James Pethokoukis has a column at Reuters today, claiming that there is a "Secret GOP Plan" to push states into bankruptcy and thereby "smash unions." He cites three items on the next Congress's legislative agenda: the Devin Nunes bill, which Steven discusses below, to require greater state pension transparency; an unwillingness to reauthorize subsidized Build America Bonds, which states have used heavily to finance themselves in the last two years; and possible legislation to authorize state bankruptcies.
I think the Nunes disclosure bill is very a good idea, but I am skeptical about the idea of legalizing state bankruptcy, and it is a straight up terrible idea to encourage a bankruptcy in any state. Even if California and Illinois could go bankrupt, they don't need to (yet), and they should be encouraged to meet their obligations (and avoid stacking up new ones) rather than to discharge them.
(For the record, I think Nunes's bill is a common-sense transparency measure--not part of some grand conspiracy to push Illinois or any other state into bankruptcy.)
The idea of using state bankruptcy as an avenue to "smash unions" is very short-sighted. A rash of state bond defaults would destabilize the financial markets and impoverish retirees who have invested their savings in tax-exempt muni bonds. And it is no sure thing that a bankruptcy trustee will be appropriately tough on public employee unions--indeed, many municipal bankruptcies have left employee pension obligations entirely untouched, while bondholders took haircuts.
More broadly, we should be discouraging governments from taking on liabilities they cannot repay. A bankruptcy option would reduce the cost of profligacy, and make it even easier for states to spend and borrow more than they should. Instead, states should balance their books the old fashioned way--by negotiating better contracts with public employee unions, and by amending their bargaining and arbitration laws as necessary to make that possible.
There is a place for bankruptcy--some municipalities manage to dig themselves into holes that they cannot surmount with any plausible amount of austerity. (This is also what happened to Greece.) But states have more flexibility to levy added taxes to pay their debts than municipalities do; and while their debts (explicit and implicit) are in some cases large, no state currently has a liability load that has reached the point of unserviceability.
As for BABs, I take a more favorable view of that program than many of the other contributors here, but I also don't think ending the program would imperil the solvency of any states. I don't view BABs as a particularly revolutionary development--they simply take the longstanding practice of subsidizing state and local borrowing, but swap out a tax expenditure (the federal government does not tax most municipal bond interest) for an explicit subsidy (BABs are taxable but the federal government pays 35 percent of the interest).
BABs have the advantage of being attractive to investors not taxable in the United States, which make them a more "normal" security--while tax rules make traditional California muni bonds mostly attractive to natural persons who pay tax in California, anybody who invests in corporate or sovereign debt might buy California BABs. Theoretically, this should improve efficiency in the muni bond market, and if I had my druthers I'd sooner keep BABs and abolish traditional munis.
Instead of sunsetting BABs, I would make some other reforms to the muni market--converting the bond subsidy to a percentage of principal, setting a maximum yield so the most profligate borrowers do not get subsidies, and more tightly restricting the use of proceeds from subsidized issues.
But even if the BAB program goes away, it's not likely to trigger state insolvency. A large majority of sub-federal government debt in the United States is not at the state level--it is issued by authorities and municipalities. State bond liabilities are dwarfed by states' implicit pension and retiree health care obligations, which are unaffected by BAB reauthorization.
Take California for example. The state intends to issue $9.9 billion in general obligation bonds in FY 2011-12. Even if the end of the BAB program increased the premium California must pay on tax-exempt munis by 200 basis points--nearly a tripling of the state's current spread to AAA-rated general obligation muni bonds--that would raise the state's borrowing costs by about $200 million every year that market skepticism persisted.
That's not nothing, but it's not exactly the largest problem for a state with a $24 billion budget gap and upwards of $500 billion in unfunded pension costs. It certainly suggests that ending the BAB program isn't a very effective way to push California off a bankruptcy cliff. I'd be much more concerned about how the end of BABs will affect the City of Los Angeles, or the Los Angeles Unified School District--but those entities can already go bankrupt under California law.
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