The Democratic governor's $2.7 billion plan calls for saving $1.35 billion a year by reducing eligibility and coverage, eliminating programs, and other efficiencies. It also calls for dropping rates paid to providers to save another $675 million, and increasing the state's cigarette tax by $1 per pack to raise $335.7 million annually.

Money from the tax hike would in turn boost federal matching funds for Medicaid by a like amount.

"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 healthcare," Quinn said in a statement. "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 state's Medicaid program faces an estimated unpaid backlog to service providers of $1.9 billion at the end of the current fiscal year on June 30, according to the governor's office. Medicaid covers 2.7 million Illinois residents and half of the state's births.

A government watchdog group has projected the pile of unpaid bills could skyrocket to $21 billion by 2017 if nothing is done to restructure the Medicaid program.

In his fiscal 2013 budget address in February, Quinn put state lawmakers on notice that they must address Medicaid spending and the state's huge $83 billion unfunded pension liability - both of which have dragged down Illinois' finances and credit ratings - during the current legislative session.

Medicaid and pensions now account for 39 percent of the state's general fund spending.

"We're working toward a balanced budget and (Medicaid) is an important part of it," said Steve Brown, spokesman for House Speaker Michael Madigan, a Democrat.

House Republicans took issue with the cigarette tax hike, with their leader Tom Cross calling for reforms and cuts and not "revenue enhancements" to solve the problem.

A spokeswoman for Senate President John Cullerton, a Democrat, said Cullerton agreed with the tax hike, but pointed to the difficulty in getting a consensus on it.

"The Senate has twice passed a cigarette tax only to have the measure fail in the House," said Rikeesha Phelon, the spokeswoman.

Meanwhile, the Illinois Hospital Association called Quinn's plan to cut hospital payment rates by about 8 percent "too drastic and too rash to impose on the state's already fragile healthcare system."

Quinn, who held a press conference urging lawmakers to adopt his plan, said he will unveil pension reforms on Friday.

Ahead of the state's upcoming sale of up to $2 billion of general obligation refunding bonds, credit agencies this week affirmed the state's debt ratings but continued to highlight its daunting financial challenges. Those include the pension liability and an ongoing reliance on deferred payment of bills to manage cash flow.

Moody's Investors Service, which downgraded Illinois's general obligation bond rating to A2 in January, said the rating's stable outlook encompasses the state's ability in the past to "reach consensus on politically difficult issues." But it noted there is currently a modest likelihood of near-term progress in addressing major credit challenges.

(Reporting by Karen Pierog; Editing by James Dalgleish and Leslie Adler)

• A Permanent Economic Emergency