Why the idea of states filing for bankruptcy is not going away

A couple weeks ago, Senate Majority Leader Mitch McConnell said that he supported the idea of creating a bankruptcy regime so financially distressed state governments could restructure their contractual obligations. People on the left have been losing their minds ever since. How dare he suggest that the federal government not bail out blue states, when they pay so much in taxes each year to the federal government, they argue.

First, the idea of blue states as “donor” states from a tax perspective is absolute bullshit. The federal tax code does not merely consist of revenues that fund budgetary measures. It also consists of tax expenditures, also referred to as tax “loopholes.” From the government’s perspective, loopholes are a form of spending themselves, because the government is forgoing collecting money from certain groups, generally corporate entities and rich households. Blue states are the largest beneficiaries of tax loopholes.

The reality, however, is there are several states who are either functionally insolvent already or are headed there soon. Before the coronavirus crisis, Illinois was paying fully one-quarter of its “good economic times” budget to pensions, and still was nowhere close to getting them on the right track.

Right now, paying lavish benefits to people who used to work in government is crowding out health care for vulnerable populations and public education on a grand scale. This is not some accident of demographics, either. Democratic policymakers in California, the Midwest, and New England states have been raiding pension funds for decades to support their insatiable thirst for pork spending.

That is not a “political” perspective on events. That is factual. This is not a conundrum you can blame on fiscal conservatives. Fiscal conservatives simply do not want to establish an unthinkable moral hazard by bailing these programs out on your grandchildren’s dime. Policymakers in financially distressed states want to have the federal government pay for their underfunded pensions, transferring an enormous amount of wealth to Baby Boomers, and have our kids pay for it (with interest) in higher taxes down the line, realizing literally zero of the benefits. If that sounds ethical to you, then you are a sociopath.

But most states are going to see a drop in revenues of at least 25% from their ill-advised decision shut down literally all economic activity so folks could hide from a new seasonal illness. That means pension costs that were swallowing a large share of a large pie are now going to swallow an enormous share of a smaller pie.

If you stripped the names off of the above chart, then no one would argue with you that these entities are prime candidates for restructuring their liabilities. But because politicians are involved, there will be endless arguments that continue to destroy economic value.

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