ABSTRACT
The Brookings Institute projects that state and local revenues will decline $155 billion in 2020 (5.5%), $167 billion in 2021 (5.7%), and $145 billion in 2022 (4.7%).4 Dwindling revenues are insufficient to cover mounting costs, and budget shortfalls are mounting.5 The looming state economic crisis has spurred a debate about the proper federal response.6 One position, often represented by governors or Congressional Democrats, advocates for massive federal aid to distressed states.7 In talks regarding the second COVID-19 stimulus, for example, Democrats pushed for more than $900 billion in federal aid to states, reasoning that states are unable to cope independently with their financial troubles.8 Without federal funds, argue the proponents of federal assistance, states may collapse, bringing the nation's economy with them.9 The other position, often represented by congressional Republicans, objects to using federal funds for state bailouts.10 According to this view, states should handle their own finances, and federal funds should not be handed out to poorly-managed ("blue") states.11 In lieu of federal aid, a state bankruptcy solution is offered.12 Bankruptcy law, it is argued, can reduce the states' debt overhang and spread their losses among their creditors, obviating the need for federal funds.13 But both of the suggested federal responses, bankruptcy law and ex post federal aid, seem problematic. [...]states don't have the resources to finance their rising costs, and a state economic crisis develops. [...]opposite to the directives of standard economic theory, in times of recession states cut spending and investments, and these measures damage not only the distressed states, but also the national economy. [...]as emphasized by opponents of federal bailouts, federal aid creates moral hazard problems. if states know that the federal government will provide financial assistance when they fall on hard times, they have little motivation to save or follow prudent financial policies.17 Second, and no less importantly, the Article shows that because federal aid is provided through a political process, it is dispensed according to politicians' personal interests and not necessarily pursuant to the beneficiaries' financial needs.