McConnell Supports Allowing State Bankruptcies as Governors Call for Federal Bailouts

What’s the story?

• With Congress's passage of the $484 billion “phase 3.5” coronavirus (COVID-19) relief package in hand and its enactment soon to follow, lawmakers’ collective attention is turning to the next potential aid package.
• Despite receiving $150 billion in funding under the CARES Act for COVID-19 related expenses, state governors have requested an additional $500 billion in “unrestricted fiscal support” in the next COVID-19 relief bill to shore up their budgets.
• In some cases that funding would alleviate budget shortfalls caused by the coronavirus pandemic, but in other cases the funds would go toward resolving longstanding fiscal issues like underfunded public employee pensions or accumulated debt obligations.

Illinois: A Case Study

• Illinois’ unfunded public employee pension liability is the largest of all 50 states at $138 billion, and it has an additional $54 billion in liability for other post-employment benefits for retired public sector workers. 
• Spending on pensions in the state has grown by 500% over the last two decades to consume 25% of Illinois’ general funds budget and 36% of education spending, while benefits have increased by 900% since 1987.
• Illinois Senate President Don Harmon (D) sent a letter to the state’s congressional delegation in Congress requesting $41 billion in assistance from the federal government. That includes $10 billion in direct relief for Illinois’ public employee pensions, which Harmon said is needed to offset “significant revenue losses.” 
• The Illinois Republican Party said Harmon & state Democrats were “brazenly using a global pandemic as an excuse to ask the [federal government] to bail them out of the fiscal disaster they manufactured over the last two decades.”

What does it mean for other states?

• Illinois is far from the only state facing ballooning public pension costs, and a report by the Pew Charitable Trusts in 2017 found its relative pension shortfall was the third-worst in the country behind Kentucky and New Jersey.
• Additionally, a number of states have accumulated substantial debt obligations through the issuance of bonds. The American Legislative Exchange Council put states’ bond obligations in 2019 at a total of $1.16 trillion, with California’s $212.3 billion surpassing the next two most-indebted states combined (Texas with $80.9 billion & New York with $74.9 billion).
• U.S. Senate Majority Leader Mitch McConnell (R-KY) said in an interview with Hugh Hewitt:

“There’s not going to be any desire on the Republican side to bail out state pensions by borrowing money from future generations… I would certainly be in favor of allowing states to use the bankruptcy route. It saves some cities. And there’s no good reason for it not to be available.”

What is bankruptcy & why can’t states declare it?

• Bankruptcy is a tool for an overburdened borrower to restructure its obligations. U.S. bankruptcy laws allow individuals, businesses, and some local governmental entities to reorganize through bankruptcy.
• Cities, counties, and their subordinate agencies (like a school district) are allowed to declare bankruptcy under Chapter 9. The largest municipal bankruptcy in U.S. history was declared in 2013 by Detroit, Michigan, with more than $18.5 billion in liabilities.
• Unlike municipalities & counties, state governments are not allowed to declare bankruptcy as a means to restructure their debt obligations under the bankruptcy code. That’s in part because of the Contracts Clause in Article I, Section 10 of the U.S. Constitution bars states from making laws “impairing the obligation of contracts.”
• However, Congress could enact a law allowing states to declare bankruptcy which would face a near-certain constitutional challenge in the Supreme Court.
• While states can’t currently declare bankruptcy, they are able to default on their obligations ― although it’s been a long time since that happened. 
• In 1841-1842, nine state governments defaulted and another three repudiated their debt. From 1873-1884 a total of 10 states defaulted.
• Most recently, in 1933 Arkansas unilaterally restructured its debt on general obligation bonds through a default that was ultimately resolved by a federal banking agency buying half of the bonds.

— Eric Revell

(Photo Credit: iStock.com / udmurd_PL)