An Ex Ante Approach to Excessive State Debt

51 Pages Posted: 16 Aug 2013 Last revised: 8 Nov 2014

See all articles by Vincent S.J. Buccola

Vincent S.J. Buccola

University of Pennsylvania - The Wharton School - Legal Studies & Business Ethics Department

Date Written: January 29, 2014

Abstract

The recent recession has shone a very public spotlight on the perilous financial condition of many American states. At the same time, it has renewed academic interest in the question of excessive state debt — its causes and possible cures. Scholars who see risk externalization as a primary driver of systematic over-borrowing have proposed bankruptcy legislation for the states as one solution. Advocates argue that a formal debt-adjustment mechanism could reduce the appeal of federal bailouts and thereby curtail the moral hazard leading to excessive debt. But given the states’ unilateral power to set the terms of default, it is hard to see why an opportunistic state would be inclined voluntarily to invoke an ex post debt-adjustment mechanism — and indeed this Article shows that even under existing law states could effectively opt into Chapter 9 if they so desired. An ex ante approach is needed. This Article identifies one such approach, “tax-credit borrowing,” as an alternative solution, and argues that with minimal changes to federal tax policy it could reduce risk externalization more effectively than bankruptcy legislation can. The advantage of tax-credit borrowing in this context stems from its capacity to preclude default by toggling the plaintiff-defendant distinction that lies at the heart of modern sovereign-immunity doctrine. Without a credible threat of default, a state’s leverage in bailout negotiations and, with it, the concomitant moral hazard would be greatly reduced. But tax-credit borrowing would have important implications for state fiscal policy even if agency problems rather than risk externalization best explain state borrowing habits. This Article shows how the availability of risk-free debt could reduce borrowing costs and improve the monitoring of state political actors.

Keywords: State bankruptcy, Chapter 9, tax-credit borrowing, risk externalization, sorting

Suggested Citation

Buccola, Vincent S.J., An Ex Ante Approach to Excessive State Debt (January 29, 2014). 64 Duke Law Journal 235 (2014), Available at SSRN: https://ssrn.com/abstract=2296378 or http://dx.doi.org/10.2139/ssrn.2296378

Vincent S.J. Buccola (Contact Author)

University of Pennsylvania - The Wharton School - Legal Studies & Business Ethics Department ( email )

3730 Walnut Street
Suite 600
Philadelphia, PA 19104-6365
United States

HOME PAGE: http://lgst.wharton.upenn.edu/profile/buccola/

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