23 January 2013

State of the States

I haven't posted lately on state-level insolvency and the prudence of enacting a new chapter in the Bankruptcy Code to provide a forum to deal with that looming problem. (For some earlier thoughts go here, here, and here.) The effect of the Great Recession is one source of the financial distress of some American states. Long term shifts in the economy, e.g., from manufacturing to "information," is another. An aging population (Roe v. Wade anyone?) combined with a desire to live where it's warm is yet a third reason why the economic and tax bases of some states are in decline.

That's the income side, primarily; but what about expenses? Can't insolvent states simply cut expenditures to balance the profit and loss statement? The short answer is "not enough." Many current expenses (roads, education, the number of state employees, various forms of welfare, etc.) can be reduced. Painful? Sure. But doable if there's the political will.

Retiree benefits, however, are another matter. Retiree benefits come in two primary flavors: pension and health care. And both were and are locked in pursuant to collective bargaining agreements (read: contracts) over the course of many years. No more than the rest of us can states breach their contracts with impunity. Cutting contracted-for benefits would breach those contracts and the retirees would simply walk into court and sue (and win). A legal slam-dunk.

Can't a state simply pass a law "modifying" the earlier contracts? In short, no. Even though states are sorta' sovereign entities, buried in Article 1 of the Constitution of the United States is Section 10, Clause 1: "No State shall ... pass any ... law impairing the obligation of contracts ...." In other words, the legislative power of the states is limited (as indeed it should be).

Okay one might say, are these unamendable retiree benefits really a serious matter? Yes. Go here to read the Pew Center on the States Report titled "The Widening Gap Update." The subtitled says it all: "States are $1.38 Trillion Short in Funding Retirement Systems." Of course, that unfunded gap isn't spread evenly among the states; some are at or above the recommended 80% for retiree pensions (with North Carolina, South Dakota, Washington, and Wisconsin the "best of the best"). Others are woefully underfunded when it comes to pensions: Connecticut, Illinois, Kentucky, and Rhode Island (a total of 34 states are under the 80% recommendation).

The situation is more dire with regard to retiree health care obligations. Here Alaska and Arizona are the leaders (and Virginia is at least in decent shape). Seventeen states don't have a penny in reserve for these obligations. Thus is will be pay (and tax) as you go, unless folks whose taxes rise move to another state in which case the taxes on those who remain will go up even more.

States can either ride out their insolvency with a combination of cuts for future retirees, tax increases, spending cuts elsewhere, and pie-in-the sky-higher investment returns. Or, if Congress were to act, they could seek relief under the Bankruptcy Code and modify what they currently owe. The Constitution prohibits states from "impairing" contract but the same Constitution gives Congress the bankruptcy power which most definitely includes the power to impair contracts.

The current constituency for authorizing state bankruptcy proceedings is small. The states don't want to come clean about their situations and the labor organizations that represent (or represented) the retirees are deadest in their opposition. Keep kicking the can down the road is the typical attitude. But that response will last only so long before some states will find themselves over their own "fiscal cliff" and landing hard on the taxpayers below.

1 comment:

  1. Professor,
    Could the Federal government offer bailouts to the states, on the condition they revert back to territories for a time?

    It seems like that would solve several problems. California would receive a bailout and meet their obligations. America would benefit because we would lose 55 votes in the Electoral College, and it would be difficult for Democrats to win the White House.