Barry Lynn, executive director of the Washington-based advocacy group Americans United For Separation of Church and State, which brought the lawsuit, said the ruling would have major implications for the Bush administration's policies of allowing faith-based groups to offer services to government institutions.

"This is an enormously significant case on the whole question of how government can, or in this case, cannot aid religious ministries," Lynn said.

"I think this has implications far broader than a prison in a single state because the basic framework of this decision, the way they reached the conclusion is that government can't pay for these religious social services nor can they turn over functions of government essentially to religious operations," he said.

Prison Fellowship Ministries, which contracts with InnerChange Freedom Initiatives Inc. and other organizations to conduct faith-based programs, must repay about $160,000 to the state for money received between June 2006 and June 2007, said Mark Early, the group's president.

He said the ruling would clarify how faith-based programs could work with government agencies.

"We're pleased because in this opinion there are some clarifying guidelines to help us and other faith-based organizations working in government settings, such as prisons, to be able to fashion a program and make sure they do comply with current understanding of constitutional law in this area."

Prison Fellowship operates nine programs in six states: Iowa, Arkansas, Kansas, Minnesota, Missouri and Texas. All are now privately funded through donations from individuals and foundations, he said.

The 24-hour a day, seven-day a week program at Newton immerses inmates in evangelical Christianity. Inmates who complete the 18-month program also get help after they're released from prison.

Fred Scaletta, a spokesman for the Iowa Department of Corrections, said corrections officials were reviewing the ruling with the attorney general's office to determine how the state would proceed with the operation of the program.

Bob Brammer, a spokesman for the Iowa attorney general's office, said attorneys were reviewing the ruling and considering whether to appeal.

An appeal could include asking the three-member 8th Circuit panel for clarification on issues or could seek consideration by the full 8th Circuit Court. The ruling also could be appealed to the U.S. Supreme Court.