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False Alarms on State and Local Bankruptcy

January 20, 2011 at 11:41 AM

We released a major report (and press release) today to correct the misconceptions behind recent media reports that states and localities are facing an imminent fiscal meltdown.

A number of articles have lumped together the current fiscal problems of state and local governments, stemming largely from the recession, with longer-term issues relating to debt, pension obligations, and retiree health costs, to create the mistaken impression that states and localities must take drastic and immediate measures to avoid an imminent meltdown.

Most states project large gaps between revenues and spending for fiscal year 2012, which begins July 1 in most states.  States have faced large projected shortfalls in each of the past three years — mostly due to an unprecedented drop in revenues during the recession — and have closed them through a combination of reserve funds, federal stimulus funds, budget cuts, and tax increases.  They’re required to close budget gaps before the fiscal year starts, and they will do so again as they enact budgets for the upcoming fiscal year.

In contrast, states and localities have several decades to address issues related to bond indebtedness, pension obligations, and retiree health insurance. Unfortunately, numerous articles have greatly exaggerated the size of these long-term costs and have added them to states’ projected operating deficits for 2012 as if they are an immediate problem.  All of that has produced a severely distorted picture of the state and local budget situation.

In a series of posts over the next several days, I’ll examine those three major long-term issues and explain why the kinds of measures that some have suggested, such as allowing states to declare bankruptcy or forcing them to change the way they report their pension liabilities as a condition for issuing tax-exempt bonds, wouldn’t be appropriate.  I’ll also highlight some reforms that states and localities should adopt to strengthen their budgets over the long term.