Budget

Commentary: The State Bankruptcy Debate

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As states across the country face fiscal crises, discussions have begun about legislation which would permit individual states to declare bankruptcy. Currently, federal law prohibits states from filing for bankruptcy, but a number of prominent policymakers and scholars have proposed changing the rules.

A Los Angeles Times article by Tom Petruno reports on the proponents and opponents of this idea and their respective arguments regarding state bankruptcy claims. The main culprit for these crippling budget deficits are the unfunded employee pension plans and healthcare liabilities which swallow up public funds and tax dollars. The conservative argument for permitting bankruptcy filings is that it would allow states to clear up the state of their finances and develop a sustainable, long-term fiscal plan while identifying the sources of the fiscal decline.

David Skeel, a law professor at the University of Pennsylvania, writes that “the issues are so big I really think they can’t be dealt with outside of bankruptcy… What bankruptcy does is force the issues.” One prominent supporter of this idea is Americans for Tax Reform, who see this as a way to address the issue of union pensions and benefits. Currently, 37% of public sector workers are unionized, compared to a mere 7% of private sector workers. Patrick Gleason of ATR argues that the specter of bankruptcy will entail a renegotiation of these unsustainable contracts.

Another influential figure pushing for bankruptcy legislation is Newt Gingrich. Gingrich believes that Congress needs to make a statement that profligate states should not expect the federal government to bail them out. In particular, Gingrich cites New York, California, and Illinois as those states most likely to request federal money. Unsurprising, these states have the most union and public-sector friendly political climates and the most unsustainable pension plans.

The political leaders of these states are ardently opposed to such bankruptcy legislation, which they assert will irrevocably harm investment and perpetuate the current financial hardships. California’s recently elected Democratic Gov. Jerry Brown instead has offered a budget plan which would deeply reduce state spending while maintaining tax raises, although it remains to be seen whether California will take the necessary step of cutting back union benefits. Illinois, in response to a monstrous deficit which is nearly half of the state’s general fund revenue, decided to raise the income tax rate 66% while failing to address the union-favoritism which threatens to send the state into default. Such a measure will greatly worsen the state’s climate for economic development, punishing families and small businesses while obfuscating the issue of special interests.

Though bankruptcy legislation is merely hypothetical at this point, it is already facing questions of constitutionality and effects on the bond market. Manhattan Institute scholars Nicole Gelinas and E.J. McMahon have made strong arguments against the option of bankruptcy, and House Majority Leader Eric Cantor has stated his opposition to this approach.

While bankruptcy may or may not be a sensible option, the pattern of raising taxes, emergency budget cuts, and federal bailouts is no solution. Present circumstances demand comprehensive reform, and in the case of certain states, this reform is unlikely to transpire absent a dramatic turn of events.

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