NCPA - National Center for Policy Analysis

Is State Bankruptcy a Viable Option?

March 15, 2011

States are in deep financial trouble.  Deficits for the current budget cycle are estimated at $175 billion.  In some states (Texas, California, Nevada and Illinois), the shortfall exceeds 30 percent of projected budgets.  One way or the other, states will close those gaps to comply with the balanced-budget amendments contained in all state constitutions except Vermont's.  Many, however, will be able to do so only by loading up additional debt, on top of already-alarming long-term obligations.  Unfunded pension obligations are estimated at upwards of $1 trillion and are probably three or four times that amount.  Unfunded health care commitments clock in at upwards of a half trillion.  Bond debt issued by state and local governments comes in around $2.8 trillion, says Michael S. Greve, the John G. Searle Scholar at the American Enterprise Institute.

Among the few concrete, plausible suggestions is a bankruptcy option for states, analogous to the process that Chapter 9 of the federal Bankruptcy Code has long provided for municipalities.

While bankruptcy cannot be a cure-all for the states' ailments, two things are right about the proposal.  

  • First, the search for a federal response draws much-needed attention to the fact that the states' travails are not entirely homegrown but a federal coproduction.
  • Second, a bankruptcy option, and even a vigorous public debate about it, may be a step toward restoring fiscal sanity -- provided that its central objectives are kept in mind.

State bankruptcy must serve to break the stranglehold of public-sector unions over state politics and budgets; help restore the federal government's precommitment against bailing out states; and advance, rather than distract from, the far more fundamental federalism reforms that will be required over the coming years, says Greve.

Source: Michael S. Greve, "Bailouts or Bankruptcy: Are States Too Big to Fail?" American Enterprise Institute, March 2011.

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