[Transkrip] What Would It Mean If U.S. States Went Bankrupt?


Dipublikasikan oleh CNBC pada 18 Mei 2020

The coronavirus pandemic is hitting America hard. Countless Americans are being advised to stay home as much as possible and governments are telling non-essential businesses to stay closed. But governments themselves are also taking a hit. Much of the economy has either slowed down dramatically or ground to a halt and with all that lost economic activity come the tax revenues governments depend on to pay for their massive budgets.


On April 21st, Senator Mitch McConnell said he would support the idea of letting states declare bankruptcy. Later, he walked back his comments. But the episode resulted in a firestorm of media commentary. 

"Come on, man… that is completely and utterly irresponsible. This is no time for bankruptcies and wishing bankruptcies." 
– Gov. Phil Murphy, D-New Jersey –

"The most un-American, uncharitable, ugly statement of all times." 
– Gov. Andrew Cuomo , D-New York –

Of course, there are reasons to be concerned about state's fiscal health.

"I think the big difference between this downturn and what we saw in the Great Recession or the recession of 2001, 2002 is the speed with which it came on and the severity with which it came on. That really makes it unprecedented from a credit standpoint. States entered this in a stronger position, but they're going to have to use all of the tools that they have available to them to maintain their credit quality through this." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

An array of industries have been badly hurt since the coronavirus began to spread. Travel and tourism have tanked. Stores are shuttered and restaurants are relying on takeout and delivery to try to stay afloat. As all that business dries up, so do the sales and tourism taxes that go with it. Some states, such as Washington, Arizona, Nevada, Louisiana, and Tennessee all rely heavily on sales tax for their revenues. A number of states with high sales taxes collect no state income tax at all. But income taxes are also taking a hit. A staggering 30 million Americans have filed for unemployment benefits.

The federal government has also extended the tax deadline from April 15th to July 15th, and many states have adjusted their own deadlines accordingly. That means that for the next three months, they will have to do without whatever state income tax revenue would otherwise remain. Meanwhile, states have to keep paying for services. Roads need to be maintained. Government workers still need to be paid. And governments are now also saddled with medical and unemployment expenses. There could be more hurt ahead for city and state finances across the U.S. By law, municipalities such as cities can declare bankruptcy. But states cannot, and they never could. However, some in the legal world have argued that state bankruptcy should be a viable option and it's a better alternative to bailouts. 

University of Pennsylvania law professor David Skeel is one of them. He and fellow U Penn professor Robert Inman co-authored an editorial on May 5th arguing that McConnell was right to say that emergency aid from Congress should not be a bailout for state deficits that have nothing to do with the pandemic. They argue that Congress should act as an insurer of last resort and only hand out aid to states for losses incurred during the pandemic, and not for pre-existing problems. Skeel has argued in the past that states in deep financial trouble should be allowed to file for bankruptcy. Inman is skeptical. But it is clear that McConnell is not the only person who has expressed support for the idea. 
So legally, why can cities, towns, or school districts declare bankruptcy when states are unable to? 

Since 1937, the federal bankruptcy code has allowed municipalities to declare bankruptcies. Municipality is a broad term that basically includes all kinds of subdivisions of states, such as towns, cities, and counties, but also school districts and some government organizations within a state that collect revenue but don't cover a geographic area, such as a bridge authority. But the contracts clause of the U.S. Constitution prohibits states from impairing the obligation of contracts. Subsequent Supreme Court decisions have generally supported the notion that states cannot refuse to pay their debts. 

"So in our constitutional system of federalism, there's really only two sovereigns. There's the sovereign United States government and there's the sovereign state governments. There's no such thing as a sovereign city government. And so the idea is that the United States has been thought not to be allowed to do things that would impair the ability of the states to function as governments. But there's no similar principle that would prevent the federal government from doing things that would impair the ability of cities to function as governments, because cities are not dual sovereigns the way states are." 
– Kenneth Katkin, Professor of Law, Northern Kentucky University –

So for states to even legally allow themselves to declare bankruptcy. Congress would have to pass a law adding language to the federal bankruptcy code that explicitly allows states to declare bankruptcy. Then individual states would have to each pass a law that allows them to declare bankruptcy. Finally, the Supreme Court would have to determine that all that legislation does not conflict with the Constitution. 

“So if a state declared bankruptcy, then necessarily that means that some of their creditors would not get paid in full what the state owes them. And so those creditors would take that case to the Supreme Court and argue that it was unconstitutional for the states to be relieved of the debt to the creditors. So that's how we get to the Supreme Court. That would be the last step in the process.” 
– Kenneth Katkin, Professor of Law, Northern Kentucky University –

So if it's even possible, it's not a process that would be likely to happen quickly. The question of whether states should be able to file bankruptcy is a thorny one. And there are some critics of the idea that say allowing states to file for bankruptcy would, for example, raise the risk of lending money to states. It could also pit the interests of creditors against the interests of states. But the idea does have support. David Skeel, the University of Pennsylvania law professor, made the case for letting states go bankrupt when the country was in the depths of the recession, spurred by the financial crisis of 2008. At the time, several cities and states were in deep financial trouble, which some, such as Skeel, attributed to runaway expenses. "Allowing states to file for bankruptcy would save taxpayers a great deal of money," he said. Such laws could be squared with the Constitution and could be structured in a way that ensured bankruptcy courts did not override the states abilities to pass their own laws. "Anyone who proposed even a decade ago that a state shouldn't be permitted to file for bankruptcy would have been dismissed as crazy," Skeel wrote in 2010. "But times have changed." 

"States always have the ability to pay their debts by raising taxes. There's some views that would say that's not a good thing to do. And then states also have the ability to pay their debts by borrowing. But there's often even more consensus that that's not a good thing to do. And a lot of states actually operate under their own state, a balanced budget amendment which are in their state constitutions. So states could change those. There's no federal requirement that states balance their budgets. But a lot of states have imposed that requirement on themselves. And so if you think that a state should keep a balanced budget, it shouldn't raise taxes and it doesn't- And the state doesn't have enough money to pay all its bills. Then bankruptcy starts looking attractive. Right. So I think there's some there's some people who want to take those other two options off the table. And then they say, well, if you're not going to contemplate those other two options of raising taxes or borrowing money, then bankruptcy is the most orderly way to figure out how a state is going to pay pay some bills if it doesn't have enough money to pay all of them. But I think, you know, people on the other side of that partisan divide have not been as opposed to states sometimes raising taxes or sometimes borrowing. And those would be alternative ways of getting the bills paid without really requiring the creditors.” 
– Kenneth Katkin, Professor of Law, Northern Kentucky University –

But the situation prompts another financial question: whether coronavirus is even putting states in a position where they would need to declare bankruptcy if it was a legal option. And none of the research from the three largest credit rating agencies in the U.S. suggest any states are in danger of defaulting on their debt obligations. 

"Nearly all of the states are in very strong credit position. And that's not even something that they need to think about. There certainly would be constitutional issues of the federal government somehow overseeing state finances. But it's not an issue." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

In fact, states tend to have pretty high credit ratings. 

"So two-thirds of our states are in our two top rating categories. And that really reflects the broad range of powers that states have over their finances. They determine what taxes they have. They determine what tax rates they have." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –


The reason is that despite the trouble they face, states have a pretty high degree of financial flexibility. They tend to have very large tax bases. Of course, that varies depending on the size of the state's population and the health of its economy. But overall, their sheer size gives them a deep well to draw from. They also have two fundamental levers to pull. They can raise taxes and cut spending. States can push some expenses down to local governments. Aside from that, they can also issue debt. State debt issuance activity has been relatively flat over the last decade. 

"States generally only borrow for capital purposes to build schools, jails, essential government facilities. They don't really borrow for operations overall. They're in a strong position as it relates to debt. We might see some states do deficit financing through this crisis depending on how bad the revenue situation is. That is a typical for the sector. But it is another option for states that also generally have very good market access." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

In fact, many states are not out of cash yet. The financial recovery of the last 10 years or so has allowed many states to build up rainy day funds that can be quite large and hold some of them over for a while. In mid-April, the median available state governmental fund was 8% of fiscal 2018 year spending, according to Fitch, one of the three major credit rating agencies. 

"25 states had reserve levels high enough to cover the largest revenue decline they had had before coronavirus. And we, of course, don't expect that states will solely solve their budget problems with reserves, and coronavirus probably has created revenue problems that their reserves can't handle altogether. We expect to see states take structurally-balanced solutions, but they have significant powers over their finances." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

As of April 30th, credit rating agency Moody's had not downgraded any states because of the coronavirus pandemic. It had, however, lowered outlooks on a few states. A lowered outlook means there could be some downward financial pressure on states, and it also means that they are at a greater risk of a downgrade in the future. In early May, Moody's lowered its outlook on all U.S. states from stable to negative, citing uncertainty as to when life will return to normal across the country. That does not mean states are all going to be downgraded, but it does mean the economic downturn has accelerated, and there are rising state revenue headwinds, especially in sales and income taxes. 

"That sector outlook really reflects that the operating environment for states is much weaker than it was going into the coronavirus crisis. The employment situation has weakened significantly. Consumer sentiment has weakened significantly. Spending has weakened significantly. And all of that is having negative impacts on state tax revenue. We estimate that in the current fiscal year and the next fiscal year that starts July 1, that state tax revenue will be 15% lower than it was in the last fiscal year." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

The three states that have Moody's lowest credit ratings are Illinois, New Jersey, and Connecticut. All three have deep structural financial difficulties that pre-date the pandemic. Of the three, Illinois is by far in the worst shape. 

"There are two states in particular, Illinois and New Jersey, that had pre-existing credit conditions coming into the coronavirus crisis. Those two states have very high fixed costs for debt service pensions and retiree health care relative to their revenue compared to other states. That just limits their financial flexibility and how they will be able to manage through this. That contrasts sharply with triple-A rated states like Utah or Tennessee that have very low fixed costs. And that just gives them a lot of runway to be able to manage through this crisis." 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

Credit rating agency Standard and Poor's lowered its outlook on New Jersey April 29th, in part because of coronavirus-related effects. The state still has an A-minus rating, well within investment grade. However, Fitch downgraded Illinois to BBB-minus, the lowest investment grade, on April 16th. But even for states in relatively good shape, there are a number of concerns on the horizon. 

"The problem for state finances probably really started in March, when social distancing and quarantine policies really began to have an impact of economic shutdown. And that's had a very sudden and severe impact on sales tax revenues, in particular because people are really only consuming the essentials right now: groceries, pharmaceuticals, and the like. And those largely aren't taxed. Sales taxes for states are about 30% of overall revenue. But in some states, that's as high as 70%.” 
– Nick Samuels, Vice President and Senior Officer States Team, Moody’s –

Despite a record $115 billion dollars in aggregate cash reserves on hand for all states combined, few will be able to cover their projected tax losses with cash, Moody's said in a recent report. The agency expects coronavirus will reduce state tax revenues by $160 billion dollars from fiscal year 2019 to fiscal 2021. Fiscal 2021 tax revenue is expected to be $200 billion dollars less than governments would otherwise collect if there were no downturn and moderate growth. Even if an upturn were to begin in 2022, Moody's base case projection doesn't see state tax revenues returning to 2019 levels until 2024. "Achieving revenue consistent with a moderate growth path is even more out of reach," the agency said. Arizona, for example, finished 2019 with a $1 billion dollar surplus. But a recent report from the state's Joint Legislative Budget Committee projected a $1 billion dollar deficit by 2021, due in large part to the effects of the virus. 

There are other red flags popping up around the country that credit agencies are watching. Hawaii's State Council on Revenues recently lowered the general fund revenue forecast by about $300 million dollars through the next fiscal year, primarily due to coronavirus effects. In the state of Washington, the Department of Health asked for an additional $100 million dollars from the state legislature to combat the virus. In California, San Francisco's city controller recently reported sharp declines in hotel occupancy and airport traffic, and he estimated city revenue losses in the tens of millions of dollars. 

2019 was a record year for tourism in the city, according to the San Francisco Travel Association. Tourism brought in $819.7 million dollars in taxes and fees for the city that year, a 6% increase over 2018. About 51% of that amount came from hotel taxes alone. 

The Federal Reserve established the municipal liquidity facility to help state and municipal governments deal with cash flow pressures. The facility will purchase up to $500 billion dollars of short-term notes directly from U.S. states, including the District of Columbia, U.S. counties with a population of at least 500,000 residents, and U.S. cities with a population of at least 250,000 residents.
 
The federal government has set aside one $150 billion dollars for state and local governments through the CARES Act, and there will also be an additional $10 billion dollars through Medicaid per fiscal quarter, much of which is likely to be eaten up by virus costs. There is also a $45 billion dollar Disaster Relief Fund and $25 billion dollars for mass transit. But state and local governments are asking for another $750 billion dollars from the federal government, five times the enough allocated in the CARES act. And there is no clear idea of when case numbers will drop low enough to allow the country to get back to work.

Produced by
Jade Tungul

Senior Producer
MacKenzie Sigalos

Reporter
Robert Ferris

Additional Footage
Getty Images

Sources
The New York Times, The Washington Post, Tax Foundation, Congressional Research Service, University of Pennsylvania, Moody’s, S&P Global Ratings, Fitch Ratings