Relax, U.S. States Aren't About to Go Belly Up

Last Updated Feb 2, 2011 10:56 PM EST

Are debt-laden U.S. states about to go bust? No way, says Center on Budget and Policy Priorities senior fellow Elizabeth McNichol, noting that over the last century only one state -- Arkansas during the Great Depression -- has ever defaulted on its debt. As she writes in a timely rebuttal to alarmist reports that several states are considering bankruptcy:
States do indeed face long-term budget challenges, including revenue systems that need modernization and pension funds that are somewhat underfunded. But there is no evidence that they won't be able to address these challenges.
Here's why, according to the nonpartisan think-tank:
States' budget shortfalls for next year shouldn't be lumped together with their longer-term budget issues. States are required to balance their budgets each year. Over the past three years they've done so despite a plunge in revenues due to the recession, and next year (fiscal year 2012) could be states' toughest yet.
But these are cyclical deficits that will diminish as the economy improves. They are distinct from the longer-term issues -- states' bond indebtedness, pension obligations, and health insurance costs for retirees -- that some observers see as evidence of imminent fiscal disaster.
State debt levels aren't particularly high by historical standards. States are in no danger of defaulting on their debt.... In the second quarter of calendar year 2010, state and local government outstanding debt stood at 16.7 percent of GDP, up from a recent (and relatively brief) low of 12 percent in 2000, but similar to the average levels from the mid-1980s to the mid-1990s (click on chart below to expand).
States aren't interested in walking away from their obligations. As the National Governors Association stated last week, "The nation's governors strongly oppose federal proposals to provide states with bankruptcy protection. Allowing states to declare bankruptcy is not an authority state leaders have asked for, nor would they use."
So how will state governments make ends meet? The old-fashioned, if politically dicey, way -- by cutting spending and raising taxes. States still have plenty of tools for balancing their budgets, McNichol says. (The debate over whether states, which are legally barred from declaring bankruptcy, should have the right to restructure their debts in court is another story.)

As for fears that state pension plans facing up to $3 trillion in unfunded liabilities could suddenly fail, they're overblown, according to a recent report by the CBPP. True, states such as Illinois, New Jersey and Pennsylvania have skipped or curbed deposits to public pensions to help balance their budgets. Rising retirement liabilities also could threaten some states' credit rating. But the situation is less dire in most parts of the country.

As of 2010, state and local pensions were at funded at 77 percent of their future obligations. Although that figure is expected to drop another 4 percent over the next two years, such funding levels do not represent an "imminent" crisis, the group concluded, while acknowledging that states will eventually have to take steps to replenish plans. It's a problem, in other words, but hardly the kind of time bomb that's about to blow a hole in state budgets.

Another concern for states are the health benefits they offer to retired employees. State and local governments have some $500 billion in unfunded retiree health liabilities, according to industry data. The CBPP acknowledges that mounting health care costs means that some states may eventually have to cut benefits or increase premiums. But the larger point is that state and municipal governments retain multiple, if difficult, options for getting a handle on retiree benefits, such as raising insurance premiums or limiting services.

So despite all the dark prognostications, states live. McNichol concludes:
The reality... is that no state is at all "likely" to go bankrupt.

Charts from Center on Budget and Policy Priorities; other images from morgueFile
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