How Would US States Actually Declare Bankruptcy?

Stephen Anderson, in his Mises Wire essays of February 1 and February 23, worries that some US states may be on the precipice of bankruptcy.

While a potential problem-especially in light of high debt levels among federal government, businesses, and consumers-possible state bankruptcies and defaults must be clarified before we conclude that state bankruptcies lie ahead. Mr. Anderson is correct that federal bankruptcy law does not allow states to declare bankruptcy.

According to the contracts clause of the US Constitution-Article 1, Section 10-states are barred from impairing the obligation of contracts, and the Supreme Court has interpreted this to mean that a state cannot refuse to meet its financial obligations to pay debt service just because it would prefer to spend the funds for some other public purpose.

Operating losses figure largely in the financial status of large states like California, which currently faces a projected 2024-25 operating budget deficit of $38 billion or $68 billion.

The state constitutions of nearly all US states cannot run operating deficits, so if facing operating deficits, they must either draw down available reserves, cut expenditures, or raise taxes.

The February 1 essay devotes several paragraphs to bond defaults in states such as Arkansas in 1933, possible upcoming defaults in Illinois and New Jersey, then pivots to the California budget deficit and spending trends in New York, Connecticut, and Michigan that could lead to "Future defaults and possible bankruptcy unless budget and policy reform is enacted." The February 23 essay presents further details of Arkansas's bond defaults, stating in its initial paragraph that "We might call a state government bond payment default a bankruptcy." These statements further conflate operating and capital budgets and expenditures.

Is Mr. Anderson suggesting that state governments may decide to use contractually obligated debt service funds for other general public purposes instead of honoring bond holders' promised interest and principal payments? If so, this would breach the US Constitution's contracts clause cited above, inviting legal action.

https://mises.org/mises-wire/how-would-us-states-actually-declare-bankruptcy