This is a great ideal, in theory, but the flip-side of it is that in reality if we don't have any sort of negative consequence for unsustainable policy-making, you have a moral hazard, and institutional corruption and rot. Heaven knows there is a lot of that at the State and local level. You ultimately need some creative destruction in the long-run to ensure that we have the best possible governments. I heavily caveated that we must make sure that, in the short run, the poorest are taken care of. Insofar as one would be in support of allowing States to fail in a "good faith" way, it would be if the Federal policy ensured that the poorest among us are bailed out and taken care of in the short run.
> These same states (often blue) have higher taxes to fund their barriers to entry with surpluses that give them the capital to weather aberrant situations like these.
Sure, and a lot of Blue states will be fine and not have to go into packaged restructuring / bankruptcy. For a lot of States (both Red and Blue), the most worrisome line item is the defined-benefit pensions — they promise a certain return that has never happened and will never happen. These pensions will _never_ be solvent. Most people in Illinois under the age of 50 know that they will probably never see a dime of these pensions, and that's terrible. You would want to push States to more sustainable pension systems, maybe a Sovereign Wealth Fund like Singapore / Scandinavian countries, or just raw publicly funded 401(k)s. If those same pension plans instead put the annual contributions into the S&P500, they would have been more solvent than they are today.
> In addition, it is difficult to argue that constituents will vote for their economic best interests if social issues are more top of mind in redder states.
I mean, you have to let constituents look out for themselves in a democracy. If they don't vote in their economic best interests, then that means those societies favor different outcomes. All of these states have republican forms of government with checks and balances to ensure that democracy doesn't turn into mob rule. Letting Blue states go into bankruptcy might even be better off for Blue states and worse off for Red states, but the underlying idea is that we need to let States test out different approaches to welfare and infrastructure and prevent long-term institutional rot.
> This will only exacerbate the problems without a federal solution in place.
Yes, hence my caveat to bailing out individuals.
States pay first responders - medics, firefighters, police, teachers - fund projects, and invest in their communities. State governments themselves employ huge amounts of people. They fund homeless shelters and food banks and all sorts of public services. It would be incredibly harmful to these communities to have their support systems that they depend on removed. Not to mention not being able to pay first responders during a crisis. Hows that for a moral hazard?
I also do not see how your post addresses the fact that blue states are overwhelmingly net contributors in federal taxes, and how red states are overwhelmingly net takers. It seems like it warps your view of price discovery, since the government has for decades guaranteed the bond prices of red states. The consistent federal allocation of tax money towards the everday failure of red states totally discredits your theory weeding out "institutional rot" during a crisis, and of optimal taxation.
Taxation and economic performance are essentially the 2 core predictors for any political entity's prosperity. This is true of any nation in the world, from Germany, Denmark, Belgium, France, the Netherlands, Sweden, Finland, Estonia, etc. The core thesis is that we want States to be as prosperous, if not more prosperous than those countries. There's no way to get there without digging ourselves out of the fiscal hole — or if you believe in it, MMT. And unless we totally swap out the governing decision-makers responsible for digging States into the fiscal hole in the first place, this will keep happening again and again. It's the same reason bailing out big banks and corporations is also bad.
> States pay first responders - medics, firefighters, police, teachers - fund projects, and invest in their communities. State governments themselves employ huge amounts of people. They fund homeless shelters and food banks and all sorts of public services. It would be incredibly harmful to these communities to have their support systems that they depend on removed. Not to mention not being able to pay first responders during a crisis. Hows that for a moral hazard?
Going into bankruptcy doesn't change any of this, it just means that they get to keep the funds that they borrowed in order to pay for all of those things without having to pay back bond-holders. The bond-holders lose. Then the next thing that happens is that the credit rating falls, and they would have to pay higher interest rates on future bonds. This is definitely painful in the short-term, but institutional investors will continue to have some appetite for higher-yield bonds for near-term projects. In the long-term, credit ratings can change if the people of a State elect better leaders, and the State can take out lower interest-rate bonds. California had a BBB credit rating in 2003, and through strong leadership and good policy, raised their credit rating up to an A+ rating in 2006.
Additionally, States can also raise revenue by raising taxes. State taxes are awfully low. Those services, while good and important, aren't free — and their societies need to pay for them through sustainable taxation. The marginal income tax rate in the US is lower than it was in a lot of the 20th century — Illinois, California, New York, etc can all raise taxes to fill in that void. In most European countries, the middle class income tax rate is what pays for most programs, and is far higher than the middle class tax rate in the US. Another avenue that States can look into.
> I also do not see how your post addresses the fact that blue states are overwhelmingly net contributors in federal taxes, and how red states are overwhelmingly net takers. It seems like it warps your view of price discovery, since the government has for decades guaranteed the bond prices of red states. The consistent federal allocation of tax money towards the everyday failure of red states totally discredits your theory weeding out "institutional rot" during a crisis, and of optimal taxation.
Yes, fiscally irresponsible Red states should also declare bankruptcy, and all of this applies to them as well. 2 things can be true at the same time: we should ensure that there is a mechanism to weed out long-run institutional corruption/rot in both Red and Blue states, and we should also reduce transfer payments from net contributors to net takers. If there is a net contributor that ends up having to go through bankruptcy restructuring they should be able to use their surplus to weather the short-run fallout.
There are a bajillion different variables that go into how we price corporations / assets in a decentralized way. This includes basic stuff like revenue, margins, balance sheets, growth, but can also include macro risk, which political party is in power, the current weather, etc. Apple isn't worth $1T because some schmuck decided it was worth that much, it's worth that much because we all play some part in the price discovery. When you remove some of the variables from this equation, the price becomes less reliable (mis-priced assets).
You might argue that it doesn't matter for most assets like airlines, and you'd probably be right about that, but there are certain types of assets like junk bonds where this has more negative consequences in the long run. We've been mis-pricing junk bonds to the degree that, at a macro level, there is way more capital being allocated to bad companies with poor fundamentals than there should be. We want more Amazons, Stripes, and Shopify's, and fewer WeWorks and SoftBanks.
States are similar, you have some States that are incredibly well run (Massachusetts, Washington) and some that are very poorly run (eg Illinois). We need some mechanism to nudge poorly run states in the right direction, and encourage well run States to keep doing what they're doing, and more.
There's a caveat here that the Federal laws will need to change a bit to allow States to go into packaged restructuring. And to ensure that we are bailing out specific individuals to ensure that they are not too negatively affected.
One of the strongest arguments against "bailouts" of large corporations is that it negatively impacts price discovery. More specifically, it removes a company's ability to thrive in certain extreme conditions from the pricing equation entirely. An example: Amazon is at all-time-highs right now, and it's because it's proven itself to be a hugely important institution, both during wartime and peacetime. Its market price should reflect this value. Airlines, OTOH, are an institution that can be prone to failure when some things go wrong (exogenous or otherwise), and the price should reflect that. A theoretical airline doing $1B in revenue should be worth less than a theoretical Amazon doing $1B in revenue, even if both have identical profits, growth, balance sheets, etc. The net effect of this is inefficient and poor capital allocation, where more capital would be allocated towards airlines than warranted, and that capital could be allocated elsewhere in more productive / less risky endeavors.
This may come across as overly fundamentalist about the market, but where this really manifests is in the Fed's bailout of junk bonds, which is absolutely nuts. The whole point of junk bonds (I.e. the type of a loan that WeWork would have to take) is that it's default risk is high, but the yield is also high. If junk bonds are bailed out, then that means that we all ought to go and buy junk bonds. High yields for everyone! The Fed is going to bail you out no matter what. This, then, overly inflates the demand (and price) for junk bonds, and you now have a total capital mis-allocation, with a lot of capital going into AirBNBs and WeWorks of the world, rather than the Amazons of the world.
How does this relate to States? Taxation is the price we pay to live in a society, and States are a really underrated way we can accurately come up with the correct "price" for the correct basket of services society might offer. This is the Charles Tiebout school of thought. Bailing out states with shitty fiscal policies is 1) a moral hazard and 2) messes with the long run calculation of the optimal level of taxation.
Okay great, so then what happens if we just let States "fail", like we might let Corporations fail? If we allowed States to declare bankruptcy, the bond-holders won't get paid, and the State credit ratings will shift to reflect their true creditworthiness. In this regard, bailing out bad States is no different from bailing out junk bonds — the only difference is that today State bond-holders don't know that they're holding onto junk bonds — most States have a generally high credit rating (except Illinois, because, well lol)[1]. The only mechanism we know of for the system to correct the ratings of these bonds is to 1) let States relieve themselves of their debt obligations, and 2) organically allow the bonds for those States to become more high-yield.
You might argue that this makes it difficult for States to fund infrastructure projects and safety nets. Yes, it makes it difficult to finance projects in the short run, because the bond failures are reflective of the quality of the current governance. Who comprises the government, who is running things can change democratically — if citizens want more infrastructure projects / better development, they will have to vote for better policies and better representatives. It's the democratic equivalent of swapping out the entire executive team at WeWork with the executive team at Amazon. The alternative is that you never see these governance changes at the State and local levels, and you have the same problems in perpetuity because the same people are always in power, and we never learn from mistakes — institutional rot. Better governance might be to restructure bad pension systems, or raise their own State taxes (IMO State taxes are far too low).
TL;DR — the best argument for letting States go bankrupt is that it's an effective way to weed out institutional rot in the long run, and come up with the optimal level of taxation for the optimal basket of State provided services. Such a scheme can only work if individuals continue to be bailed out so that they are not caught in the onslaught.
[1] https://en.wikipedia.org/wiki/List_of_U.S._states_by_credit_...