Pulling the Plug on State Debt with a New Chapter in Bankruptcy Law By David A. Skeel
A
nyone who proposed even a decade ago that a
the economy picks up considerably or some miraculous alterna-
state should be permitted to file for bankruptcy
tive emerges to save the day. This is where bankruptcy comes in.
© Phil Foster
would have been dismissed as crazy. But times have
When the possibility is mentioned of creating a new chapter
changed. As California’s budget travails and Illinois’ startlingly
for states in U.S. bankruptcy law (Chapter 8, perhaps, which
underfunded state pensions have made clear, the states are the
isn’t currently taken), most people have two reactions. First, that
next frontier in “too big to fail.” In the topsy-turvy world we
bankruptcy might be a great solution for exploding state debt;
now inhabit, letting states file for bankruptcy to shed some of
and second, that it can’t possibly be constitutional for Congress
their obligations could save American taxpayers a great deal
to enact such a law. Surprisingly enough, this reaction is exactly
of money.
backwards. The constitutionality of bankruptcy-for-states is
The financial mess that spendthrift states have gotten them-
beyond serious dispute. The real question is whether the ben-
selves into was well known even before the battles over public
efits would be large enough to justify congressional action. The
employee contracts in Wisconsin and Ohio hit the headlines last
short answer is yes. Although bankruptcy would be an imperfect
year. In 2010 and 2011, the red ink was diluted by large doses
solution to out-of-control state deficits, it’s the best option we
of federal money from the controversial stimulus legislation. But
have, at least if we want to have any chance of avoiding massive
that money will soon slow to a trickle, dropping from $59 bil-
federal bailouts of state governments.
lion last year to a projected $6 billion in 2012. There is little
Start with the issue of constitutionality. The main objection
evidence that the most troubled states have gotten their runaway
to bankruptcy for states is that it would interfere with state
expenses under control. This means we can expect a major push
sovereignty – the Constitution’s protections against federal med-
for federal funds to prop up insolvent state governments unless
dling in state affairs. The best known such barrier is the Tenth
A version of this article previously appeared in
the
W eekly S tandard .
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