Schragger on Debt Crises Facing States, Localities

November 2, 2011

Faculty Q&A

University of Virginia School of Law professor Richard C. Schragger explores the debt crises facing state and local governments around the country in a forthcoming Yale Law Journal article, "Democracy and Debt."

In his paper, Schragger argues that distrust of state and local democratic decision-making is unwarranted, that efforts to constraint fiscal politics will likely fail and that the solution to state and local fiscal challenges is more a matter of politics than institutional design.

Professor Richard C. Schragger's forthcoming paper, "Democracy and Debt," examines the debt problems facing state and local governments.

How did you become interested in this topic?

I was asked by the Yale Law Journal to write an essay addressing the state and local government debt crises. Their request was animated by recent events, including bankruptcy filings by a handful of cities and some high-profile discussions about the need for a state bankruptcy option.

Can you outline the paper's key takeaway?

The central argument of the paper is that the institutional mechanisms that are supposed to limit state and local spending are destined to fail as long as economies continue to experience boom and bust cycles. Efforts to impose discipline" on state and local governments, which already exercise limited control over their local economies, are mistaken.

In your paper, you note that existing fiscal constraints on states and localities have failed to prevent fiscal difficulties and, in fact, have contributed to those difficulties. Can you elaborate on that?

After the debt crises of the 19th century, many states adopted limitations on borrowing, balanced-budget amendments, tax and expenditure limitations, and other mechanisms to control state and local taxing and spending. Many scholars now think that these constitutional limits do more harm than good because they undermine state and local efforts to respond to economic downturns. These procedural constraints also encourage states and localities to engage in problematic financing and accounting policies.

Why are constitutional fiscal constraints, such as balanced budget amendments, problematic?

Balanced budget amendments have been shown to be pretty ineffective and tend to encourage off-budget accounting practices. They also fly in the face of commonplace Keynesian economic theory, which counsels the government to run budget deficits during downturns.

You note that many of the fiscal constraints on state and local government were enacted in the 19th century, when state and municipal debt crises led to defaults by nine states and hundreds of municipalities. Today, we're seeing a small number of cities filing for bankruptcy and there have been calls to allow states to declare bankruptcy. Do we not need new fiscal constraints on states and localities for the modern era?

No. We don't need new constraints. We need to rethink the ones we have and start to address the structural reasons for state and local fiscal crises. Those structural reasons include: boom and bust cycles, the existing fiscal constraints, market manipulation and a set of political incentives that lead higher-level governments to impose new obligations without new resources on lower-level governments.

Some have suggested that state and local governments are overspending, thereby causing their budget shortfalls. Do you think this is true?

In some cases, states and localities have gotten into trouble with ill-timed infrastructure projects or they are facing difficult public pension obligations. Nevertheless, most states and local governments are relatively well-managed, considering the difficulties that any long-term economic downturn imposes. In such times, some governments will fail. The question is how the larger political community responds to those failures.

What role, if any, do you think the federal government should play in helping solve budget challenges at the state and local level?

In our federal system, the central government controls monetary policy and can more easily engage in countercyclical spending. It thus has more tools at its disposal than do the states or localities to fight economic recessions. There is lots of talk these days against bailouts" of distressed states and localities, based on the notion that states and localities need to learn their lesson" and get their fiscal houses in order." But again, this simplifies a complex problem. States and cities aren't like people who respond to punishments; states and cities are political jurisdictions made up of an array of constituencies. In considering a bailout, one needs to take into account all distributional considerations, and especially how the existing fiscal crisis is hurting the worst off.

What are your thoughts on the idea of a balanced budget amendment to the U.S. Constitution?

Most scholars and economists think it is a bad idea.

What will you be working on next?

I'm going to continue to write about state and local fiscal practices as well as local economic development efforts: where, when and how they might succeed, and the role of the national government in promoting economically stable cities.

Founded in 1819, the University of Virginia School of Law is the second-oldest continuously operating law school in the nation. Consistently ranked among the top law schools, Virginia is a world-renowned training ground for distinguished lawyers and public servants, instilling in them a commitment to leadership, integrity and community service.

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