NCPA - National Center for Policy Analysis

Should States Be Allowed to File for Bankruptcy?

April 15, 2011

Total states debt is estimated at more than $1 trillion, and that does not include another $3 trillion in unfunded liabilities from pensions and other obligations.  We cannot afford a federal bailout of this sum nor the precedent it would set, says Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University. 

Constitutionally, states cannot be forced into bankruptcy by their creditors or the federal government.  That means even if a bankruptcy law was adopted, any proceeding would have to be initiated by state legislatures voluntarily.

The good news is that states have other options.

  • One is the threat of massive layoffs.
  • Governors and legislators can also prospectively freeze wages or even cut them through involuntary furloughs.
  • Another reform would be to remove the protections that allow state workers to collectively bargain for wages and benefits, giving lawmakers more leeway during negotiations and opening the door to privatization.
  • States also could improve their pension systems through accounting reforms and by switching from defined-benefit plans to defined-contribution plans, in which employees' benefits reflect the amount of money they or their employers deposit in their accounts.

There is no shortage of reforms that would help restore some fiscal sense to the states.  But they will require hard political work to pass.  Bankruptcy may sound like a silver bullet that could solve budget woes, dismantle cronyism, fix pensions and forestall a federal bailout, but it contains plenty of potentially counterproductive consequences.  Restoring the states' fiscal health requires fundamental changes to the way they do business.  Until that happens, their balance sheets will be bleeding red ink, whether they are officially bankrupt or not, says de Rugy.

Source: Veronique de Rugy, "A Bankrupt Option," Reason Magazine, May 2011.

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