jeopardize the program -- is that the shift would take the federal government off the hook if costs continue to skyrocket, leaving Vermont to pay for any spending above the $4.7 billion ceiling.

"State policy-makers would have to choose between covering those costs entirely with state funds or reducing health care coverage or provider payments," wrote Judith Solomon of the Center on Budget and Policy Priorities, who has been analyzing the proposal for skeptical advocates and Medicaid beneficiaries.

Douglas' response to the criticism is simple.

"What's the alternative?" he said at a recent news conference. "We're facing a tremendous shortfall in the Medicaid program in the next few years and I think in the end legislators will understand this is the better approach."

Although she did not weigh in on the merits of Vermont's approach, Roherty of the Medicaid directors group said every state will be looking for similarly innovative ways to control their budgets.

"States are having to be more creative in their programming," she said.