At The Weekly Standard, University of Pennsylvania law professor, David Skeel asks if it’s time to consider allowing state governments a way to declare bankruptcy.Despite signs of skittishness in the municipal bond market and increasing budgetary pressures, states continue to avoid the kind of austerity measures that are going to be necessary to balance their books while meeting pension obligations.
Why cut spending or raise taxes when the bill can be shifted upward? The hard budget constraint necessary for market-preserving federalism has been already violated via bailouts (and one can argue, federal grants-in-aid). The bailout route also indirectly grants states an escape hatch from their political dilemma. The federal government can raise taxes, issue debt, or create money: the last refuge of a profligate government.
Would a state bankruptcy law be Constitutional? Does it constitute the federal government meddling in the state’s affairs? Skeel argues that no one is forcing a state to declare bankruptcy, but merely providing a legal avenue to do so. For an active debate on the idea check out the Volokh Conspiracy.