Let states go bankrupt

After two years of bailouts, “stimulus” spending, TARP and earmarks, the country took a deep breath and is now beginning a discussion about the unsustainable trajectory of federal expenditures and the reforms necessary to right the country’s fiscal ship.

This is all good and healthy. However, Washington is not the only place with an overspending problem. We are now starting to see greater attention being paid to the dire financial straits of state governments — which pose just as grave a threat to the country.

New Jersey Gov. Chris Christie, who knows what it’s like to begin fixing a state where profligacy has carried the day for far too long, said on “60 Minutes” last Sunday, that, for states, the “day of reckoning has arrived.”

This day of reckoning has convinced policy experts, political observers and some on Capitol Hill that federal legislation allowing states to file bankruptcy might be the only way to avoid a federal bailout of the most fiscally reckless states in the union.

Many states, including those with the country’s largest population centers, are now on a path to insolvency. This is primarily due to fiscally promiscuous lawmakers, skyrocketing Medicaid costs and unsustainable gold-plated government employee pension plans that most Americans could never dream of.

These states’ ballooning obligations simply cannot be met without either soaking state taxpayers or federal assistance — read: taking taxpayer dollars from properly managed states.

Heading into 2011, states are facing an overspending-generated budget shortfall of $72 billion, according to the National Conference of State Legislatures. Coupled with unfunded state and local pension obligations estimated in excess of $3 trillion — a half-trillion in California alone — one understands the concern that states are the next “too big to fail.”

In a recent Wall Street Journal interview, Richard Ravitch — the New York state lieutenant governor and real estate developer, who is best known for helping save New York City from financial ruin in the 1970s — laid out why bankruptcy may be the only way to sort out the mess in Albany.

Facing an $40 billion budget deficit generated by projected overspending in the next three years, along with soaring Medicaid costs and pension obligations, Ravitch has concluded that there doesn’t seem any solution other than to “stop lending money and enabling politicians to have cash to spend.”

The University of Pennsylvania law professor David Skeel, in a Weekly Standard article last month, also concluded that permitting state bankruptcy is the best option to avoid a monumental federal bailout of state governments. “Letting states file for bankruptcy to shed some of their obligations,” Skeel wrote, “could save American taxpayers a great deal of money.”

In fact, a bill that may well serve as a precursor to state bankruptcy legislation was introduced early this month by Reps. Devin Nunes (R-Calif.), Paul Ryan (R-Wis.) and Darrell Issa (R-Calif.). This legislation would require states and municipalities to provide an accurate assessment of their public pension liabilities.

Thanks to inflation of assets’ fair market value as well as high discount rates, state and local governments currently under-report their pension liabilities by approximately $2 trillion. The bill also makes clear that these pension obligations are the sole responsibility of state and local governments.

Some critics allege that a state bankruptcy code would be used as a tool to “smash unions.” On the contrary, government employee unions and their dogged defense of the status quo are, in fact, smashing budgets and credit ratings in California, Illinois, New York and other states where they are dominant and have outsized influence in the state capitol.

Though it is true that the bond market might not be happy with a state filing for bankruptcy, as Skeel noted, the market is already beginning to take the possibility of default in certain states into account. California, for example, put $10 billion in revenue anticipation notes on the market in November — yet was only able to sell $6 billion worth.

Advocacy for permitting state bankruptcy should not be confused with a desire for states to go bankrupt. In fact, simply having bankruptcy as a tool at states’ disposal is likely to be a boon to lawmakers trying to rectify their unsustainable financial plight.

The mere “threat of bankruptcy,” as Michael Barone recently noted in National Review Online, “would put a powerful weapon in the hands of governors and legislatures: They can tell their unions that they have to accept cuts now or face a much more dire fate in bankruptcy court.”

States cannot afford to continue on their current path. Federal taxpayers, who have been hit with more than $350 billion in higher taxes in just the past two years, cannot afford to absorb the $3 trillion in unfunded liabilities run up by state governments.

Passing a law to allow states the option of bankruptcy — an option available to cities for more than 70 years — would protect both federal and state taxpayers and give honest political leaders a tool to reform state spending commitments.

Grover Norquist is the president of Americans for Tax Reform. Patrick Gleason is director of state affairs at Americans for Tax Reform.