Bail outs for Failed States? No Way!

The Blue State governance model

by James A. Bacon

As Greece stumbles towards default on its budget promises and the European Union continues its slow-motion meltdown, a growing number of people are wondering if default is in the cards within the Dollar Union, in other words, the good ol’ United States of America.

California’s projected budget gap has increased from $9 billion in January to $16 billion today, a gap that Gov. Jerry Brown proposes to close with a debilitating combination of tax hikes and spending cuts. Meanwhile, despite jacking up income taxes last year (or perhaps because of it), Illinois faces a $2.7 billion revenue shortfall. In desperation, Gov. Pat Quinn is pushing cuts to programs serving his core Democratic constituencies, Medicaid recipients and public sector employees.

The Blue State governance model is in free fall. Normally, states don’t incur budget crises until a recession devastates their revenues. Now, we’re experiencing budget crises three years into a business cycle. I would advance the argument that a number of Blue States — California and Illinois, most visibly — have entered into an irreversible downward spiral. If they don’t raise taxes and cut spending, they will default on their debts, with incalculable consequences. If they do raise taxes, they’ll chase businesses and the productive class out of the state. If they cut spending programs, they will betray their core constituencies. When the U.S. falls back into recession, as eventually it will, the Blue States are toast.

Now people are seriously pondering the possibility of bailouts for failing states. In a Wall Street Journal op-ed, Representative Kevin Brady, R-Texas, and Senator Jim DeMint, R-South Carolina, argue that it’s time to take that option off the table.

As big government-low growth states fall deeper into the fiscal hole, the question becomes whether Washington politicians will force taxpayers in more prudent states to bail them out. This cannot be allowed to happen. As the 2008 financial crisis proved, bailouts never solve anything. They only create more problems—moral outrage on one side, and moral hazard on the other.

It is becoming clear that the only way to force recalcitrant states to put fiscal reform on the table is for Congress to take state bailouts off of it. Recent experience on Wall Street and in Athens suggests that if decision makers in Illinois, New York, California or anywhere else believe Washington will bail them out of their fiscal mismanagement, we cannot expect any self-directed reform from them. … Congress must—in word and if necessary in law—make plain that the taxpayers will not protect these states from the consequences of their policies.

I whole-heartedly concur. Virginia is among the fiscally responsible states that have worked diligently on a bipartisan basis to balance budgets, issue debt with restraint and maintain an attractive business climate. We haven’t done everything right by a long shot — as I frequently remind readers. Over and above engaging in dubious budget tricks, we have pusillanimously avoided fundamental reform of basic institutions from education and health care to transportation and land use. But, hard as it is to believe, we’ve screwed things up less royally than many others. Virginians should not be asked to pay for the glaring failures of others.

Virginia’s Congressmen need to join Brady and DeMint to make it crystal clear that they will oppose any bid to bail out failed states… a bid that is surely coming, whether next  year or next decade. It won’t be hard for Republican representatives, who have no sympathy whatsoever for the travails of the Blue States, to say no. But Democrats could find themselves conflicted.

Republican candidates for Jim Webb’s U.S. Senate seat should press the inevitable Democratic nominee, Tim Kaine, on whether he would vote to bail out the blue states. Get him on the record. If he waffles, make it a campaign issue.

For that matter, it wouldn’t hurt to put heat on Sen. Mark Warner. While Warner has been vocal about the dangers of the impending federal budget apocalypse, he voted for the Obama stimulus and for Obamacare. Virginia voters cannot take it for granted that he would oppose a budget-busting bail out of failed Blue States. Let’s get him on the record.

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  1. thebyurokrat Avatar

    Perhaps the first step should be to allow “blue” states to keep a greater portion of the revenues currently extracted by the federal government and redistributed to your low-tax, low-spend “red” states. Perhaps if that 22% of federal revenues extracted from California and spent elsewhere was left in the state, incomes and economic activity would increase (leading to an increase in state revenue.)

    It’s amusing to see Virginians talking about limited-government and fiscal responsibility when the primary driver of the State economy is massive and continual spending by the Federal government within the state. What would our budget situation look like without receiving a $1.50 in federal spending for every $1.00 in federal taxes paid?

    1. Maybe Blue State congressmen ought to re-think their income redistribution schemes. Democrats and Progressives are the ones who created the schemes. Why are they fighting so hard to keep them in place? Every time a Republican suggests trimming the social safety net, we hear a chorus of how they’re abandoning the poor, the disabled, the women, the children, etc.

      1. thebyurokrat Avatar

        We’re fine with redistribution, I’m just amused with your logic here and elsewhere. Virginia is a huge beneficiary of federal largesse, and you have the temerity to scold other states for not getting their fiscal houses in order?

        And it’s particuarly rich coming from the party that plugged a fiscal hole by “borrowing” from VRS, and in doing so created a pension shortfall that they addressed by cutting future benefits for employees. Your side calls this “reform” and “responsibility”, many would call it theft.

        And what the hell does “bullet proof the state budget” mean? Like, print it on kevlar? If your side gets the austerity and federal government retrenchment it so desires, it’s going to take a lot more than the mythic “diversification” to save Virginia.

  2. larryg Avatar

    I’m darkly amused. How is the Federal govt.. in debt to the tune of 15 trillion+ dollars going to bail out anybody?

    but I also don’t see the gloom & doom “civilization as we know it will fail” scenario.

    Bacon narrates this with a hint of glee in his


    here’s what business is saying about this:

  3. DJRippert Avatar

    Another great theory that seems low on reality.

    For the sake of argument, let’s assume that a bailout can be defined as the step just prior to bankruptcy. Therefore, the bailout of an American state would be the last ditch effort to avoid bankruptcy of that state.

    The question immediately arises as to whether the US Constitution allows the federal government to permit a state’s bankruptcy. Many believe that it does not. This is ironic for Virginia since it’s essentially the same sanctity over the sovereign nature of states that gives rise to both Dillon’s Rule and the possibility that the federal government cannot stand by and let a state go bankrupt.

    However, there is a much more important question for people like Jim Bacon. Just over 150 years ago the people of Jim’s hometown led an immoral war against their fellow countrymen for the primary purpose of preserving slavery in south. Virginia, in general, and Richmond, in particular, took a leadership role in that insane, hopeless and immoral war. As usual, the political class in Richmond backed a cause that had no chance whatsoever of winning. As usual, the political class in Richmond brought great devastation, ruin and misery on the population of Virginia.

    Did the federal government abandon Virginia after the Civil War? Did the federal government execute the Virginians who led the war effort? Did the federal government even ban the building of government funded operations in Virginia?

    Jim Bacon and every other Richmonder and Virginian would do well to remember the cataclysm unleashed by Virginia against the people of the United States. As Mr. Bacon berates and advocates for the abandonment of the people of California and Illinois he should perhaps visit a Civil War battlefield where some of the hundreds of thousands of Americans killed in that Richmond-led war are buried.

    Shame on you, Jim Bacon! You claim to be an American but are only too happy to abandon tens of millions of your countrymen. You claim to understand history but can’t forgive the governance mistakes of some states even as the very city where you live was forgiven for the greatest crime ever committed against the people of the United States of America.

    1. Are you kidding me? Are you serious? Or are you just trying to get my goat? I can’t always tell.

      1. DJRippert Avatar

        Maybe a bit of all three.

        I don’t see the federal government allowing any state to go bankrupt. What bankruptcy court has authority over a sovereign state? None. Beyond that, the inability of a number of states to borrow money would destroy the state economy and social fabric. Sorry Jim, but you Tea Pots are out to lunch on this one.

        I would also love to hear your opinion of how Richmond and Virginia were treated by the federal government after the US Civil War. My opinion is that Virginia was treated a whole lot better by the victorious Union Army than any other defeated nation was ever treated. In fact, had the political elite in Virginia accepted the fact that they were totally and unconditionally defeated the whole state would have been a lot better off.

        Here are Lawrence Goldstone’s thoughts:

        “The South, with its abundance of natural resources, favorable climate, and navigable rivers, should have been a magnet for manufacturing…..But southerners were more interested in trying to maintain the past, to replicating as near as possible, the social economy of the slave system. The more they struggled to maintain a dead status quo, the more they were throttled by it. Scant was the opportunity for blacks or whites in a society in which universal education was discouraged and the perpetuation of an antiquated dysfunctional social order overwhelmed economic considerations.”

        In other words, Reconstruction could have been a bailout but the entrenched political class in Richmond was just too stupid to take it.

  4. Larry, the U.S. is facing the same dilemma as the blue states. The difference is, the federal government has a printing press, the states do not. If the feds can’t sell their Treasuries, ol’ helicopter Ben Bernanke buys more bonds. So, the day of reckoning for Uncle Sam is further off than for the states. But when federal policy implodes — some combination of uncontrolled spending cuts and runaway inflation — the disaster will be of far greater magnitude.

    As for the “hint of glee,” you misinterpret. I can see clearly what’s coming. Unfortunately, I have no good idea of how to protect myself and my family from it. I’m counting on Medicare and Social Security to help underwrite my retirement. I don’t want to see those programs severely retrenched. I worry about what awaits my children, and I worry about what awaits Americans less fortunate than me.

  5. bosun Avatar

    I am confused. The federal government chose to bail out Wall Street banks; before that Chrysler. It gives billions to subsidize private business, including very profitable companies. So, it’s OK to bail out the private sector, but states and local governments should be punished for their mistakes? Bosun

    1. Sure, Bosun, let’s bail out EVERYBODY! If you screw up, just go to Uncle Sam with tin cup in hand.

      I’m opposed to corporate welfare. That’s a good place to start cutting back the size and scope of the federal government. Put it right at the top of the list. Then keep on going…

  6. larryg Avatar

    rank list of economies

    1 US
    2 Japan
    3 China
    4 Germany
    9- California
    30 – Virginia
    41 – Greece

    Fed Dollars per Capita:

    Virginia: $19,734. (2nd highest)
    California: $9,360

    what would happen to Va if we ended up with the amount that California has?

    Would we still be the “good” fiscal state?

    1. DJRippert Avatar

      LarryG asks a good question:

      Let’s equalize fed payment to VA at the CA level. That’s $10,000 per year per person less for Virginia.

      Virginia has 8M residents. That fed reduction reduces VA’s state GDP from $428B / Year to $348B / Year.

      In per-capita terms, Virginia moves from the 9th most prosperous state to the 23rd most prosperous state.

      Unfortunately, there is more bad news. I haven’t accounted for the “velocity of money” with this calculation.

      The Lord only knows how much further Virginia would fall if the velocity of money was taken into account.

      This is so depressing I think I’ll go outside, sit under a tree and wait for answers to “bubble up”.

  7. Without all those federal dollars, Virginia’s economy will look very different. Federal largesse will end, and we’re fools if we don’t recognize it. That’s why I keep harping on the fact that (a) we’ve got to diversify our economy, (b) bullet proof our state and local governments, and (c) start the hard work of transforming our outmoded institutions.

    1. DJRippert Avatar

      Ah, and now the great fallacy of Baconian logic….

      1. The feds must spend less in order for the republic to survive.
      2. Virginia has been one of the greatest recipients of the federal lagrasse.
      3. Therefore, Virginia is under threat and must change.
      4. The best approach is to wait for things to “bubble up” rather than undertake an active transformation. if we just watch those rusting out aluminum factories long enough they will eventually turn into condos for the creative class.

      Jim Bacon is stuck between a rock and a hard place. On the one hand there is Ed Risse pushing for fundamental transformation. On the other is Grover Norquist whispering in Jim’s ear that all taxes and government are bad.

      Jim knows things in Virginia must change but thinks they will change magically and for free. Or, as Scarlett O’Hara once said, “Tomorrow is another day.”.

      Jim, like all the other Boomers, has benefitted vastly beyond any contributions that sad generation made. From the runaway deficits to the frozen gas tax, Boomers are defined only by their selfishness and greed. Now the chickens are coming home to roost and the Boomers still don’t want to put any of their ill-gotten gains back into the country. Sad. Pathetic.

  8. larryg Avatar

    I’m still not sure what a bankrupt state looks like. Do the creditors get to take over their state parks and other physical assets and sell them at auction?

    Do they remove the Gov and replace him with a …what do you call it… oh yeah a Special Master or similar?

    Do they let J.P. Morgan take over and run things and then they can go running to the govt for a bailout if things get too sticky?


    who exactly are the creditors of state govt anyhow?

    1. I’m no expert, so take anything I saw with a grain of salt. I doubt that a sovereign state can go bankrupt. But it can go insolvent in the sense that it is unable to meet its legal and programmatic obligations and unable to pay its commercial bills. It can reach a point (which Illinois seems to be approaching) at which vendors decide to stop providing services to it and, conceivably, employees decide to quit working for it. A state can reach the point at which it sows chaos among its citizens and its economy.

  9. larryg Avatar

    re: Blue vs Red state finances…. I’m a skeptic on this… but if someone listed the top 10 states in financial trouble and their State Gov “color” it could be more convincing.

    Texas is a red state for sure but their health care and education are abysmal ….compared to states like Massachusetts which as far as I know is also operated fiscally competently.

    here’s one list of the most fiscally stressed states:

    1. California
    2. Arizona
    3. Rhode Island
    4. Michigan
    5. Oregon
    6. Nevada
    7. Florida
    8. New Jersey
    9. Illinois
    10. Wisconsin

    here’s another.. more detailed but in a pdf …perhaps Jim can break it out:

  10. thebyurokrat Avatar

    If you look at Table 17, per capita state expenditures in Illinois are substantially lower than Virginia ($4,727 vs. $5,096). Perhaps Illinois needs to raise taxes to support Virginia’s fiscally conservative spending levels?

    Or maybe Illinois should finagle the $17,008 per capita the feds spend in Virginia, vs. $8,571 they’re spending in Illinois (Table 16 of same report). Should be easy, what with a Chicago boy in the White House?

    Maybe they should change their flat personal income tax rate from 5% to the 5.75% max seen in Virginia (which basically acts like a flat tax, considering the top rate kicks in at $17,000 of income.).

    Who knows? But you’re probably right, every technical budget issue can be solved by spending cuts, tax cuts, and deregulation. Damn the consequences!

  11. larryg Avatar

    I think thebyurokrat has a good point about the VRS. What did the employees of Va do to deserve this?

    Did Virginia renege on a financial commitment?

    Is this how the States ultimately will resolve their budget dilemmas?

    ultimately the costs of govt are people …. salaries… and Jim B points out, in effect, that the states have hired more people than they can afford to pay.

    1. thebyurokrat Avatar

      How do we determine what states can afford to pay? It’s certainly some function of the economic activity and resultant incomes within their state. On it’s face, there’s nothing unreasonable in saying that New York and California can sustain a higher level of government services than Alabama and Mississippi.

      One method might be too look at State and local taxes as a percentage of personal income. In Virginia, that ratio in 2010 was 8.7%, or 45th in the nation. California was 10.4% (20th) and Illinois 9.6%. The top 10 are mostly those fiscally conservative states you like to talk about, South Dakota (20.5%), Texas (11.6%) and even Alabama (11.4%).

      Maybe those “high-tax” blue states just aren’t taxing enough? Virginia certainly appears to have the capacity to increase taxes. Even going to the nationwide average of 10.4% would likely solve many of Virginia’s budget woes.

  12. The research shows pretty conclusively that low-tax states out-perform high-tax states in population growth and job creation over the long run. That’s not to say that every low-tax state out-performs every high-tax state. Taxes are not the only factor that drives job creation. Other factos can intervene. But there’s not much to debate here. The proposition that, all other things being equal, low tax states out-perform high-tax states, is verifiably true.

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