Executive summary

Subnational governments (states, provinces, regions, municipalities, local governments) often play major roles in public spending — infrastructure, public services, education, healthcare, pensions, local investment. Over time, many accumulate large liabilities (bonds, loans, revenue anticipation operations, pension obligations). While subnational debt can be manageable when revenue is stable and borrowing is disciplined, various structural, institutional, and macroeconomic shocks can lead to unsustainable debt burdens.

This white paper examines:

Sources and drivers of subnational debt accumulation Examples of large subnational debt burdens and past crises Challenges in financing and restructuring Policy / institutional lessons and best practices Recommendations for governance & restructuring frameworks

1. Introduction: scope, definitions, and context

Subnational governments (SNGs) are government units below the central/federal level: states/provinces, regions, municipalities, local public entities. They typically raise revenue via local taxes, transfers from the central government, fees, or issuing bonds/loans. Debt can take many forms: long-term bonds, short-term lines, revenue anticipation loans, or implicit liabilities (e.g. pension or other post-employment obligations). Risk arises when revenues fall short, or when debt servicing and unfunded obligations exceed sustainable capacity. Many jurisdictions are legally constrained or have limited institutional frameworks or accountability.  Some countries have enacted reforms / fiscal responsibility laws to limit subnational borrowing or require transparency. E.g. in Brazil, after subnational debt crises, reforms and laws were enacted. 

2. Drivers of subnational debt accumulation

Here is a typology of major drivers:

Driver category

Mechanisms

Risk factors

Infrastructure / capital investment

Regions/states borrow to fund infrastructure (roads, water, sanitation, public works). Debt is issued expecting future returns or fiscal growth.

If project cost overruns happen or revenues don’t materialize, debt servicing becomes burdensome.

Revenue volatility

Many subnational units depend partly on transfers from central government or commodity revenues that fluctuate.

Economic downturns reduce local tax base and transfers; local revenues may decline sharply.

Short-term cash management

Use of revenue anticipation loans or short-term borrowing to smooth flows.

Liquidity shocks or lower receipts make short-term obligations hard to roll over.

Implicit obligations / pensions

Promised pensions, retiree benefits, health obligations. These are long-term liabilities, sometimes not fully funded.

Unfunded pension / OPEB (other post-employment benefits) can create hidden debt burdens.

Legal / institutional gaps

Weak fiscal rules, poor transparency, weak accounting or governance.

Borrowing without proper limits or oversight allows debt to grow unchecked.

Interest rates / refinancing risk

Rising interest rates or roll-over at higher cost increases debt servicing burden.

If debt is refinanced at higher rates or foreign currency, currency risk also matters.

Political cycle and soft budget constraints

Subnational governments might expect bailouts from the central government.

This reduces fiscal discipline, causing excessive borrowing. 

3. Examples of subnational debt crises or large debt burdens

Here are some illustrative cases:

Case A: Puerto Rico (US territory)

Context & debt accumulation

Puerto Rico, although not a U.S. state but a territory, had accumulated large public debt, including public finance corporation bonds and other obligations.  A combination of weak economic growth, declining population, and limited ability to raise certain taxes contributed to fiscal stress. Crisis & restructuring It defaulted on its debt obligations; for example, in March 2022, debt restructuring replaced about $34.3 billion in outstanding bonds.  The Government Accountability Office (GAO) has analyzed the public debt outlook of U.S. territories, including Puerto Rico.  Lessons Limits on bankruptcy (or legal constraints) can complicate restructuring. Need for legal frameworks and orderly restructuring mechanisms for territories or subnational units.

Case B: São Paulo / states in Brazil

Context & debt accumulation

During the 1990s, many Brazilian states accumulated large debts, including cash management debt and short-term obligations, often expecting federal bailouts.  Many used revenue anticipation loans or short-term instruments to smooth flows, but accumulated unsustainable obligations.  Restructuring / reforms The federal government intervened with debt restructuring agreements with states and municipalities in the late 1990s.  Later, Brazil introduced a Fiscal Responsibility Law (Lei de Responsabilidade Fiscal) around 2000, imposing limits and requirements on subnational borrowing and fiscal transparency.  Lessons Institutional reforms helped restore discipline and transparency. Legal limits on new debt issuance were implemented (e.g. prohibiting states from issuing new bonds or limiting them). 

Case C: Buenos Aires Province (province in Argentina)

Context & debt accumulation

The province issued foreign-law bonds; debt increased in period ~2016-2019 significantly (report suggests +68 % in that period).  It had liabilities that were not paid (default in July 2020 on foreign-law bonds).  Restructuring & litigation In 2020, default triggered restructuring; bondholders withheld acceptance.  Recently, the province settled lawsuits with hedge funds; in 2025, it settled with two hedge funds after a New York court judgment.  Lessons Use of foreign-law bonds exposes subnational units to cross-jurisdiction legal vulnerability. Negotiations can be long, and holdouts or litigation may hamper restructuring.

Case D: U.S. states in aggregate

Debt scale

As of end 2023, U.S. state governments collectively reported about $1.9 trillion in long-term debt (including bonds, loans, notes).  That includes bond/loan debt, pension liabilities, retiree health (OPEB), etc.  There are large variations: some states have more than $100 bn in long-term liabilities: e.g. California ($299bn long-term), Illinois ($199bn).  Pension obligations are large: e.g. Illinois has among the largest pension debt, over $145bn.  Challenges Many states face large unfunded pension or retiree health obligations; these are long-term and often not captured fully in budgets.  Some states do not have enough assets to cover liabilities; many subnational governments are considered “sinkhole states” due to inability to cover future obligations. 

4. Challenges in financing, default risk, and restructuring

Here is a breakdown of the main challenges:

4.1 Financing challenges

Revenue volatility: Subnational governments often depend on transfers from central government or variable revenue sources (tax, commodity, intergovernmental transfers). Economic downturns reduce revenues sharply. Refinancing risk: Many subnational debts are short-term or need frequent rollover. When interest rates rise or credit spreads widen, debt servicing burdens increase. Currency risk: If subnational units borrow in foreign currency or foreign-law bonds, fluctuations in exchange rates can greatly increase local debt burden. Limited access or high cost: Without good credit rating, subnational units may face high borrowing costs or limited market access. Investors demand premium because risk of default is nontrivial. Legal constraints: Some regions may be restricted in ability to declare bankruptcy or restructure obligations; legal frameworks might not exist or be weak.

4.2 Default / restructuring challenges

Lack of formal insolvency framework: Many countries lack legal framework allowing subnational default or restructuring in an orderly way. Creditors may have to rely on ad hoc negotiations.  Holdouts & litigation: When bonds are issued under foreign law, creditors or hedge funds may litigate or refuse restructuring. (E.g. Buenos Aires province case).  Coordination with central government: Restructuring often requires coordination or approval from central government or financial oversight agencies. Without that, subnational units may face political or legal constraints. Soft budget constraints: Subnational governments may expect bailouts, so may borrow recklessly. This reduces incentive to maintain discipline.  Social and political costs: Restructuring often implies cuts to public services, renegotiation of pension promises, or budget cuts; politically sensitive especially at local/regional level. Transparency and data gaps: Poor accounting or lack of timely fiscal data makes assessment of debt sustainability difficult. 

4.3 Systemic / spillover risks

A subnational default can put strain on local banks (banks that hold local government bonds or debt instruments). E.g. local banks may be exposed to local debt; difficulty in servicing may reduce asset quality.  Contagion to broader financial sector or central government if bailouts are required. Loss of investor confidence may raise borrowing costs for many subnational units.

5. Institutional lessons and best practices

Based on experiences and academic / policy research, here are lessons:

Area

Lessons / Best practices

Legal & institutional frameworks

Put in place formal insolvency / restructuring frameworks for subnational governments; define procedures in advance. 

Fiscal rules

Impose limits on borrowing (debt ceilings), require balanced budgets or constraints on short-term borrowing or revenue anticipation loans. E.g. Brazil introduced fiscal responsibility legislation to require transparency and limits. 

Transparency & data

Subnational units should publish timely fiscal data: revenue, expenditures, debt, unfunded obligations, off-balance sheet items. 

Risk management

Manage currency risk, interest rate risk, and refinancing risk. Avoid excessive short-term borrowing or foreign-currency exposures without hedging.

Coordination with central government

Clear rules for transfers and oversight; ensure that intergovernmental transfers are stable and predictable to reduce revenue shocks.

Stakeholder engagement & negotiation

In restructuring, negotiate with creditors, allow holdouts but design fair burden sharing. Use frameworks that reduce litigation risk. 

Public pension / implicit liabilities

Recognize and fund pension liabilities or retiree health obligations; avoid deferring these obligations to future budgets unaccounted for. 

6. Recommendations

Here are recommended policy / governance recommendations, framed with your interest in institutional / legal frameworks and governance:

Design a robust subnational insolvency / restructuring law Define triggers (liquidity stress or debt servicing inability) and legal process for negotiation with creditors. Provide for restructuring of debt, renegotiation of terms, and holdout resolution mechanisms. Improve fiscal transparency and accounting Mandate full disclosure of debt (both explicit and implicit liabilities). Require forward projections of obligations (pension, retiree benefits) so obligations are visible. Implement fiscal rules Debt ceilings or debt service limits. Constraints on short-term cash lending or anticipation loans. Local governments should have to justify borrowing with clear revenue forecasts. Strengthen central-subnational coordination Ensure intergovernmental transfers are stable and formulaic. Provide guidance / oversight so subnational budgets remain sustainable. Debt restructuring planning & tools Pre-approve bond covenants that allow restructuring. Use domestic legislation to avoid over-reliance on foreign law holdouts. Provide mechanisms for collective negotiations with creditors (bondholders, banks, etc). Political and institutional reforms Grant more autonomy but impose accountability, so subnational governments cannot rely indefinitely on bailouts. Ensure local authorities have capacity for forecasting and fiscal planning. Monitoring and crisis prevention Set up early warning indicators (debt service ratio, revenue shocks, fiscal deficit). If a region is trending toward unsustainability, trigger corrective measures or central oversight.

7. Conclusion

Subnational debt is a significant and sometimes neglected dimension of public finance. Large debt burdens at the local/regional level can threaten fiscal stability, especially when paired with implicit liabilities and limited capacity. Past crises (in territories, provinces or states) show that without adequate legal frameworks, transparency, and fiscal discipline, subnational jurisdictions can end up in restructuring or default.

For your work (especially in analyzing institutional structures, legal frameworks, and governance), subnational debt offers a rich case: legal constraints across federated vs unitary states, different insolvency regimes, and the role of coercive fiscal relationships (central transfers, soft budget constraints). It also connects to your interest in institutional governance & coercion, because subnational governments may be coerced by central authorities, creditors, or financial markets into austerity, restructuring, or reform.