What happens when states go bust? Well, the options don’t look pretty, as one article by The Weekly Standard points out . First, one has the inevitable buildup. The unholy alliance of a political party with the unions of teachers and police officers leading to massive amounts of unfunded liabilities, the never-ending budgets for things like education, bond issues, law enforcement (including jails) and infrastructure leads to states with massive debts. Then, one has the options. For states, there are much fewer than for the federal government.
Since a state has a much more limited bond market than a nation and also lacks the ability to solve its debts with “the inflation option,” since it cannot coin money, its remaining options are less than pleasant. If one can no longer borrow money and delay the day of reckoning, one has three basic options, or a mix and match between the three. Option one is the “Dave Ramsey” option–slash expenditures and live way below one’s means to pay off one’s debts. Option two is the “tax your way to prosperity” option, where one increases taxes (often most useful in combination with option one in states without constitutional prohibitions on raising taxes). Option three is the bankruptcy option.
Option one makes life unpleasant for anyone–engineers, professors, teachers, social workers–who depends on either state contracts or state funds for one’s work. Option two makes taxes miserable for everyone, especially if combined with a decline in social services that people take for granted (like schools and roads). Option three harms the ability of states to borrow money in the future (meaning that the underlying deficits need to be addressed) and threatens banks and lending institutions with massive losses.
Given the partisan nature of government spending, the bankruptcy option may seem appealing for some as a way of harming rival constituencies, but there are a lot of players here (political parties, banks) with money on both sides of the aisle, reluctant to give states the freedom to legislate themselves out of debt by defaulting on their obligations. Additionally, states could pass the buck by getting the federal government to bail them out, but that only increases the unsustainable burden of the federal debt even faster by having them guarantee the debt of their more impecunious constituent parts. The options do not look good though, and the longer the delay comes before problem is addressed, the more tragic and painful the outcome is likely to be. What can be done about it, though?