The Indebted States of America

August 28, 2013

Most states have restrictions on debt and prohibitions against running deficits. But these rules have been no match for state and local governments, which have exploited loopholes and employed deceptive accounting standards in order to keep running up debt. The jaw-dropping costs of these evasions have already started to weigh on budgets; as the burden grows heavier, taxpayers may decide that it's time for a new fiscal revolt, says Steven Malanga, the senior editor of City Journal and a senior fellow at the Manhattan Institute.

Most state constitutions and many local government charters regulate public debt precisely because of past abuses.

  • In the early 19th century, after New York built the Erie Canal with borrowed funds, other states rushed to make similar debt-financed investments in toll roads, bridges, and canals -- projects designed to take advantage of an expanding economy.
  • But when the nation's economy fell into a deep recession in 1837, many of the projects failed and tax revenues cratered as well, prompting eight states and territories to default on their debt.

Stung by losses, European markets stopped lending even to solvent American states.

  • The debacle inspired a sharp reevaluation of the role of state governments, with voters looking "more skeptically" on legislative borrowing, wrote political scientist Alasdair Roberts in 2010 in the academic journal Intereconomics.
  • A member of New York's 1846 constitutional convention even warned that "unless some check was placed upon this dangerous power to contract debt, representative government could not long endure."
  • Over a 15-year period, 19 states wrote debt limitations into their constitutions.

State and local debt had hit $15 billion ($260 billion in today's dollars) by the Great Depression's onset. Arkansas was one of the heaviest borrowers, with obligations reaching $160 million ($2.8 billion today). It defaulted in 1933 -- one of more than 4,700 Depression-era defaults by state and local government entities, including nearly 900 by school districts.

Even as governments scramble to find ways of paying their existing obligations, taxpayers should demand fundamental reforms that will make state and local leaders more fiscally responsible going forward. An easy place to start would be a push for honest accounting and greater transparency.

There's no single cure for the debt crisis afflicting state and local governments. But unless taxpayers start pulling harder in that everlasting tug-of-war, they can expect to keep losing ground.

Source: Steven Malanga, "The Indebted States of America," City Journal, Summer 2013.

 

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