State Bankruptcy Is Irrelevant to COVID-19: And Bailouts Aren’t the Answer

COMMENTARY Debt

State Bankruptcy Is Irrelevant to COVID-19: And Bailouts Aren’t the Answer

Jun 29th, 2020 4 min read

Commentary By

Rachel Greszler

Research Fellow in Economics, Budget and Entitlements

Adam Michel

Senior Policy Analyst, Grover M. Hermann Center

Socializing government debts by redistributing state and local costs to federal taxpayers in times of crisis is like splitting the check. IronHeart/Getty Images

Key Takeaways

If states or municipalities do face insolvency, it will be the result of decades of fiscal mismanagement.

It’s becoming increasingly clear that what states really want is just an all-purpose bailout for their pre-existing problems.

Bailing out states denies the problems of socializing costs.

The nation’s governors have asked for at least $500 billion in federal bailouts to make up for falling state revenues and to backfill their systemically underfunded pension plans. Some members of Congress have seconded the request, but, Senate Majority Leader Mitch McConnell(R-Ky.) recently suggested that states have another option: Bankruptcy.

The fact is, no state or local government will need to declare bankruptcy just because of COVID-19. Rather, if states or municipalities do face insolvency, it will be the result of decades of fiscal mismanagement.

The important takeaway behind Sen. McConnell’s statement is that the federal government is not responsible for states’ budgets.

Yes, the federal government has an obligation to help cover the costs of addressing the pandemic. To that end, Congress has already sent states unprecedented aid.

And, yes, state and local governments are experiencing a decline in income-, sales-, and some other tax revenues. But unforeseen circumstances is one of the reasons states have rainy day funds. In aggregate, those funds were at an all-time-high prior to COVID-19, but not every state was well-prepared. While Wyoming had an entire year’s worth of revenue saved away, Illinois and Kansas had mere minutes of revenue saved.

COVID-19 could be the straw that broke the camel’s back for states already headed toward insolvency. But it alone isn’t sufficient to create a need for either bailouts or bankruptcy.

When Puerto Rico entered bankruptcy, its debt equaled about three times its annual revenues. And when Detroit entered bankruptcy in 2013, the city’s debt was 13 times its annual revenues. A few months or even a few years of lower revenues won’t create bankruptcy situations for states. Government insolvency results from prolonged, systemic mismanagement.

Already, the federal government has provided state and local governments with direct grants worth $150 billion to help cover COVID-19 expenses. And it appears that states don’t need more money for that. Otherwise, why have governors asked for flexibility to use these funds for non-pandemic costs? Why have some used the money for temporary pay raises and bonuses for public-sector workers, while 26 million Americans have lost their paychecks? 

Then there’s the Federal Reserve’s $500 billion in unprecedented short-term lending to state and local governments. That amounts to half of every state and local government’s annual income- and sales-tax revenues. It’s unlikely those revenues will fall by 50 percent, if only because Congress has provided roughly $1.3 trillion in the form of small-business grants and loans, checks to households and massively-expanded unemployment insurance benefits—all of which will help prop up state and local tax receipts.

It’s becoming increasingly clear that what states really want is just an all-purpose bailout for their pre-existing problems.

Prior to the pandemic and despite the exceptionally strong economy, New York Gov. Andrew Cuomo was facing a $6.1 billion annual budget deficit. Illinois had projected a $3.2 billion deficit.

The $40 billion in federal taxpayer funds requested by Illinois’ Senate Democratic Caucus would go mostly to financing the state’s consciously-enacted deficit and propping up its bloated pension systems, which entered the year with an unfunded liability of $137 billion.

If Congress were to provide a nation-wide state bailout proportionate to what Illinois requested, it would cost federal taxpayers an additional $1 trillion. That’s not far off from what House Speaker Nancy Pelosi (D-Calif.) is seeking.

There’s a fundamental unfairness to state bailouts. They force taxpayers in well-run states to subsidize those who have systematically squandered a strong economy and shortchanged pension plans of trillions of dollars’ worth of required contributions.

Some have suggested requiring more prudent budgeting from states that accept bailouts. It’s a rather ironic suggestion, considering that the federal government’s fiscal recklessness has created over $70,000 in debt per capita, while state debt averages less than $10,000 per capita.   

Moreover, bailing out states denies the problems of socializing costs. If you’ve ever gone out to dinner with a large group, you might remember how the expensive steak, an extra drink and dessert are more appealing if those costs are split by everyone at the table. If that’s what everyone is thinking, then everyone pays more in the end.

Socializing government debts by redistributing state and local costs to federal taxpayers in times of crisis is like splitting the check: Everyone still pays—they just wind up paying a lot more.

This piece originally appeared in The Hill on 4/28/20