State Bankruptcy the Wrong Response to an Exaggerated Problem

Today’s New York Times report that Congress may consider allowing states to declare bankruptcy provides yet another example of the widespread misunderstanding of state budget problems.

The Times described state debt as “crushing,” but it really isn’t.  As the report we issued yesterday documented (and as the graph shows):

In the second quarter of calendar year 2010, state and local government outstanding debt stood at 16.7 percent of GDP, up from a recent (and relatively brief) low of 12 percent in 2000 but similar to the average levels from the mid-1980s to the mid-1990s.  The vast majority of this debt is long-term, fixed rate debt used to finance infrastructure projects.

States are incredibly faithful in repaying their debt, and have been since the late 1800s.  Over the last century, only one state has defaulted on its general obligation debt:  Arkansas in 1934, during the depths of the Great Depression.  In most states, bonds have the first call on revenues; the state makes required debt service payments before funding any public services.

States do indeed face long-term budget challenges, including revenue systems that need modernization and pension funds that are somewhat underfunded.
But there is no evidence that they won’t be able to address these challenges — just as they’ve successfully closed large, recession-induced budget gaps over the past three years in order to balance their annual operating budgets.

So a state bankruptcy law isn’t needed.  Moreover, it would do real harm.  As our report said:

It would be unwise to encourage states to abrogate their responsibilities by enacting a bankruptcy statute.  States have adequate tools and means to meet their obligations.  The potential for bankruptcy would just increase the political difficulty of using these other tools to balance their budgets, delaying the enactment of appropriate solutions.  In addition, it could push up the cost of borrowing for all states, undermining efforts to invest in infrastructure.

Despite the talk, no lawmaker has yet filed a bill in Congress to allow state bankruptcy.  Let’s hope it stays that way.